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Capital enters cautiously into small firms

By Jin Jing (China Daily)
Updated: 2008-04-21 14:06

As the launch of the growth enterprise board on the Shenzhen stock exchange approaches its final stage, venture capitalists are searching for golden opportunities among the many private-sector companies with big ideas but little funding.

In the past, most venture capitalists were interested only in companies that were already well established with a track record that can, with some adjustments, qualify them for a stock exchange listing. As always, venture capitalists not only consider profit growth but also exit potential that allows them to realize their gains.

With the new board, they look for the exit potential for smaller companies, or even start-ups. "The launch of the growth enterprise board will provide an exit channel for some venture capitalists and also help diversify mainland capital market," says Zhou Chunsheng, a professor from Cheung Kong Graduate School of Business.

Shi Yi, managing director of Lilly Asian Ventures, says that he views it as an attractive exit option for venture capital investment in China.

"We are excited with the upcoming launch of the growth enterprise board in China We are currently evaluating over a dozen projects, some of which will be ideal candidates for the growth enterprise board in the next few years," says Shi, who manages over $10 million venture capital in China.

Fifty-six venture capital funds have been set up in China, up 41.5 percent from 2006. The capital under management jumped 89.8 percent from 2006 to $8.41 billion in 2007, according to statistics from ChinaVenture Investment Consulting Co Ltd.

Domestic venture capital is also growing rapidly in the past years mainly because of the growth of the diversified capital market, including the growth enterprise board, says a recent report from ChinaVenture Investment.

The percentage of the number of domestic venture capital funds compared to all venture capital funds grew from 27 percent in 2006 to 43 percent in 2007,

"More and more companies will choose the domestic capital market after the growth enterprise board is set up," says Ni Zhengdong, CEO and president of Zero2IPO Group, a venture capital and private equity information provider.

There were 96 mainland companies, which launched initial public offerings in 2007, with investments by venture capitalists or private equity, up 134.1 percent from 2006. Among them, venture capital or private equity from 35 companies left the domestic capital market, up 250 percent from 2006, according to the statistics from ChinaVenture Investment.

To prevent the large sales that appeared after the growth enterprises were listed, "the China Securities Regulatory Commission can set one year line that restrict the time the old shareholders had to sell stocks," Chen Jianping, executive vice secretary general from Shanghai Venture Capital Association tells China Business Weekly.

In the suggestion letter Shanghai Venture Capital Association submitted to the CSRC on March 28, it says that the CSRC can also give listing priority to those companies that had received investments from professional institutional venture capital funds that will play an important role in the development of the companies after they are listed.

"It will encourage more professional venture capitals to invest in small companies before they are listed," says Chen.

CSRC also released a draft rule for IPO management on the growth enterprise board on March 21, and asked for public suggestions.

However, despite the enthusiasm by some venture capitalists, Chen says that "some venture capitalists' enthusiasm for the growth enterprise board is not as high as previously expected because of the seemingly not so sound profits they will get after the company is listed.

"This will still make some venture capitals stay away from the growth enterprises, even though they may get listed and make a profit," Chen adds.

In the draft rules released by China Securities Regulatory Commission on March 21, companies are required to post an annual revenue growth rate of no less than 30 percent for two consecutive years and an annual net profit of 5 million yuan.

The rules also say that the company's total equity capital should be no less than 30 million yuan after the IPO.

"The companies seem too small for many large venture capitalists, which usually expect much bigger earnings after the company is listed," says Chen, who had talked with many venture capitalists, stockbrokers and lawyers, after the CSRC released the draft rule.

In addition, the risks in investing in growth enterprises are higher compared with companies in an expansion stage.

Past experience shows that only around 30 to 40 percent of companies successfully grew through an early stage to enter a development or expansion stage, and only a portion of them will grow stronger.

And according to the latest report from ChinaVenture Investment, more venture capitalists are now transferring from investing in companies in their early stages to companies at the development or expansion stage.

In 2007, there are only 91 early-stage projects that had attracted venture capital, down 59.3 percent from 2006. Meanwhile, 142 expanding companies lured venture capital, up 132.8 percent from 2006, and the investment in developing companies was up 18.4 percent.

The Shanghai Venture Capital Association said in a suggestion letter that more rules should be established for the growth enterprises board in order to encourage venture capitalists to invest in early growth companies.

For example, "for those venture capitalists who entered the company two years ago, they can chose to exit before one year, which will encourage initial investments on those growth enterprises," says Chen.

"Companies just entering an expansion period have lots of uncertainties in areas such as corporate technology, products, marketing, earnings, operation and management," said in the suggestion letter.

"In order to ensure the steady development of the growth enterprise board, the number of listed companies should be strictly controlled to prevent someone committing fraud to seize money," says Chen. For example, Chen suggests that the number can be set at around 300 companies in the first year.