Venture capital and private equity funds find life tough

Venture capital and private equity sectors are finding life tough as investors lose their appetites in a weak economy and IPOs dry up

PUBLISHED : Monday, 04 February, 2013, 12:00am
UPDATED : Monday, 04 February, 2013, 5:43pm


Related topics


A slew of new data suggests mainland-focused venture capital and private equity funds may be finding the going tough after a dream run in past years.

The natural life cycle of these funds, from raising cash to investing and eventual exit, is now in jeopardy amid a drought in initial public share offerings because of a weak economy and poor investor confidence.

The dire scenario in the once highly lucrative venture capital and private equity sectors has made fund managers increasingly concerned about their own investments and divestments, sparking worries among investors that they would continue to do poorly this year.

The Beijing-based consultancy Zero2IPO said 369 China-focused funds were launched last year, nearly two-thirds more than in 2011. However, the sum raised amounted to US$25.3 billion, more than a third lower than in 2011.

The number of new venture capital funds last year hit 252, down a third from the previous year, Zero2IPO said. The sum raised by these new funds fell two-thirds to US$9.3 billion.

The IPO market in the United States remains closed for Chinese companies after a string of accounting scandals, while the domestic securities regulator has tightened approval procedures on new flotations in Shanghai and Shenzhen to bolster investor confidence.

IPOs, particularly those at exorbitant prices on the mainland's board for small and medium-sized firms and the Nasdaq-style ChinNext market, used to be the main choice for private equity and venture capital funds to exit.

The funds were in full flow as investors enjoyed hefty paybacks amid a buying euphoria on start-up firms that allowed them to be listed at high prices.

In May 2010, a rosy listing debut by Shenzhen Hepalink Pharmaceutical on the SME board at the Shenzhen Stock Exchange brought Goldman Sachs a 235-fold return as mainland investors flocked to the most expensive public offering ever, believing the medicine maker was a future star.

The mainland investment community was taken with the terms PE and VC in 2010, with nearly every wealthy entrepreneur avidly looking to be a limited partner of such a fund.

Several venture capitalists admitted that blind optimism had resulted in unreasonable deals, bringing severe losses in some internet-related start-ups that proved unable to generate profits.

A Shanghai-based fund manager said the funds would have to write off their investments in a large number of internet firms in the coming years.

Last year, the securities regulator curbed fresh equity supply to avoid a liquidity drain from the beleaguered stock market.

A total of 155 IPOs, little more than half the number seen in 2011, netted 103.4 billion yuan (HK$128.6 billion) on the Shanghai and Shenzhen exchanges last year, down nearly two-thirds from the year before.

The mainland IPO market size last year was at a four-year low, as the China Securities Regulatory Commission temporarily suspended new share approvals in October to shore up investor confidence.

Bonnie Lo, a partner and co-head of China businesses at NewQuest Capital Partners, said: "Overall, chances for investors to succeed in the investment-divestment-fundraising cycle will continue to be limited. Particularly, we believe exits will remain difficult in 2013, which of course affects fundraising as well."

More importantly, the opaque regulatory environment and policy risks continue to weigh on investors.

Beijing is likely to impose a new capital tax on yuan-denominated funds, taxing gains on these funds at a rate of up to 40 per cent, against the 25 per cent corporate income tax now.

The move, which is likely to eat into funds' profits, would dent cash-rich mainlanders' enthusiasm in the private equity and venture capital sectors.

Beijing is also lining up a new securities investment fund law that will probably also regulate the two sectors. The aim is to prevent illegal fund-raising and other illegal operations.

If the regulations come into force, all yuan-denominated venture capital or private equity funds would be subject to stricter scrutiny by the China Securities Regulatory Commission.

Jing Yi, an executive partner with the private equity group Sedum Holdings, said: "Tightened regulations are a double-edged sword. It could hamper the growth of the funds but it might also be a good opportunity for top performers to get stronger."

Fund managers said an "unclear winter" facing the PE and VC funds would give rise to the sale of assets by the partners as they struggled to cash out, providing opportunities for other funds to chase lucrative deals in the secondary market.

Lo said: "The China market is waking up to the fact that over-reliance on capital markets for exits leaves too few options and limited ability to control divestment timing. There is already an increasing awareness of the secondary market as an option."