The Hong Kong-based China Venture Capital Research Institute (CVCRI) has released its first report on the development of China's venture capital (VC) sector. The report is based on a survey, conducted between July 2003 and January 2004, among 190 VC companies in 25 provinces, municipalities, autonomous regions and the Hong Kong Special Administrative Region. The report says the VC industry began to recover in 2003 after several years of depression and adjustments and the total capital under management reached 3.72 billion yuan (US$449 million).

Here are some extracts from the report.

On the whole, the VC industry bounced back in 2003. According to responses to our survey, we believe the industry displays the following significant characteristics.

Geographical distribution of VC business was very uneven, mainly being concentrated in big cities and developed regions.

Shenzhen, Shanghai and Beijing lead the nation both in terms of the number of newly invested projects, investment volume, the average investment value of every project, and the newly increased capital under management.

VC companies in Beijing, Shanghai and North China were the most active in the country. Around 40 percent of VC firms invested in Beijing last year, while the proportions in Shanghai and Shenzhen were 33 percent and 30 percent.

VC institutions' managed capital focused on Shenzhen, Beijing and Shanghai accounting for 26 percent, 15 percent and 10 percent of the total.

Newly increased capital under management was 3.70 billion yuan (US$447 million) last year, with more than 20 percent of that being made in Beijing, 17 percent in Shenzhen and 5 percent in Shanghai.

Over 1.16 billion yuan (US$140 million) was invested in Shenzhen and 455 million yuan (US$54.95 million) in Shanghai and 324 million yuan (US$39 million) in Beijing. Investment in the three cities accounted for 52 percent of the national total.

The number of projects in the East China region excluding Shanghai reached 115, while Shenzhen ranked second with 51 projects, while Beijing had 31 projects and Shanghai had 23.

Electronics and information technology, biotechnology and medicine, medical equipment, and network and telecommunications attracted a great deal of investment in 2003.

The survey showed 170 VC companies invested in 341 projects and the CVCRI collected detailed information on 184 projects made by 83 VC institutions.

About one quarter or 44 projects were in the electronics and information industry and 38 projects were in biotechnology, medicine and medical equipment. The two sectors were followed by the manufacturing and financial sectors, both with 18 projects invested.

Out of the 341 projects, 325 projects revealed the amounts of investments and 139 also provided information about the industry they were involved in.

Total investments in the 325 projects were 3.71 billion yuan (US$448 million).

More than 611 million yuan (US$79.83 million) of investment went to the electronics and information industry, while biotechnology, medicine and the medical equipment sector attracted 210 million yuan (US$25.36 million).

VC institutions were dominated by state-owned companies or organizations; enterprises and governments were the major sources of capital.

According to the CVCRI report, 92 VC firms were controlled by the State or State-owned organizations; 52 by private capital; 26 were wholly owned by the State; and 20 were controlled by foreign investment.

The CVCRI survey also shows that enterprises and governmental organizations contributed 49 percent and 25 percent of capital managed by VC companies respectively.

Investments were mainly made in later-stage projects.

With the depression of the VC sector since 2000, the focus of investments shifted to the later stage of a company's development.

According to the survey, 73 percent of VC companies said they prefer to invest in later-stage projects, while 53 percent and 31 percent chose the expansion and initial stages respectively.

In addition, among the 341 projects with new investment, 156 provided information about the stage of their development. More than 50 percent of the projects were in their later stages, while 28 percent and 11 percent in seed and expansion stages respectively.

Project financing was the main business of VC companies and melon-cutting revenue was their common source of income.

VC companies' major business was in project financing, investment consulting and management consulting last year. Out of the 190 respondents to the survey, 172 regarded project financing as one of their core businesses, while 67 participants chose investment consulting and management consulting as some of their main businesses.

The survey also shows venture capital controlled by foreign investors mainly focuses on the above three businesses, but the other VC companies were also engaged in other businesses like investment banking and guaranty.

Melon-cutting revenues from invested projects, incomes from exits of projects and charges on management consulting were the major sources of income for the domestic VC sector.

Stake transfer was the major exit channel for VC companies, which were satisfied with the profits from the exits.

The CVCRI survey indicates 38 VC firms wholly or partly exited out from 64 projects last year. Out of the 64 projects, 61 provided information about the amount of their exits, which stood at 423 million yuan (US$51 million).

A total of 62 projects also provided the forms of exits and 51 were made through stake transfer, five through management buy-out, three from overseas public offerings, and three through bankruptcy clearing.

The result of the survey also shows the returns of VC companies were good. More than 60 percent of the projects generated 1 to 100 percent of returns and 27 percent projects with above 100 percent returns, while VC firms said they just broke even or suffered from losses in 10 percent of projects.

The data indicates the VC sector had made some progress and the profitability of companies improved.

Diversification of means of management and supervision of invested projects.

Management and supervision of invested projects is a key to the success of an investment.

The survey shows the management of invested projects was mainly conducted through project managers, but the means of management was diversified.

About 100 VC companies adopted the project manager model, but 50 VCs also chose to set up special management organizations and 39 percent assigned staff to invested firms.

Supervision is an important aspect of work after making an investment, with supervisory models being varied.

Among the 179 effective responses to the question, 155 companies chose to have directors or supervisors, 81 appointed chief financial officers in invested companies, and 76 named other executives in invested companies.

VC institutions and intermediaries improved.

According to the survey, China's VC sector was still dominated by the State, but the stakeholding structure had shown a trend of diversification.

In March 2003, the first Sino-foreign joint investment fund management company the Sino-Swiss Partnership Fund was founded. Especially in large funds with more than one billion dollars, government-related capital still had a large proportion. Limited partnership and VC units in large companies, two popular forms internationally, still could not be applied in China.

Related industries with the VC sector and supporting organizations were also being improved. More equity exchanges like the Zhongguancun Technology Equity Exchange were founded. Industrial organizations such as the Guangdong Venture Capital Promotion Association and the Shaanxi Venture Capital Association were set up.

However, the political environment for the VC industry still needs further improvement.

After strenuous efforts in the past years, the legal and political environment for China's VC industry has been improved, but the progress still fails to fully meet the requirement of the industry's development.

The survey shows 38 percent of the respondents say there is still much work to be done in the regulatory structure and 19 percent say the industry needs some policies to encourage its development.

(China Daily April 2, 2004)