Reposted from Linkedin
Written by Johab Khamala, Joab’s Capital and Equity Research
The Chinese Innovation and Venture Capital Environment
Within the broad topic of China’s support of innovation, financing commercialization stands out as a special issue. It requires not only capital, but also external risk capital, that is, capital from outside the firm that is supplied by investors willing and able to take the risks involved in technology creation, adaptation, and adoption. The VC industry emerged to fill the funding gap for start-up and early-stage risk capital for innovative firms.
Despite its relatively early start in the mid-1980s and strong government backing, China’s domestic VC industry remains in an early stage of development. Creating a viable VC industry involves more than setting up and capitalizing a number of individual VC funds. More important is the creation of the ecosystem for the industry, the key elements of which include the structure, funding, management, and exit routes for VC investments. The VC industry in China faces challenges in those areas. The way forward is for the government to invest more in improving the ecosystem, as follows:
• Structure: With close involvement of institutional investors, assess the new VC structures by conducting an assessment of the operations of those domestic VC funds created following the newly amended Partnership Law and by identifying loopholes and weaknesses that require further legislative or policy actions.
• Funding: Expand the sources of VC funding by considering policy measures to allow institutional investors to begin investing in domestic VC institutions. Because the risks of VC investing are high, the first step could be to develop a short- and medium-term action plan that would provide institutional investors with a roadmap for investing in private equity and VC funds.
• Management: Build stronger venture partners for investee companies by enhancing corporate governance. The government could organize the formulation of a Code of Conduct for Corporate Governance to facilitate the enforcement of the amended Company Law. It is particularly advisable for the State Council to adopt a regulation to govern the issuance of preference shares.
• Exit: Further widen the exit routes for venture investments by providing mechanisms for foreign-VC-invested companies to list on both foreign and local exchanges and continuously improve the domestic listing process. These steps may include a further reduction of application time, greater transparency, and reducing government management of listing volumes.
Finally, a cross-cutting area of the VC industry is the direct role of the government. As is the case in many other countries, there is very limited transparency regarding direct government intervention in China’s VC industry and little rigorous empirical study of its effects. Nonetheless, the practical experiences of other countries are mixed. China could consider giving priority to strengthening the VC ecosystem while it simultaneously assesses the merits of direct involvement in the VC industry and considers the most appropriate role for government intervention in innovation financing more generally.