Venture Capital in China: Strategy and Decision Making; New Research Shows How Venture Investment Processes and Practices in the West Have Been Adopted and Modified for the Chinese Market. This Article Is an Abridged Version of a Longer Paper
Vega, Paul, Chong, Li-Choy, European Business Forum
The shift from a centrally planned socialist economy to a market-driven economy initiated by the Chinese government in the 1970s marked the beginning of one of the most significant economic and socio-political transitions in modern history. One of the results of this ongoing economic reform in China was the creation of a domestic venture capital industry. By definition, venture capital refers to investment entities with pools of capital that invest in unquoted high growth companies that offer prospects of superior returns after a holding period of several year,s leading to an investment exit (Gorman & Sahlman 1986, Gompers 1994, Wright & Robbie 1998, Aylward 1998).
In China, the origins of venture capital can be traced back to the Chinese government's focus on high technology development in the mid-1980s. In response to the shortcomings of centralised economic planning and sluggish competition in the high technology sector, the Central Committee of the Communist Party proclaimed its 'Decision on Reform of the Science & Technology Management System', leading to several initiatives including the Program for High-Tech Research & Development in 1986, and the Torch Program in 1988 (Walsh 2003). This spurred the creation of numerous government-backed Venture capitallst (VC) firms in China, often staffed with state officials who hailed from government agencies or large state-owned enterprises. Unsurprisingly, many state-led VC efforts struggled or failed during this period. Unfazed by these initial challenges, the Chinese government continued to promote VC as one of the pillars of its high technology strategy, representing 'long-term, non-speculative investment that supports innovation and skill transfer' (Vaughn 2002, White et al 2002). More recently, the VC industry has seen explosive growth since 2000, and by some accounts, the industry now comprises close to 300 VC firms in mainland China alone (China VC Yearbook 2003), including many foreign VC investors.
Venture capital is an established industry and business model in the West, with finely tuned and tested investment processes, especially with reference to the Silicon Valley example. On the other hand, China's VC industry is still at a very early stage of development along with the rest of the financial services industry in China. Drawing on VC literature initially developed for the western economic and political environment, our research shows how venture investment processes and practices in the West have been adopted and modified for the Chinese market. Building on a review of western VC literature, 40 research interviews were conducted with offshore and onshore VC investors active in China. The interview sample included domestic VC investors (DVC), foreign VC investors (FVC), as well as government-backed VC firms (GVC). The aim of this exercise was to map the VC investment process in China based on practitioner insights and market research, to allow a side-by-side comparison against the reference process in the West. The findings are of relevance not only to new market entrants to venture capital in China, but also to most other foreign investment activities in China focusing on high risk opportunities.
VC in the West
In essence, the VC business model represents a type of arbitrage, where a VC investor trades off short-term illiquidity by investing in private high risk companies in return for future liquidity and returns potential (Gorman & Sahlmann 1986). This is one of the key differences between VC and conventional corporate finance investments, for example, where the latter typically focuses on public companies featuring higher levels of liquidity and information disclosure (Wright & Robbie 1998).
Investment decision-making can be split into several phases, namely preparation, planned actions, and resource allocation (Mintzberg et al 1977). VC follows a similar pattern though incorporating multiple stages and feedback loops that reflect the high level of risk and informational asymmetries inherent in venture capital. …