The rapid expansion of the Chinese economy has been made possible largely by the transformation from the inefficient central planning socialist ideology to a system that is ever-closer to market capitalism. Part of this transition has led to a venture capital system that reflects the particular features of the Chinese environment.
In this working paper, Steven White, Assistant Professor of Asian Business and Comparative Management at INSEAD, and Jian Gao and Wei Zhang at the School of Economics and Management, Tsinghua University, Beijing, propose a framework within which a venture capital system is defined in functional terms, examine the origins and trajectory of China's system and suggest a research agenda for further studies in China and across different venture capital systems.
Their framework is based on the definition of a venture capital system in terms of five fundamental activities: pooling funds, identifying investments, channelling funds, monitoring investments and appropriating returns to invested funds. The system is the configuration of structures and processes by which these activities are organised and integrated, and these evolve in response to a particular environment.
In providing background to the emergence and development of venture capital in China, the authors point out that the Chinese government has always seen science and technology as a critical part of its search for economic growth and national security. By the early 1990s, R&D institutes and universities, banks and technology zones were the principal supporting elements for new technology ventures. However, the system was hampered by, among other issues, the lack of an adequate legal framework.
The authorities saw the venture capital system in the US as a key factor behind the success of its high-tech industries. As a result, they began to expand their conception of venture capital from being a type of government funding to also being a commercial activity, and in 1998 finally announced that venture capital firms could be established.
The authors describe the various forms of venture capital firms that have emerged to undertake the activities of a venture capital system. They also provide details of related organizations, including technology zones and incubators, in addition to the new ventures that are being funded.
Although China's venture capital system has developed rapidly and is vibrant in terms of funding activity, it also has several weaknesses. Many of the domestic venture capital firms, for example, lack professional skills and experience. Both the government and venture capital firms remain fixated on high-technology ventures, leaving high-potential new ventures in more mundane businesses under-funded. There is also much work still to be done in strengthening and clarifying the regulatory, legal and other elements of the institutional environment that have an important impact on economic development. Finally, without a domestic option for new firms to list their shares publicly, investors do not have the attractive opportunities to appropriate returns as is found, for example, through NASDAQ. Many venture capitalists hope that the new board announced in Shenzhen will be modified to specialise in growth enterprise listings and that this will provide better returns that the current exit options, primarily trade sales, acquisitions and management buy-outs.
The authors offer the framework to serve as a basis for comparing venture capital systems not just as they evolve over time, but also across different national contexts. This could help identify alternative ways of organising the same set of activities within different legal, social, political and technological environments.