By Wang Xu (China Daily)
Updated: 2007-09-06 06:26

Neil Shen (left), founder and managing partner of Sequoia China, Tim Gong (right), partner of Susquehanna Investment Group LLP, and Liao Changguang, chairman of Chongqing Little Swan hotpot restaurant chain, at the signing ceremony where the first two invested into the latter. Chinafotopress

A bullish stock market combined with overseas listing constraints and investment difficulties are enough to convince foreign venture capital firms in China that it's time to start setting up renminbi funds.

"We are now helping three foreign venture capital firms to establish renminbi funds," says Li Ying, a partner at HellerEhrman LLP. The US law firm set up a Beijing office in 2004 and has helped clients such as CID Greater China Venture Capital Fund II and TDF Capital China II in their fund formation.

Foreign venture firms, so far the dominant players in China's venture capital arena, used to raise funds mainly from overseas investors using dollar-denominated funds to invest in Chinese companies. But while they allowed firms to tap the global capital market, the funds also ran into investment difficulties in China because of the inconvertible renminbi and regulatory hurdles.

In the first half of 2007, venture investors spent more than $2.36 billion on stakes in local companies. But only 7.7 percent of the investments were made by renminbi funds, most of which were from local venture capital firms.

In recent years, a handful of overseas venture firms such as Sequoia Capital and SAIF partners have set up trial renminbi funds with local partners.

Sequoia Capital China, which has about $1 billion under management, is preparing to establish a renminbi fund with Shenzhen Capital Group Co Ltd, according to the Asia Venture Capital Journal.

In 2005, SAIF Partners, a China-savvy venture capital firm, established its first renminbi fund with Tianjin Venture Capital Co Ltd, a government-backed local venture firm.

Foreign venture firms must find a local partner to establish a renminbi fund under the current rules. And local and central governments, eager to explore new ways to finance domestic start-ups, are expected to play an important role in those renminbi funds. Some analysts say government investment institutions could become the "funders of funds".

"We are in talks with a number of foreign players for setting up renminbi funds," says Hu Bin, a senior official at the Investment Banking Department under the China Development Bank. According to Hu, the lender has invested more than 3 billion yuan in homegrown venture capital firms in recent years.

Local governments have already set up several bodies to invest in venture capital firms. For example, Shanghai's Pudong New Area has earmarked 1 billion yuan to invest in venture capital firms.

Beijing's Zhongguancun Science and Technology Park also established a similar fund of 165 million yuan.

"A renminbi fund could be the choice for venture firms trying to use China's stock market as an exit channel," says Guo Dehong, managing director of Orchid Asia Group Management Ltd. "The high price- earnings (PE) ratio in local bourses is very attractive now."

The mainland's stock market, after a decade of sluggish performance, has more than doubled over the past two years, pushing the PE ratio of local shares up more than 30 times, much higher than stock exchanges in Hong Kong and the United States.

The bullish market, accompanied by the government's move to float non-tradable shares, has helped some local venture capital companies to reap good returns from their investments in local firms.

Shenzhen Fortune Venture Capital Co Ltd, a local investor, has raked in a return 40 times its investment in Coship Electronics Co Ltd, a Shenzhen-based producer of digital TV receivers and set-top boxes.

Fortune Venture Capital paid 930,000 yuan in 2001 to buy 10 percent of Coship, which held a share offering on Shenzhen's small- and medium-sized enterprise board last year.

"There are still some concerns about establishing renminbi funds, such as the three-year lock-in period, double-taxation and uncertainties in the listing process," says Chen Hao, managing director of Legend Capital.

Local companies must remain profitable for three straight years before they can hold a share sale, compared with no requirement on profitability history on the NASDAQ, analysts say.

And venture investors must wait three years after a portfolio company holds its initial public offering on a mainland stock exchange before they can sell their stake in the firm.

"Double taxation is another concern about setting up renminbi funds," says Huang Ping, a partner at Softbank China Venture Capital. "The new Partnership Enterprise Law still leaves uncertainties over the double taxation issue."

China's Company Law introduced in 2005 and the new Partnership Law conform to international standards.

The country revised its Partnership Enterprise Law last year and now allows alternative financing and investment structures such as onshore limited partnerships.

The revision is expected to boost the number of renminbi funds in China with the introduction of a limited and general partner concept, a common practice in overseas venture capital markets.

But whether limited partners will be taxed on their investment returns is unclear, say industry insiders.

"There will be more trial renminbi funds set up," says Gavin Ni, CEO of Zero2IPO Group, a Beijing-based consultancy focusing on venture capital in China. "But it will take a while for overseas investors to become familiar with the procedures - from fundraising to the listing process."

(China Daily 09/06/2007 page58)