Overview of China’s Venture Capital Industry

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China’s venture capital and private equity industry was until recentlydominated by foreign currency offshore funds run by internationalinvestors. However, in 2009 Chinese-yuan funds for the first time took thelead over foreign-currency funds in terms of amount of new capital raisedand number of deals. Domestic funds in China are smaller but nimbler asthey face fewer regulatory hurdles.

A total 428 VC investments in China were reported in 2009 according toChinaVenture, down 20% year-on-year. The total value of these dealsstood at USD $3.77 billion, down 24.8% year-on-year. The number andvalue of the 2009 deals were the second-highest on record after the peakresults posted for 2008.

The average size of the deals conducted in China by Chinese funds wasUSD $3.6 million in 2009 while foreign funds posted an average deal sizeof USD $18.1 million. The average size of deals for the whole country wasUSD $8.8 million in 2009, a slight decline from 2008, but up more thantwofold compared with 2002-2005.

The technology, media and telecommunications sectors account forroughly half of all deals. China displays the characteristics of an emergingmarket as the investments in all development-stage projects are morenumerous and represent a larger investment value than all expansion-,profitability- and early-stage deals combined.

Almost 3/4 of all VC deals occur in China’s coastal provinces, with thecities of Beijing and Shanghai alone accounting for over one-third in bothnumber of deals and invested value.

Global trends show that VC firms in China, India and Brazil are veryoptimistic about growth prospects in their home region. The number of VCfirms in these countries is expected to increase by 2015 and theopportunities that exist there are increasingly attracting the attention ofwestern and eastern funds alike.

1. Introduction to China’s VC industry

China’s venture capital and private equity (VC/PE) industry was untilrecently dominated by foreign currency offshore funds run by internationalinvestors. In recent years China has been relaxing restrictions in theprivate equity field and has since 2009 allowed foreign firms to raise fundsdenominated in Chinese yuan (RMB). In 2009 Chinese-yuan funds for thefirst time took the lead over foreign-currency funds in terms of amount ofnew capital raised and number of deals.

The year 2009 also marked the launch of China’s third stock exchange,ChiNext in Shenzhen, which provides an alternative exit for those PEacquisitions which are not sold on to a strategic investor.

Competition is increasing from the smaller but nimbler domestic fundswhich enjoy protection and encouragement from the Chinese government.The local funds are quicker to win deals due to fewer regulatoryconstraints. Restrictions on the size of stake purchases in Chinesecompanies to below the majority control threshold still exist for the yuandenominatedforeign-run funds.

Statistics for 2009 from ChinaVenture, a VC research and consulting firm,tell a story of a “Chinese David and western Goliath”:

  • 105 Chinese-yuan funds raised USD $12.3 bn in 2009
  • 19 foreign-currency funds raised USD $6.52 bn in 2009

An interesting characteristic of Chinese limited partners is the fact thatthey expect returns in three years, while investors in developed marketstypically sign up for up to a ten-year time horizon, according to the WallStreet Journal (Will Private Equity Play China Rules, May 29, 2010). Chinese investorsalso tend to expect to be more involved in investment decisions and theday-to-day management of the fund than western VC/PE firms are used to.

2. Number and value of VC deals in 2009 and Q22010

A total of 428 VC investments were disclosed in 2009, according toChinaVenture. This figure marks a 20% decline year-on-year, but is stillthe second highest number on record. The decline comes naturally as the2008 results came at the peak of the cycle, right before the global impactof the recession was felt.

The total amount of VC investments of USD 3.767 billion in 2009 wassimilarly 24.8% lower year-on-year but was still the second highestannual value on record (see graph).

As the quarterly graph below shows, a robust recovery in the VC industrywas underway in the second half of 2009. However, the trend was laterderailed by two important trends in the economy:

a) The on-going phasing-out of economic stimulus policies by theChinese government. This was recently underscored by a 25 basispoint interest-rate rise to check inflationary pressures resulting fromoverheating industries and the growth of real estate bubbles.

b) The crash of the domestic stock markets in 2008 and the timidrecent recovery of the Shanghai Stock Exchange Composite Index tolevels recorded in early 2007.

3. Average size of deals

The average deal size in China fell to USD $8.8 million in 2009, from USD$9.36 million in 2008. Still, the level in recent years has hovered aroundthe USD $8-$9 million mark, which shows a growing appetite for largerdeals by the funds. In comparison, the first half of the decade sawaverage deal sizes of around USD $3-$5 million.

Quarterly statistics until the second half of 2010 roughly follow the annualtrend, except for a few large deals which skew the statistics for the firstmonths of the year.

4. Breakdown by Industry (tech, media,telecoms vs. traditional)

The IT industry (mostly hardware and software) led in terms of numberof deals in 2009 with 75 purchases worth USD $706 million and anaverage amount of USD $9.4 million per deal. However, the IT sectorwas outpaced by the Internet sector in terms of value and deal size, asthe 65 Internet deals were worth USD $948 million in 2009 and had anaverage value of USD $14.6 million per deal.

Overall, the Technology-Media-Telecoms (TMT) sectors in Chinaattracted 44% of all deals and 51% of the invested value in 2009.

The share of TMT deals as a percent of the whole number of deals hasdeclined since 2006. However, the larger value of individual TMT deals in2009 makes the decline in value smaller than the decline in number.

A breakdown of all sectors and detailed figures for 2009 and Q2-2010 areavailable in the appendices.

5. Breakdown by stage (development, expansion,profitability)

Out of all 428 VC deals struck in China in 2009, 243 deals worth USD$2.453 billion were in development-stage companies/projects, accountingfor 57% of the number and 65% of the invested amount for the year. Thisis typical of emerging markets where development- and expansion-stagedeals vastly outnumber profitability-stage deals.

6. Breakdown by round (A,B,C,D,E)

The vast majority of deals in 2009 were A-round deals, that is these werethe first VC investment in the given company. A-round deals accounted for71% of the number and 63% of the value for the year.

7. Breakdown by geographical region

There are no surprises here: the developed coastal provinces of Chinaaccount for well over 2/3 of all VC activity. Beijing, the Yangtze RiverDelta around Shanghai (including Jiangsu and Zhejiang provinces) and thePearl River Delta (excluding Hong Kong in this report, but includingShenzhen and all of Guangdong province) led the way in 2009. The onlynon-coastal areas to find a place in the top ranking were the east-centralpopulous provinces of Hubei and Hunan.

8. Breakdown by source of funding (Chinese,foreign, joint-venture)

Chinese institutions were more active in the number of deals in 2009 forthe first time, clinching 267 deals worth USD $949 million, but theaverage investment amounts were fivefold smaller than the average forthe foreign-funded deals.

The decline in the number of foreign-funded deals comes in stark contrastto the relatively constant share of overall investments. This shows that thenimbler Chinese funds have entered the market with an increasingnumber of smaller deals while foreign funds have maintained a focus onlarge-value acquisitions.

9. Global Trends in PE/VC in the West

The 2010 Global Venture Capital Survey 2 of Deloitte and theNational Venture Capital Association (NVCA) projects a lacklusterperformance for the VC industry in the West. The survey, which measuresthe opinions of over 500 venture capitalists worldwide, shows that 92% ofUS VC firms expect the number of venture firms in the States to fall in thenext five years. Respondents in France (83%), Israel (80%), the UK (70%)and Canada also expect a similar outcome for their countries by 2015.

The main reasons for the lack of optimism among US venture capitalists isthe weak IPO market and difficult exits in recent years (88% ofrespondents), unfavourable tax policies (59%) and the unstable USregulatory environment (53%).

A total of 56% of US VCs expect that their limited partners will be lesswilling to invest in US venture capital funds in the future. The sameexpectations about investing in their home country are shared by 89% ofrespondents in France, 61% in the UK, and 44% in Germany.

10. Global Trends in PE/VC in Emerging Markets

In stark contrast to the gloomy sentiment of western VC firms, investorsin the rapidly growing emerging economies of Asia and Latin America aremarkedly optimistic about their markets, according to the 2010 GlobalVenture Capital Survey of Deloitte and NVCA.

A vast majority of venture capitalists in China, India and Brazil expect thenumber of venture firms in their country to grow: 99% of respondents inChina, 97% in Brazil and 85% in India.Yet, 62% of respondents in China point out that the unstable regulatoryenvironment in the country may present a challenge.
Emerging market VCs are also becoming more inward-looking as theinvestment opportunities within their countries become more and morenumerous. Only 34% of all respondents expect to increase theirinvestment activity outside their own country in the future, but the figurefor the BRIC countries is three times lower than the average for developedeconomies: 11% in China, 15% in India and 19% in Brazil, as opposed to49% in the UK, 50% in Israel and 56% in France.

The limited partners of emerging market VCs are showing distinctoptimism about their home countries and a willingness to investdomestically: 92% of respondents in Brazil, 91% in China and 76 % inIndia.

11. Conclusion

The 2010 VC survey of Deloitte and NVCA confirms the overall trend thatinvestment opportunities are moving from North & West to South & East.The robust growth of China, India and Brazil, even though some of it iscatch-up growth resulting from a lower starting point, shows that the centre of gravity of global capital markets and the entire world economicorder are shifting. Positive demographic trends in India and Brazil, soundmacroeconomic policies in China and an abundance of natural resources inBrazil (and Russia) augur well for the development of the BRIC economies.

The BRICs are already establishing their role and gaining confidence in theVC industry, but they will continue to rely for decades on the West’s“mortar”, in the form of capital and expertise. Thus, western VCs will keepproviding structure and knowledge to this mutually beneficial BRIC-andmortarmodel in which opportunities lie in the East while expertise comesfrom the West.

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About Merar

Merar Investment Network (www.merar.com) is a global web-basedinvestment network focused on the emerging markets of Asia, Central andEastern Europe and Africa. Merar operates in English, Russian, Chineseand Turkish and helps investors establish the initial contact withentrepreneurs in need of capital.

The web-based platform serves as the meeting place where VC/PE funds,investment intermediaries, angels and strategic investors from across theworld find emerging-market projects, entrepreneurs and companies inwhich to invest. Merar is a membership service.

About the author

George Iliev is the China Business Development Manager of MerarInvestment Network. He speaks Mandarin Chinese and holds an MBAdegree from Emory University (Atlanta), where he attended on a Fulbrightscholarship awarded by the US State Department. He also has a master’sdegree on China from the London School of Economics and a bachelor’sdegree in Chinese Studies from Sofia University.

Before joining Merar, George was the Managing Editor of a Chinesebusiness news service published on Reuters Business Briefing andFactiva/Dow Jones. He has also taught Economy of China at SofiaUniversity and attended an MBA semester at the Hong Kong University ofScience and Technology.


Merar Investment Network would like to extend its special gratitude to ChinaVenture (www.chinaventure.com.cn) for all statistical and graphicaldata used in this report.


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