Venture capital (VC) in China has grown enormously since its establishment in the mid-1980s such that the level of VC investing is now second only to the USA. Dr. Keith Arundale, the author of Venture Capital Performance: A Comparative Study of Investment Practices in Europe and the USA (2019, Routledge), and his colleague, Dr. Ying Zhao, have set out to explore Chinese VCs in depth. During the period July 2020 to April 2021, the researchers conducted qualitative interviews with 10 investment executives from 9 VC firms in China and with 7 other stakeholders. Discussions were also held with 12 other individuals who are knowledgeable about the Chinese VC sector, including investors, academics, and data providers. Preliminary findings from this ongoing study are captured below.
Structural aspects – Chinese VCs are from a variety of backgrounds
The predominant source of funding for the Chinese VC firms included in the study was from the local and central governments, although some VCs were raising US $ funds with foreign capital from independent sources. RMB funds are typically smaller than US$ funds. The typical life of a Chinese VC fund is 7 years with extensions of up to 2 years compared to the norm of 10 years plus 2 years in Europe and the USA.
Investment partners working at Chinese VC firms come from a variety of backgrounds, including finance and investment, operational often from working with large technology companies, and entrepreneurial, much the same as the US firms in the earlier study where proportionately more partners with operational and, to a lesser extent, entrepreneurial backgrounds were engaged than was the case with European firms.
The precise sectors that the more established VCs invest in China are often determined through relationships and specific sector focus may arise as a result of trial and error in seeing which sectors result in better returns, or by simply following the trend: “Chinese talk sector focus but get seduced by deals to make a quick return and go off in different directions” (Note: comments included in italics throughout are verbatim from those interviewed).
Operational aspects – the Government may get involved in approving investments
Government RMB funds adopted a lower risk investment strategy than US$ funds which is reflected in their investing in later-stage companies: “It’s a big deal when government money is at risk”. This contrasts with US VCs in Keith’s earlier study who pursued a higher risk “1 in 10” (home run) investment strategy. The perceived reluctance of government-backed funds to invest in early-stage companies as evidenced in this study is in contrast to the government’s pivotal role in financing new ventures in the 1970s and 1980s prior to the VC industry being established.
Deals at Chinese VC firms were found through the partners’ personal networks and the strong relationships that they have developed with advisors and other contacts through “guanxi”. European VCs are largely proactive in sourcing deals whereas US VCs have traditionally relied more on their branding and profile in the marketplace to attract entrepreneurs.
Investment committees to approve investments were comprised not only of investment partners but also anchor limited partners and municipal government representatives, with the latter having votes and even veto rights in some instances. The majority vote tends to prevail but a senior person may be the ultimate decision-maker, similar perhaps to the practice of senior partners in some US VC firms being able to railroad deals through the investment committee.
Chinese VC terms can be onerous on entrepreneurs
Investment terms used by Chinese VC firms were considerably more “investor-friendly” than either European or US VCs with the Chinese enforcing what could be seen as onerous term sheet clauses on their investee companies. These included negative ratchets, common with state-owned funds, and if management teams fail to make their revenue or profits targets they might even have to pay cash or equity compensation to the VC: “Chinese investment terms are the most strict investment terms I have ever seen compared to the US and the UK”.
In terms of monitoring post-investment, this can be quite informal in China, with calls and social events more of the basis for keeping in touch with portfolio company performance rather than necessarily attending board meetings and reviewing reporting packs as would be the case in Europe and USA. Periodic portfolio reviews are however carried out formally often on a quarterly basis.
Value-adding activity is largely through leveraging contacts for the benefit of portfolio companies through the VC’s personal network and guanxi, much as is the case in Europe and USA. Foreign investors in China are seen as weak in terms of adding value to their portfolios as they do not have “the right relationships”.
Chinese VCs like quick exits: “so people normally want to see the outcome very quickly”. IPOs are currently the most popular exit route, following the establishment of the new Shanghai and Shenzhen stock exchanges STAR market for technology stocks. Sale to large corporates, or to state-owned enterprises through guanxi connections, is the main alternative exit route.
Wider environmental aspects – trust and relationships “guanxi” are all important
Chinese investors and their portfolio companies exhibit a pragmatic, “get up and go” approach, perhaps similar in some ways to the drive, ambition and “thinking big” approach demonstrated by US VCs, more so than European VCs. Chinese VCs are looking to make the best returns as quickly as possible. Trust and relationships are very important in the Chinese culture: “The good old boys network”. VCs in China, place great emphasis on the honesty, social networks and guanxi of the entrepreneur.
Whilst there are an ever-increasing number of technology clusters in various regions in China, often supported with substantial funding from the government, over 80% of the top 75 VC firms by AUM are headquartered in the main centres of Beijing, Shanghai and Shenzhen (cvsource.com.cn) unlike the specific technology region of Silicon Valley in the USA where VC firms proliferate:“They fly everywhere so most of them are still based in major cities”.
The findings are part of an ongoing effort by Dr. Keith Arundale and Dr. Ying Zhao.
These preliminary findings have been presented to the ISBE Conference in Cardiff in October 2021 and at the Global Corporate Venturing Symposium held in London in May 2022. As the sample size is increased through the planned cooperation with a Chinese university the above differences between the structural, operational and wider environmental aspects of VCs in China and those in Europe and USA will be confirmed and differences between the different types of VC firms in China (government-backed, independent and foreign-owned) will be investigated.
About the authors:
Dr. Keith Arundale is a Senior Visiting Fellow at the ICMA Centre, Henley Business School and Dr. Ying Zhao is a Lecturer in Business Management at the University of Chester Business School.
Keith and Ying would welcome hearing from any London Business School alumni who either invest in China or have contacts with Chinese VC firms who might be willing to be interviewed for this study on a completely confidential basis. They can be contacted by email at email@example.com.
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