Capital allocation, not the amount of capital, Â is the largest financial challenge confronting the private equity industry in China. Capital continues to flood into the PE sector in China. 2011 was a record year, with over $30billion in new capital raised by PE firms, including both funds investing in dollars and those investing in Renminbi.Â China’s private equity industry seems destined now to outstrip in size that of every other country, with exception of the US. Ten years ago, the industry hardly existed in China.
Yes, it is a time of plenty. Yet, plenty of problems remain. Many of the best private companies remain starved of capital, as Chinaâ€™s domestic banks continue to choke back on their lending. As a result, PE firms will play an increasingly vital role in providing growth capital to these companies.Â
These are some of the key themes addressed in CFCâ€™s latest research report, titled â€œ2012-2013: ä¸å›½ç§å‹Ÿè‚¡æƒèžèµ„ä¸Žå¸‚åœºè¶‹åŠ¿â€. It can be downloaded from the CFC website or by clicking here.
The report is available in Chinese only.
Like many of CFCâ€™s research reports, this latest one is intended primarily for reference by Chinaâ€™s entrepreneurs and company bosses. Private equity, particularly funds able to invest Renminbi into domestic companies, Â is still a comparatively new phenomenon in China. Entrepreneurs remain, for the most part, unfamiliar with all but the basics of growth capital investment. The report assesses both costs and benefits of raising PE.
This calculus has some unique components in China. Private equity is often notÂ just the only source for growth capital, it is also, in many cases, a pre-condition to gaining approval from the CSRC for a domestic IPO. Itâ€™s a somewhat odd concept for someone with a background only in US or European private equity. But, from an entrepreneurâ€™s perspective, raising private equity in China is a kind of toll booth on the road to IPO. The entrepreneurs sells the PE firm a chunk of his company (usually 15%-20%) for a price significantly below comparable quoted companiesâ€™ valuation. The PE firm then manages the IPO approval process.
Most Chinese companies that apply for domestic IPO are turned down by the CSRC. Bringing in a PE firm can often greatly improve the odds of success. If a company is approved for domestic IPO, its valuation will likely be at least three to four times higher (on price/earnings basis) than the level at which the PE firm invested. Thus, both PE firm and entrepreneur stand to benefit.
The CSRC relies on PE firmsâ€™ pre-investment due diligence when assessing the quality and reliability of a companyâ€™s accounting and growth strategy. If a PE firm (particularly one of the leading firms, with significant experience and successful IPO exits in China) is willing to commit its own money, it provides that extra level of confidence the CSRC is looking for before it allows a Chinese company to take money from Chinese retail investors.
From a Chinese entrepreneurâ€™s perspective, the stark reality is â€œNo PE, No IPOâ€.
CFCâ€™s Jessie Wu did most of the heavy lifting in preparing this latest report, which also digests some material previously published in columns I write for â€œ21 Century Business Heraldâ€ (â€œ21ä¸–çºªç»æµŽæŠ¥é“) and â€œForbes Chinaâ€ Â (â€œç¦å¸ƒæ–¯ä¸æ–‡â€). The cover photo is a Ming Dynasty Xuande vase.