The Lack of Efficient Exit Channels for Chinese Domestic VCs

Zhang, Lin

doi:10.1007/978-1-4614-1281-6_5

Lin Zhang²

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Abstract

Chapter 4 has analyzed the shortage of incentive mechanisms in the operation of Chinese domestic VCs in comparison with their American competitors. More importantly, on the basis of this analysis, the hypothesis that the underdevelopment of incentive suffered by Chinese domestic VCs is closely linked to the institutional barriers imposed by the control-based model of Chinese state-controlled listed companies has been demonstrated. Following Chapter 4, this chapter explores the last section of the whole cycle of VC - its exit from successful portfolio companies.¹ Prior to making a performance comparison between American VCs and their Chinese counterparts in this aspect, it is essential to answer two relevant questions. First, why does a VC need to exit from successful venture enterprises? Second, what is the optimal exit channel for the principal participants of successful ventures? As for the fi rst question, Bernard Black and Ronald Gilson have made a plausible explanation through the two dimensions below.² First of all, the economies of scope between fi nancial contributions and non-fi nancial ones supplied by VCs for portfolio companies require its exit.³ Practically, venture capitalists provide both capital and non-capital inputs for their portfolio companies.⁴ The non-capital inputs, such as management assistance and reputational capital, are especially valuable to start-up companies.⁵

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Notes

1.
The reason for the author’s focus on successful ventures is that they can add value to the entire VC industry as opposed to the value-loss effect of failed ones.
2.
See footnote 39, pp 252–257, Chapter 1.
3.
Ibid., p 255.
4.
Barry CB (1994) New direction in research on venture capital finance. J Financ Manag 23:3–15.
5.
Ibid.
6.
See footnote 39, p 255, Chapter 1.
7.
Ibid.
8.
Ibid.
9.
Ibid.
10.
Ibid.
11.
Ibid.
12.
See footnote 38, p 1092, Chapter 1.
13.
Salhman WA (1990) The structure and governance of venture capital organizations. J Financ Econ 27:473–522. In this article, Salhman pointed out that one-third of venture capital investment ends in losses.
14.
See footnote 39, p 259, Chapter 1.
15.
Hellmann T (1998) The allocation of control rights in venture capital contracts. Rand J Econ 29:57–76.
16.
See footnote 39, p 259, Chapter 1.
17.
Ibid.
18.
Yu G (2002) The policy implication of comparative studies on venture capital markets. Jurists Rev 4:14.
19.
Ibid.
20.
See footnote 33, p 887, Chapter 1.
21.
See footnote 18 above.
22.
Ibid.
23.
See footnote 18 above, p 15.
24.
Ibid.
25.
See China Venture Capital Research Institute Limited (2007) China venture capital yearbook (2007). Democracy and Construction Press, Beijing, p 263.
26.
Ibid.
27.
See footnote 18 above, p 15.
28.
Ibid.
29.
See footnote 39, pp 257–264, Chapter 1.
30.
Xin S (2008) NASDAQ: the model of growth enterprise markets. Shenzhen Stock Exchange 1:62.
31.
See footnote 6, Chapter 4.
32.
See footnote 13, Chapter 4.
33.
Currently, the NASDAQ consists of the NASDAQ Global Select Market, the NASDAQ Global Market and the NASDAQ Capital Market. The NASDAQ Capital Market aims to provide listing services for small- and medium-sized enterprises, especially those in the high-technology field. http://www.nasdaq.com/about/nasdaq_listing_req_fees.pdf. Accessed 13 Oct 2009.
34.
Ibid. Even though they are updated from time to time by the NASDAQ, those rules always match the features of small-scale enterprises.
35.
Ibid.
36.
Pursuant to the Securities Exchange Act of 1934, “if the exchange authorities certify to the Commission (the SEC) that the security has been approved by the exchange for listing and registration, the registration shall become effective 30 days after the receipt of such certification by the Commission (the SEC) or within such shorter period of time as the Commission may determine”.
37.
See footnote 30 above.
38.
http://en.wikipedia.org/wiki/Dot-com_bubble. Accessed 14 Oct 2009.
39.
Ibid.
40.
From the author’s point of view, the dot-com bubble reflected the shortcomings of continuous listing regulation by the NASDAQ.
41.
As analyzed in Chapter 3, the funds of American VCs operating in China are principally in the form of US dollars. Therefore, after harvesting, American VCs must provide returns to their VC investors in the form of US dollars as well. If their portfolio companies are listed on Chinese stock markets, American VCs can only obtain RMB by selling their shares in the secondary market. Then, they need to convert RMB to US dollars and transfer it to their VC investors outside China. However, China always adopts stringent policies regarding foreign currency exchange and transfer. Hence, in order to avoid the potential hassles caused by Chinese foreign currency policy, American VCs generally choose to list their successful portfolio companies on overseas GEMs located in jurisdictions with free and flexible policies concerning foreign currency exchange and transfer. See China Venture Capital Research Institute Limited (2006) China venture capital yearbook (2006). Democracy and Construction Press, Beijing, p 371.
42.
Without using SPVs, Chinese domestic companies must file an application to be listed on overseas stock markets with the CSRC. See “Notice regarding the overseas listings of Chinese domestic enterprises” promulgated by the CSRC on the 14th April 1999. http://vip.chinalawinfo.com/NewLaw2002/SLC/slc.asp?db=chl&gid=23191. Accessed 8 Nov 2009.
43.
For an overview of the SPV model used by American VCs in China, please visit http://finance.sina.com.cn/stock/blank/hcsscq.shtml. Accessed 8 Nov 2009.
44.
Ibid.
45.
Ibid.
46.
Ibid.
47.
http://news.xinhuanet.com/fortune/2006-08/10/content_4944032.htm. Accessed 8 Nov 2009.
48.
Ibid., the Article 11.
49.
Wu L (2007) A primary analysis on the red chip model. Hebei Enterprises 2:56.
50.
See footnote 47 above.
51.
See footnote 49 above, pp 55–56. In practice, the approval of the incorporation of foreign-invested companies is a routine administrative issue for Chinese governments. So, it is much easier than the approval of the takeover by SPVs from the Ministry of Commerce.
52.
Sino-manager Online (2009) The mystery of Zhongwang’s IPO. http://www.sino-manager.com/200987_7517.html. Accessed 8 Nov 2009.
53.
Interview with the venture capitalist of the provincial GVC. In 2004, the State Council promulgated the document entitled “Suggestion on the reform and development of domestic financial markets”. http://www1.peopledaily.com.cn/GB/jingji/1037/2314920.html. Accessed 10 Nov 2009.
54.
Interview with the venture capitalist of the provincial GVC. For example, Putian municipal government explicitly holds this view in its document entitled “Suggestion of Putian municipal government on fully taking advantage of capital markets to boost the development of economy”. http://big5.putian.gov.cn/a/20081113/10871.html. Accessed 10 Nov 2009.
55.
Interview with the venture capitalist of the provincial GVC.
56.
Financial Times (2009) Chinese domestic VCs are hopefully catching up with the GEM. http://cnstock.xinhuanet.com/08zhongguorz/2009-04/29/content_4251328_3.htm. Accessed 10 Nov 2009.
57.
Ibid.
58.
People’s Daily (2009) GEM: promoting innovation and serving economic development. http://big5.xinhuanet.com/gate/big5/news.xinhuanet.com/fortune/2009-10/23/content_12304608.htm. Accessed 4 Dec 2009.
59.
See footnote 1, Chapter 2.
60.
In 1988, the amendment of the Constitution of the PRC officially recognized the legitimate status of private-owned economies.
61.
Theoretically, listing standards should also have been discussed here as a tactic to protect the interests of SOEs like listing approval policies. But in practice, for the sake of superficial equality, the listing standards of the Chinese main boards are not able to play that role. Therefore, the author ignores it in this chapter.
62.
Sun R (2009) Thinking about the Chinese stock issuance system. Internet Fortune 4:58.
63.
Ibid.
64.
Ibid.
65.
Geng Z (2007) The internal mechanism underlying the evolution of Chinese stock issuance systems. J ZhengZhou Univ 40:76.
66.
Here, the incentives resulting from the control-based model include but are not limited to the better implementation of government policies, the increase of political achievements and the satisfaction of private interests.
67.
See footnote 65 above.
68.
Dai G (2008) Exploring the approval systems of stock issuance. Spec Zone Econ 8:36.
69.
Ibid.
70.
Ibid.
71.
Ibid.
72.
Ibid.
73.
See footnote 62 above.
74.
See footnote 68 above.
75.
See footnote 66 above. After the CSRC receives the requisite documents from candidate companies, it needs to solicit the advice from provincial governments where those companies are located. Thus, to a large degree, this procedure indirectly maintains the practice that local governments select listed companies. http://www.csrc.gov.cn/n575458/n870705/n1333591/11360537.html. Accessed 4 Dec 2009.
76.
See Table 2.1.
77.
Interview with the venture capitalist of the GVC.
78.
See China Venture Capital Research Institute Limited (2007) China venture capital yearbook (2007). Democracy and Construction Press, Beijing, p 274; Ceocio Online (2009) The sports meeting of listing. http://www.ceocio.com.cn/12/93/124/312/24512.html. Accessed 4 Dec 2009.
79.
Shenzhen Stock Exchange (2009) The implementation plan of the Shenzhen stock exchange regarding the establishment of the SME Board. http://www.szse.cn/main/sme/sczy/ywgz/200405255828.shtml. Accessed 15 Dec 2009.
80.
See footnote 53 above.
81.
More than 80% of listed companies on the SME Board are privately held ones. See China Venture Capital Research Institute Limited (2008) China venture capital yearbook (2008). Democracy and Construction Press, Beijing, p 362.
82.
Ibid.
83.
Ibid., p 377.
84.
Article 33 of “Provisional administration method regarding listing stocks by means of initial public offerings”. http://www.gov.cn/ziliao/flfg/2006-05/18/content_283660.htm. Accessed 15 Dec 2009.
85.
Ibid.
86.
Ibid.
87.
Ibid.
88.
Article 2 of the Company Law 2006.
89.
The CSRC (2009) Notice regarding the pilot reform of equity division. http://big5.csrc.gov.cn/SuniT/www.csrc.gov.cn/n575458/n776436/n804935/n2466682/2652975.html. Accessed 15 Dec 2009.
90.
Ibid.
91.
See footnote 84 above.
92.
http://finance.sina.com.cn/stock/opengem/index.shtml. Accessed 15 Dec 2009.
93.
See footnote 23, p 210, Chapter 4.
94.
http://www.nbd.com.cn/newshtml/20091030/20091030024557388.html. Accessed 15 Dec 2009.
95.
Beijing Newspaper (2009) Many VCs hastily approached Huaqi digital right after its application for being listed on the GEM. http://it.people.com.cn/GB/9335395.html. Accessed 15 Dec 2009.
96.
Although the accurate number of VC-backed companies which are eligible for listing on the GEM cannot be obtained, there is enough reason to believe that this number must be larger than seven. Therefore, many authentic VC-backed companies which are qualified for being floated on the GEM have not obtained this kind of opportunity.

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College of Humanities and Law, Shandong University of Science and Technology, Qingdao, Shandong, China
Lin Zhang

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Zhang, L. (2012). The Lack of Efficient Exit Channels for Chinese Domestic VCs. In: Venture Capital and the Corporate Governance of Chinese Listed Companies. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-1281-6_5

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DOI: https://doi.org/10.1007/978-1-4614-1281-6_5
Published: 29 August 2011
Publisher Name: Springer, New York, NY
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