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Wednesday, 25 May 2016

Don’t ask, don’t tell

U.S.-backed China tech shows investment curb folly

China’s tech companies may be Beijing’s darlings, but they have U.S. dollar funding to thank. The next generation of upstarts look likely to continue the pattern. Foreign currency funds poured $5 billion into venture capital the first half of this year – three times more than local funds raised. The economic benefits these foreign investors bring make the rules keeping them out harder to justify.

New venture capital funds raised almost $7 billion in the first half of this year, up 157 percent from the same period last year, data gatherer Zero2IPO Research estimates. It’s mostly U.S. investors leading this resurgence, accounting for three quarters of the total amount raised. Lucrative exits abroad, such as online retailer’s recent New York listing, make U.S. dollars the preferred choice for internet upstarts.

Local venture capitalists lack a deep funding pool to match Silicon Valley’s. Individuals and families, who dominate early-stage tech investment in China, make up half of the country’s private equity investors by number but just 1.4 percent by investable capital, according to Zero2IPO. An emerging crop of tech moguls-turned-venture capitalists, like smartphone-maker Xiaomi’s founder Lei Jun, may attract institutional investors, but this will take time.

Until then, China’s internet will need foreign capitalists’ help to grow. That makes it even more strange that local law is geared towards keeping them out. The country’s trio of web giants – search engine operator Baidu, social media and gaming company Tencent and e-commerce giant Alibaba – have all used variable interest entities (VIEs) that confer control without direct ownership, in order to circumvent foreign investment restrictions. Venture capitalists still openly use VIEs for new investments and funds while acknowledging their legal uncertainties.

It may be against the spirit of the rules, but China’s economy benefits. Alibaba estimates that its e-commerce, logistics and other operations supported some 11.7 million jobs as of last June. The People’s Republic has enjoyed successes to rival Google or Facebook without having to open its capital controls or wait for its markets to reform and mature. If foreigners are still happy to bend the rules in the hope of backing the next winner, China has good reason to let them.



Context News

Venture capital funds in China raised $6.8 billion in the first half of 2014, according to data from Zero2IPO Research. This represents an increase of 157 percent from the same period last year.

Foreign currency funds accounted for 75 percent – $5.1 billion – of those funds. The average amount raised by foreign currency funds was $242 million, approximately 9 times the average local yuan fund, according to the same data.

Foreign investment into certain industries is regulated under Chinese law. The Ministry of Commerce defines which industries fall under “encouraged foreign investment”, “restricted foreign investment”, and “prohibited foreign investment.”

Foreign investment into e-commerce and telecommunications, for example, are restricted while foreign investment into entertainment industries such as news websites, book publishing, TV and film production are prohibited.

To circumvent these foreign investment restrictions, companies set up holding structures routed through the Cayman and British Virgin Islands, typically known as a variable interest entity (VIE), to attract foreign investors. Web companies from search engine operator Baidu to social media and gaming group Tencent have adopted this model.

E-commerce giant Alibaba also intends to list in New York this year, and holds certain licenses in a VIE structure. 


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