Risk and Reward

Changing perceptions

At the same time, experts say the PE and VC market in China is still in an evolutionary phase and needs more time to evolve cohesively. They point out that PE and VC investment debuted in China only during the late 1990s with the entry of US-based PE firms such as IDG, Sequoia and KPCB.

With favorable returns and a sound investment environment, China soon emerged as the most promising market for an increasing number of PE and VC investors across the world. Both foreign investors and their Chinese counterparts showed keen interest in industries that were in line with the country's sustainable development principles, such as retail, healthcare, telecommunications technologies and alternative and renewable energy.

Further impetus for the industry came after local governments vied with each other to issue favorable regulations, even as large Chinese companies started setting up such funds.

But that also led to an alarming rise of individual investors, usually entrepreneurs who had sold their businesses and teamed up with people in the same position to form investment companies. There were no entry barriers in the industry. Even a coalmine owner with a net worth of 50 million yuan could enter the market to cash in on what was increasingly being described as the "national PE and VC craze".

"Gone are those heady days and it appears that the industry is heading for a consolidation phase," says Gavin Ni, founder and president of Zero2IPO Group.

Ni says he himself has experienced the ups and downs of the PE and VC industry. When he set up the Zero2IPO Group in 1999, very few were confident about the prospects for an industry that was regarded more as "suitcase companies".

But the industry and a burgeoning market grew. In 2010 there were 167 registered foreign managers of PE funds in China and 265 domestic players, says a report from Asia Private Equity Research.

Richard Lumb, chief executive of Accenture's financial services group, says if one were to regard the US or European PE and VC industry as adults, then China's is still in its "baby" phase and has lots of opportunity for further growth.

He says that factors, such as privatization of industry, strong GDP growth, high number of investors and a decent IPO market, have transformed the PE industry in China into the largest and fastest growing emerging sector in the world.

"Yet it is still very small when compared with the almost $2 trillion global PE market, given the relative size of China's economy," Lumb said, on a recent visit to his company's Beijing office in the World Financial Center.

Lumb admits that in the short term the PE and VC market in China faces the same opportunities and challenges as the rest of the world. The opportunity is the relative small size of the sector to China's economy, and the challenges include the lack of supply of cheap credit, a key stimulator for the growth of the sector, and the lack of exit options for existing PE and VC investors.

"The market is a baby, not in terms of ability, but in terms of size. It is normal that every baby will face some challenges in the process of growing up. I think China's VC and PE industries will catch up with that in the US in three to five years," says Lumb, who has been in the financial industry for about 18 years.

Sushil Saluja, managing director of financial services at the Asia-Pacific division of Accenture, says that SMEs are suffering from a funding shortage in China as banks are more cautious about lending to them. Saluja feels that the PE and VC funds can ideally fill this gap.

"Besides banks, various financial institutions such as PE and VC funds will play a more and more important role for China to build a comprehensive and complete financial system," he says.