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The Status Quo, Problems and Development Trends of Private Equity in China


Chen Daofu

Private equity investment, which is called PE (Private Equity) for short, refers to a kind of investment into non-listed equity or non-publicly traded equity (private equity) of listed companies. Financial sources for private equity investment may either take public offering to raise funds from non-specified public, or take private placement (non-public offering) to raise funds from specific group, especially from those institutions and individuals who can identify and bear risks. Due to high risks and insufficient diclosure of information, private equity has long been collected through private placement. In recent years, in view of liquidity, transparency and raising funds, private equity investment funds listed on public market have increased. In China, private equity investment funds generally refer to those raised by private placement and invested in private equity. In a broad sense, private equity investment funds include venture capital investment, mergers & acquisitions, growth funds, real estate, infrastructure funds and private investment in public equity.

I. The Status Quo of the Development of Private Equity in China

In recent years, with the ever booming international PE market and huge returns from individual investment as well as the appreciation of China's stock market and real estate value, the demand for corporate restructuring and industrial upgrading gets strong and the development of PE is rather rapid. Generally speaking, there are four characteristics as follows.

1. Foreign investment PE plays an important role in China's PE market

In 2001 and 2002, the number of local venture capital (VC) institutions in China reached about 300, and this figure turned into 130 in 2005. During this period, the number of foreign-invested venture capital institutions was about 50 annually, which almost remained unchanged. But, there is a huge gap between the amount of funds held by local and foreign-invested venture capital institutions. In 2005, the 130 local venture capital institutions only held about US$470 million, but the 45 foreign-invested venture capital institutions held US$11.4 billion which is 20 times as much as local funds.

Speaking of the amount of investment, China's annual venture capital cases are around 200. In 2002, local venture capital institutions invested in 168 companies and invested US$190 million, but foreign-invested ones invested in 51 companies with an investment of US$200 million. In 2005, local venture capital invested in 83 companies, while foreign-invested ones invested in 126 companies, which exceeded the local venture capital companies. Changes for the amount of funds invested by local venture capital companies are not obvious and still remain at the level of US$160 million, however, foreign-invested venture capital investment had already reached US$730 million, nearly five times that of the local one's. Since 2006, the absolute superiority for foreign-invested venture capital has been further strengthened. In 2006, a total of 40 private equity funds were established in Chinese mainland and US$14.2 billion was raised. In the first quarter of 2007, another 17 PE to be invested in China mainland completed fund-raising of US$7.6 billion; in the second quarter, there were 15 PE that could make investment in mainland China and completed fund-raising with a total of US$5.79 billion.

2. A large number of PE enterprises go public overseas

IPO is the main withdrawal approach of China's PE. Since 2006, there have been 16 IPO withdrawal cases among 17 PE ones, accounting for 94.1%. In the first quarter of 2007, 9 PE enterprises listed successfully. In the second quarter, there were 19 withdrawal transactions, of which 16 ones were realized through IPO. From 2002 to 2005, enterprises withdrawing through IPO accounted for 80%, 79%, 72%, 68% and 64%, respectively. This shows that China's current PE focused more on the preliminary listing stage, so short-term interests still remains a very obvious driving force.

However, enterprises, such as Mengniu, Li Ning, eBay, Dangdang, SINA, Shengda, AsiaInfo, STP and Belle, choose overseas market (including Hong Kong) to get listed. According to incomplete figures, by the end of 2006, the number of Chinese enterprises listed overseas had reached more than 400, of which enterprises listed by red-chip mode take up over 80%. Among them, in 2005, a total of 81 companies got listed overseas, raising US$20.49 billion. In 2006, a total of 86 companies got listed overseas, raising US$44 billion.

3. Various financial institutions enter PE market

In recent years, driven by good performance of international and domestic PE, a variety of financial institutions have turned to PE market.

A large number of trust companies entered PE markets under the framework of capital trust scheme, and they will compete more positively in PE market especially due to the fact that the recent 200 contracts were revised to be qualified institutional investors without limitation on number and less than 50 qualified natural persons, meanwhile, restrictions for trust investment loans have been raised.

In addition to trust companies, security companies are also actively preparing for a direct equity investment. Goldman Sachs made a remarkable performance on investing in western mining industry. Domestic security traders also positively promote investment, expecting to utilize their own funds for direct equity investment as a subsidiary.

By virtue of “Views of the State Council on the Reform and Development of Insurance Industry”, insurance companies got qualified for “carrying out pilot projects concerning insurance funds investment in property assets and venture capital enterprises”. Although the Insurance Regulatory Commission is still relatively cautious on this issue, in fact there are no longer any legal restrictions.

China Development Bank actively participates in national-level PE, such as Sino-Swiss Partnership Fund, ASEAN-China Investment Fund and Sino-Belgian Equity Direct Investment Fund, Bohai Sea Industry Investment Fund, the recent Mandalin Fund and Sino-African Development Fund.

In short, various financial institutions in China, being as either administrators or fund holders, are actively entering PE market.

4. The enthusiasm of the local governments in PE market has been brought into full play

In January 2007, approved by the State Council, Bohai Sea Industry Investment Fund and Bohai Sea Industry Investment Fund Management Co., Ltd. with investment mainly in Tianjin Binhai New Area and the Bohai Sea Rim were established. The total amount of Bohai Sea Industry Investment Funds is RMB20 billion yuan, of which 6.08 billion yuan was raised in the initial stage. Influenced by the demonstration effect of Bohai Sea industry Fund, the initiative of governments of various regions are fully mobilized, which had led to the designing of their own industrial investment funds. In May, four industry funds including Guangdong Nuclear Power Fund, Shanxi Energy Fund, Shanghai Financial Fund and Sichuan Mianyang Hi-tech Fund, became the second pilot industry funds approved by the National Development and Reform Commission.

In addition,there emerged more PE investment in China's traditional sectors, thus, the size of a single investment has also been increased.

II. The Current Policies and Financial Background for PE Development in China

1. Amendment and implementation of Partnership Enterprise Law removes tax obstacles for PE development

The amended Partnership Business Law which was implemented in June this year has removed tax obstacles for PE development. The amended parts related to PE mainly focus on the following three aspects. Firstly, they include regulations of limited partnership and limited liability partnership; secondly, they allow legal persons or other organizations to be partners; thirdly, they make clear the collection rules for partnership income tax, which is designed in line with the principles that tax is paid by all its partners. On June 28, China's first venture capital enterprise organized in the form of limited partnership, South Sea Growth Venture Capital Limited Partnership Enterprise, was set up in Shenzhen. Its initial funds are all raised from private capital. The company will mainly invest in proposed enterprises listed in "The Development Plan for Innovative Enterprises” in Shenzhen. The investment ratio is not less than 50%.


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