Editorial: China's analysis hard to fault

The past week’s decision by China’s State Council to set up a RMB40bn ($6.5bn) government venturing fund to back startups is a good opportunity to look both at the evolution in the country and in approaches to state-support venture capital.

It is nearly 30 years since China’s central government effectively set up the country’s first venture capital company.

The past week’s decision by China’s State Council to set up a RMB40bn ($6.5bn) government venturing fund to back startups is a good opportunity to look both at the evolution in the country and in approaches to state-support venture capital.

Back in 1986, China started its New Technology Venture Investment Corporation (CNTVIC), majority-owned by China’s State Science and Technology Commission and Ministry of Finance, in a model followed by local governments. CNTVIC was effectively an agency to support policy rather than a profit-oriented private enterprise, according to John Orcutt in his book, Shaping China’s Innovation Future.

This meant its preferential access to startups based in economic development zones were “far outweighed” by compromised investment decisions as CNTVIC and others focused on leaders’ interests, he added.

Lin Zhang’s excellent book, China’s Venture Capital Market, points out that CNTVIC’s collapse in 1998 with debts of RMB6bn followed its move away from venture investing in technology companies to real estate and public equities combined with poor corporate governance.

Similar problems affected other government-inspired venture funds as they failed to face competition from private investors until at least 1998’s reforms at the fourth meeting of the National Science and Technology Leaders team and the subsequent so-called “number one proposal”, Orcutt added. Foreign and domestic VC regulations were set out in statute in 2003 and 2006, respectively.

Since then, the venture industry has benefited from the creation of technology parks, more and more experienced entrepreneurs, more capital and more experienced VCs and the government has pushed from financial-led venture investing.

On funding, the government has continued to push market reforms and its own investments. Last month, regulators said they would allow insurance companies to invest their premiums in venture capital funds for the first time.

The Chinese government, including its various ministries and local provincial governments, have launched nearly 200 funds as of June 2014 to help drive policy priorities, according to data quoted by Chinese media reports.

This is a significant number out of a market that saw 83 funds set up, raising $6.76bn, in the first half of 2014, according to a research by Zero2IPO Capital, a service provider and investment institution in China's private equity industry quoted by Reuters.

The country now has 2,500 private equity managers oversee funds totalling Rmb1.2tn, according to Z-Ben Advisors, a consultancy, in an article by Financial Times.

What is more interesting is whether the scale of government activity might now start to be detrimental, a harder question to answer. In a 2011 paper, The Effects of Government-Sponsored Venture Capital: International Evidence, published by US-based National Bureau of Economic Research, the authors looked at exits from 21,852 enterprises based in 25 countries that received venture capital funding from 2000 to 2008 and found a little bit of government support appeared to raise investment returns, but too much government support – ie when they have actual control over business decisions - had the opposite effect.

One example of such a positive government venturing impact was Singapore state-backed TDF China fund, as part of the consortium led by investment bank Goldman Sachs, investing in the $5m series A round of China-based online retailer Alibaba in late 1999. This was 15 years before Alibaba’ss $25bn flotation on Nasdaq stock exchange valued it at more than $150bn. While TDF reinvested in the $82m D round in 2004, by September’s flotation, other state-backed agencies owned part of Alibaba.

Singapore state’s Temasek, which had been a limited partner in TDF China managed by Venture TDF, as well as government-owned China Investment Corporation (CIC) and Malaysia’s Khazanah, had invested in Alibaba. Temasek’s stake was undisclosed, CIC reportedly paid $2bn to acquire 5.6% in 2012, while, in its financial report for 2014, Khazanah said it had invested $400m in Alibaba in the previous two years, giving it a stake of 0.6% worth more than $1bn, according to a report in the Financial Times.

Given this type of success, it would appear both the venture industry and China’s entrepreneurs are already successful. In which case, why is its government preparing a fund that matches the total raised by all VCs in the first half of last year?

The answer is, for what on some measures might already be the world’s largest economy, its VC market is still relatively nascent compared to the US. Data from Thomson Reuters for the US National Venture Capital Association said $33.2bn was invested in 3,154 deals last year, with $23.8bn raised by 186 VC funds in the first nine months of the year.

By that standard, China has further to go. To continue its economic growth requires China finding ways to continue supporting entrepreneurs in nascent industries – the State Council called them “sunrise” – and governments rather than necessarily financial-only investors can encourage this through investing and providing incentives to have others do so, too. For its new $6.5bn fund, therefore, state investors will leave private investors with priority returns.

So, while China’s venture market development over 30 years has mirrored the rapid growth in its economy, it appears to think the job has only just begun. Looking at the success of Singapore state vehicles, the promise of future disruptive change and the US financial market depth means this subject is important enough to require a State Council decision. And while details on the new managers and terms of what it might replace or do in practice are unknown, its analysis is hard to disagree with.

See more from this Government Report: People's Republic of China


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