Guo Lihong

In our discussion about the mechanism for venture capital, we have put our emphasis of study on policy measures.

I. The mechanism for the formation of venture capital

The formation of venture capital and the emergence of venture capital companies are related and linked each other in many aspects. Since fund-raising for venture capital and its operation are now carried out in China by the same company under the company system in most cases, the two issues just mentioned have become even more inseparable one from the other. Capital and company, however, stay at different layers after all, and venture capital companies are companies that manage venture capital. As the situation stands, we will discuss the two issues separately in our study.

1. Source of venture capital

In the United States, venture capital makes up 30 per cent of the private capital market, while the private capital market takes up only a small share of the capital market as a whole. Let us have a look at the distribution of the sources of venture capital in the United States. During a period of 10 years, the proportions taken up by individuals and families have come down from the top to the bottom, while pension funds have risen from the fourth place to the top. Such a change of order shows that the first to enter the venture industry is inevitably the surplus private capital that is most adventurous. Pension funds, which give top consideration to safety, will come up from behind only when an industry has gradually grown mature.

When we talk about the situation in China, it is necessary to notice that both pension funds and insurance funds in our country are State-owned, and the government can not but be held liable for them in a related way. For this reason, these funds can operate at present only at the State bonds market which involves the smallest risks. It is only recently that they have tried to enter the stock exchange. If they are expected to play a leading role as those in the US venture capital market, at least one of the following preconditions is necessary: either these non-banking financial institutions are open to the general public, or the managers of these institutions can achieve success at the stock exchange or in company bonds which involve comparatively small risks. None of them can be expected in the coming three to five years.

The Financial and Economic Committee of the National People's Congress has now started drafting of the Law on Investment Funds and will try to promulgate it before the conclusion of the term of the Ninth National People's Congress. To be included in this law will be legal standards on venture funds and their management. Once established legally, venture funds composed of mainly private and company capital may come into being. Even by that time, however, it will depend on the achievements of the sector of venture capital to draw a conclusion whether these sources of capital have entered a vicious or a virtuous circle.

Viewed from this angle, the realistic source of venture capital in the immediate future will mainly be that of government capital and overseas capital, as has been shown at present.

2. Legal status

In the United States where laws and regulations are comparatively complete, to exercise self-discipline in accordance with law and to establish business on credibility is a self-evident aim of all kinds of economic activities, and government interference is reduced to the minimum. Venture capital comes from the private-equity capital market. Private-equity capital refers to equity capital that does not have the need to register with the American Securities Trading Committee and that can be traded privately or between various financial and non-financial institutions. It is not necessary to report the establishment of venture funds or venture capital companies to the government for examination and approval. Instead, they can be established only if they are in accordance with law. Even NASD, the mother body of NASDAQ, is not a government organ, but simply a legal person body set up by securities companies and the largest self-disciplined financial organization in the United States. Another branch of NASD takes charge of supervision and control of companies listed under the NASDAQ system.

As for investment funds, they are not mentioned in the Securities Law of China. The only legislation touching upon this issue is the Provisional Rules on the Management of Securities Investment Funds promulgated in November of 1997. These rules, however, govern only securities investment funds that "specialize in the investment of stocks, bonds and other financial tools" and do not cover venture capital funds. As for investment companies, it is stipulated in the Company Law that apart from investment companies and holding companies designated by the State Council, the accumulative amount of investment by a company in other companies shall not exceed half of the net assets of the investing company. It can be seen that the power over the examination and approval of investment companies resides in the State Council.

There are now nearly 100 funds and companies in China that have engaged in venture capital. The bases for their existence include the directive given in 1985 by the Central Committee of the Communist Party of China in its Decision on the Reform of the Scientific and Technical System that "investment funds for new undertakings can be established to support hi-tech development that changes rapidly and involves comparatively big risks," and the directive given by the State Council in 1991 in the Provisional Regulations on Some Policies Concerning State-level Hi-tech Industrial Development Zones that "departments concerned can establish venture capital funds in hi-tech industrial development zones for use in hi-tech industrial development that involves comparatively big risks. Hi-tech industrial development zones where conditions have matured can set up venture capital companies."

Viewed as a whole, the fairly weak legal basis and extreme ambiguity of market access constitute one of the major obstacles hindering the prosperity of venture capital.

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