Qiang Li

Venture Capital (VC) can be thought of as the entrepreneur behind entrepreneurs, and it has played a key role to the development of start.up businesses. In recent years, the VC industry in China has grown very fast along with the booming economy, and it will benefit a lot of small businesses as they create value and contribute to the economy.

Consider a typical story about VC and entrepreneurship. Alibaba, an e-commerce company in China that is the biggest business-to.business platform in the world, started in 1999 with $80 million in venture capital from Softbank. Alibaba acquired Yahoo! China in 2005 and then went public in Hong Kong in 2007. At that time, with 36 million registered users, Alibaba made an Initial Public Offering (IPO) and received $20 billion. Softbank made revenue of $5.6 billion from its $80 million investment, reaping a 70-fold return. This provides some insight into how
important venture capital is in helping start-up businesses to succeed and how much return it can provide. Almost every successful company has venture capital behind it; Sequoia was behind Google, Benchmark behind eBay, and Accel behind Facebook.

VC firms take into account business cycles and establish criteria to screen target industries and companies.

They raise money from institutional and individual investors, invest in portfolio companies, and, hopefully, exit with high returns through IPOs, trade sales, and so forth. In the US, more than half of VC efforts focus on the information technology (IT) industry. Other favored industries are in the healthcare, retail, and service sectors.

In terms of the criteria that VC firms use to assess target companies, three factors are paramount: the strength of the leadership team, the business model, and the potential market. The core team in a target company should have expertise in its domain, especially technical strength and a rich knowledge of the market opportunity, and it is best if this team has a history of collaboration and success. The business model concerns how the business plans to make money. It does not have to be complicated, but it must be unique and show how the business can be profitable. And there must be a large enough market and the company has to have the potential to occupy a significant market share if venture capital is to have a chance of achieving a high return through an IPO or merger and acquisition efforts.

The venture capital industry in China is relatively new, but recently it has been growing fast. It traces its origins to the 1980s in Zhongguancun (Z-Park) in Beijing, which is called the Silicon Valley of China. Since then most VC activity has been in three cities: Beijing, Shanghai, and Shenzhen. In the strong economy of recent years, this industry has exploded. The number of deals made in 2008 is double that of 2001, and the amount of funds invested has increased about seven times during the same period. IT is still the most favored industry for VC firms, but their second biggest investment has been in traditional industries, where China has upgraded its output drastically and has fulfilled its big potential to create revenue.

There are several critical issues facing venture capital firms in China, two of which are paramount. First, raising funds is a concern. Unlike the US, where most capital is raised from institutional funds such as pensions, endowments, and so on, China has limited resources for VC. The second concern is exiting options. Normally VC firms help entrepreneurs go public or sell their stake when they wish to exit. Due to limitations in the Chinese stock market, however, many VC backed companies can only go public overseas, which is less feasible and involves higher transaction costs.

China has recognized these problems and made an effort to encourage the industry. The strong economy is the foundation for confidence, both for VC firms and entrepreneurs. Limitations in raising funds are being addressed gradually as people understand VC better and are able to provide more capital seeking a high return. Increasingly, there are favorable policies that stimulate technology innovation and industry upgrades, so VC will find plenty of promising businesses with huge potential markets. In addition, the government has decided to start a new stock market similar to the NASDAQ. Decreased barriers in obtaining VC will definitely benefit many start-ups, allowing them to offer their stock in the stock market, and this will give VC firms a new exiting option, thereby solving liquidity problems.

In summary, venture capital is a major accelerator that allows new business to grow. It contributes greatly to technology innovation and economic growth. With the expectation of a continuing strong economy, China will become increasingly attractive for venture capital, and this industry will continue its trajectory toward a brilliant future.