China's Private Equity Market
Takeshi Jingu
Tetsuya Kamiyama

I.

Growth in China's private equity market

China's private equity market is growing. The Asian Venture Capital Journal, amagazine specializing in private equity in Asia, estimates that investment in China's
private equity market (including Taiwan) totaled $14.46 billion (roughly Rmb100
billion) in 2006, which represents growth by a factor of more than 10x over little morethan four years. Investment appears to be running at about the same pace in 2007,
with a total for the first six months of $7.42 billion (Figure 1).

Figure 1: Investment in China's private equity market(USD millions)
500
450
400
350
300
250
200
150
100
50
0

16,00014,00012,00010,000
8,000
6,000
4,000
2,000
0
2002

2003

2004

Investment amount (lhs)

Note:
Source:

2005

2006

First half of2007

Number of deals (rhs)

Includes Taiwan
Nomura Institute of Capital Markets Research, based on the Asian Venture Capital
JournalIn this report, we look at changes in the private equity regulatory environment in
China and at the status of private equity investment activity, primarily that of foreign
private equity firms. We focus on the foreign firms because of the key role they playin China's private equity market, and also because the biggest risk in that market,
especially for the foreign firms, comes from changes in government policy.

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II. The development of China's private equity market
Probably the biggest risk in China's private equity market comes from changes ingovernment policy. We examine below the extent to which changes in China's private
equity-related laws and regulations have affected the development of private equity in
China. Because China's capital markets have yet to fully develop, private equity has
been primarily an offshore activity. China's capital markets have come a long way
over the past several years, however, including by resolving problems related to nontradable shares, introducing private equity-related laws and regulations, anddeveloping domestic private equity funds.

1. Developments offshore (from the 1980s until the IT bubble collapse)
Private equity funds in China have developed in principal under government
guidance. From the late 1980s until the mid-1990s, the funds were aimed more at
supporting the development of science and technology, rather than at the developmentof capital markets.1 China's first venture capital (VC) fund was established in 1985,
and its first VC fund with a mix of domestic and foreign capital was established in
1989. VC funds had not yet established much of foothold at that time,
VC funds gradually began raising their presence in 1997. When China's IT firms
started attracting attention, overseas VC funds started getting into the act. The "redchip" listing (explained below) was created in 1999, wherein Chinese IT firms with
VC funding were listed on the NASDAQ. One reason for this was that the criteria forlisting on China's domestic exchanges were difficult to meet.
Ownership of a red-chip listing is transferred to a holding company, which is a
special purpose vehicle (SPV) established in a tax haven such as the Cayman Islands
by the founders of the domestic venture. At this point the domestic venture becomes awholly foreign-owned enterprise in what is termed an "overseas restructuring." Next,
the overseas VC fund invests in the SPV (increasing the SPV's capital), and then the
SPV is listed on an overseas market (Figure 2). From the overseas VC fund's
perspective, this is an offshore investment from offshore. When an overseas VC firm
invests in an SPV, its stake usually includes some preferential rights.

1

Li and Li (2008)

China's Private Equity Market 25

Figure 2: Structure of the offshore investment

VC

SPV
Offshore
Onshore(China)100%
Chinese company

Note:
Source:Founder

SPV stands for special purpose vehicle. The founders of the Chinese firm create
an SPV offshore, and that SPV invests back into the Chinese firm (see main text).
Nomura Institute of Capital Markets Research, based on materials from DLA Piper.

Because the domestic venture becomes a foreign-invested enterprise using thismethod, in those industry sectors where foreign investment is restricted or prohibited(including telecommunications and the Internet), the SPV creates a separate holding
company in China, and the holding company and domestic venture firm sign acommercial agreement (to provide services, for example), thereby providing a vehicle
to capture the domestic venture's profits.
Red-chip listings reached a peak during the global IT boom of 1999-2000, andmany of them were quite successful. A number of high-tech firms were on the vergeof being created during this time, but the whole process was set back by the burstingof the dot.com bubble in the US.
China's private equity sector shrank in 2001-3 following the IT boom's collapse. A
number of problems then came to the surface, and in January 2003 the Chinese
government announced its Rules Governing Foreign-invested Venture CapitalEnterprises (implemented on 1 March 2003; explained below). These rules are stillused today.
Then in January 2004, capital market reforms were given a major boost when Some
Opinions of the State Council on Promoting the Reform, Opening and Steady Growthof Capital Markets (Nine Opinions ) was announced. The Nine Opinions included a
proposal to build multi-level capital markets, and wound up promoting both VC
investments and the establishment of the Growth Enterprise Market.
In response the National Development and Reform Commission, together with 10
other government entities, jointly announced the Provisional Rules Governing
Administration of Venture Capital Enterprises (implemented on 1 March 2006;
explained later).

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Meanwhile, the government's policies on overseas listings were in a constant stateof flux. When the IT bubble collapsed in 2000, the China Securities Regulatory
Commission (CSRC) began requiring a no-action letter for red-chip listings, but later
rescinded this requirement. In 2005, amid complaints that high-quality assets werebeing drained off overseas, the State Administration of Foreign Exchange (SAFE)
issued notices aimed primarily at controlling illegal funds flows, both inbound andoutbound (Order No. 11 and Order No. 29). Although this had an adverse impact onoverseas listings, that same year SAFE issued Order No. 75, enabling China residents
to procure funding through overseas SPVs, and red-chip listings resumed.

2. Capital market reforms and the encouragement of domestic listings
China's capital market reforms, including reforms to non-tradable shares began in
2005. These reforms were aimed at addressing the problem that holders of nontradable shares (including shares in corporations) were unable to benefit from theincrease in share prices on the tradable market. In 2006, the fairly restrictive
Securities Law and Company Law were revised and made more accommodative.
These capital market reforms created a platform upon which China's private equity
market could develop.
The Law on Partnership Enterprises was revised in August 2006 (and madeeffective in June 2007; see details below). The change formally recognized venture
capital firms formed under the general limited partnership format commonly used
overseas, and also addressed the issue of double taxation. A draft version of the
Administrative Measures for Initial Public Offerings and Listing on the Second Board
was published in March 2008 (see details below). The establishment of a GrowthEnterprise Market would make it relatively easier to list a venture firm in China. As
the government increased its efforts to foster the development of private equity funds
within China, it also began reinstituting stricter treatment of overseas listings.
On 8 September 2006, the Ministry of Commerce and other government entities
announced Rules Governing Mergers and Acquisitions of Domestic Enterprises byForeign Investors (Directive No. 10), which required that domestic companies obtainapproval from the Ministry of Commerce to establish an SPV overseas. In addition, an
SPV using its equity to merge with or acquire a domestic firm must obtain approval
from first the Ministry of Commerce and then the CSRC, and if it does not list within
a year, it must restore the domestic firm to its original equity composition. These rules
have effectively once again closed off the route to red-chip listings. The government's
motivation in doing so was likely to prevent China's best companies/assets fromlisting overseas, which would put them out of the reach of the CSRC and also reducetax revenues, and to encourage them to instead list domestically, and thereby
strengthen China's own capital market.

China's Private Equity Market 27

3. Recent trends
Order No. 10 of 2006 made red-chip listings more difficult, but such listings werestill easy for those companies that had begun the process prior to Order No. 10 going
into effect. There is also speculation that if the A share markets continue to weaken, orthe establishment of the Growth Enterprises Market (GEM) winds up being delayed, it
will make it more difficult to raise venture capital domestically, which in turn may
encourage the government to deregulate the market again.2 Consequently, we expect
overseas listing to remain an option for raising funds, although over the longer term,
startups will probably increasingly seek funding from domestic sources and list theirshares on domestic markets.
Foreign private equity firms have accounted for the majority of domestic private
equity investments thus far, but domestically-capitalized private equity funds should
also start making news. These include the "industrial investment funds" initiated by
local governments, one example of which is the Bo Hai Industrial Investment Fundpromoted by the City of Tianjin. The fund, established at the end of 2006 with assetsof Rmb6.08 billion, actually began investing in 2007, and now has assets of Rmb20
billion. Second are the private equity funds established by China's private sector.
Although previously on a small scale, a large number of new ventures have been
formed as limited liability partnerships in response to the 2007 revision of the Law on
Partnership Enterprises.
Third, because of the increased difficulty in obtaining overseas listing for thecompanies they invest in, a number of the foreign private equity firms are starting toconsider domestic listings. One way to achieve this would be to convert the subject
domestic venture into a limited liability foreign invested company, and then list it on adomestic exchange. Another approach would be to establish a domestic Rmb fundusing foreign private equity. Dozens of Rmb funds have already been established as
joint ventures between foreign investors and local governments.3
In March 2008, the Ministry of Commerce announced its Guiding Opinions on theWork of Absorbing Foreign Investment Nationwide in 2008, where it proposed moreinnovative and greater use of foreign capital. Specific proposals included (1)promoting the establishment of VC firms by foreign companies and strengthening exit
mechanisms for recovering venture capital investments and (2) encouraging thedomestic listing of foreign-invested companies that meet the requirements to do so. In
step with plans to introduce a GEM, moves are underway to foster development of adomestic private equity market.

2
3This paragraph is based on interviews with private equity funds.
2 January 2008 edition of First Financial Daily

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III. Private equity-related laws and regulations
1. Rules Governing Foreign-invested Venture Capital Enterprises (2003)
The Rules Governing Foreign-invested Venture Capital Enterprises regulate theestablishment of VC firms within China using foreign capital. Chapter 6, Article 7 ofsaid regulations includes the requirements for such establishment (see Figure 3). 4
These regulations effectively laid the groundwork for limited liability partnerships
back in 2003, prior to revision of the Law on Partnership Enterprises.
Foreign-invested VC firms can be either unincorporated or incorporated (Article 4).
All investors in unincorporated VCs have joint and several liability with respect to theventure's obligations. However, they are able to enter into an investment agreementthat states that if the unincorporated VC does not have sufficient assets to pay back its
debt, its "requisite investors"(or general partners (GPs)) have joint and several liability,
but other investors' liability is limited to the amount of their investment. The liabilityof each investor in an incorporated VC is already limited to the amount of theirinvestment (Article 4). In fact, nearly all of the foreign-invested VC funds establishedthus far are based on joint venture (cooperative) agreements.5
A foreign-invested VC firm can outsource day-to-day management to either aventure capital management firm or to another VC firm (Article 21). The venture
capital management firm hired can be a domestic, foreign-invested, or overseas firm
(Article 21).
Investors can recover the funds they have invested through various means,including by selling their stake in the venture. Specifically, they can (1) transfer theirownership to another investor; (2) have the venture agree to buy back their shares; (3)sell their shares on a domestic stock exchange after the venture is listed on thatexchange; or (4) use some other legally approved method (Article 34).

4
5

In this case, the fund is treated as a domestic entity.
From DLA Piper (2008).

China's Private Equity Market 29

Figure 3: Rules Governing Foreign-invested Venture Capital Enterprises(excerpts)
Article 6
The following are prerequisites for establishing a new venture capital (VC) firm.
(excerpt)
The number of investors must be at least two and no more than 50, at least oneof which must be a "requisite investor (GP)" as described in Article 7.
Investors must commit to a minimum equity investment of USD10 million for a
non-incorporated VC firm and USD5 million for an incorporated VC firm.
Investors who are not requisite investors must invest a minimum of USD1
million. Foreign investors must invest with freely convertible currency, andChinese investors must invest with Renminbi.
Except when management of business activity is outsourced to a venture
capital management firm, the VC firm must have at least three employees withspecialized experience in venture investments.
Article 7
Requisite investors shall meet the following conditions.
(excerpt)
Their primary business must be venture investing.
Their total cumulative capital under management for the three years preceding
application must be at least USD100 million, of which at least USD50 million
must have already been used for venture investing. For requisite investors who
are Chinese, total cumulative capital under management for the three years
preceding application must be at least Rmb100 million, of which at least Rmb50
million must have already been used for venture investing.
At least three of the managers must have at least three years experience in VC
firms.

Source:Nomura Institute of Capital Markets Research, based on Rules Governing Foreigninvested Venture Capital Enterprises

In a non-incorporated VC firm, either each investor individually pays corporate
income tax (at a rate of 25%) as stipulated under national tax laws, or theunincorporated VC firm pays the combined tax for all investors (Article 35). An
incorporated VC firm pays a corporate income tax of 25%. This creates the problem
in an incorporated VC firm of double taxation, because investors are paying tax at
both the corporate and individual income tax levels. That said, 70% of the amountinvested in an incorporated, high-tech smaller business (unlisted, with investments
lasting at least two years) can be deducted from taxable income in the case of anincorporated VC firm.

2. Provisional Rules Governing Administration of Venture Capital Enterprises(2006)The Provisional Rules Governing Administration of Venture Capital Enterprises
establishes rules for VC firms. Under that law, the companies that VC firms invest in
must be domestic growth companies that are not listed publicly (Articles 2 and 14;
this excludes unsold shares after the target company is listed). The conditions forestablishing a VC firm according to that law are shown in Figure 4.

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Figure 4: Conditions for establishing a VC firm (excerpts)• Actual paid-in capital must not be less than Rmb30 million, or alternatively, paid-in
capital must not be less than Rmb10 million initially, and all investors shall agree thatwithin five years after registration, paid-in capital must be enhanced so as to not beless than Rmb30 million.
• The number of investors shall not exceed 200, and the number of investors in VC
firms established as limited liability companies shall not exceed 50. The VC firm
investment from each investor shall not be less than Rmb1 million. All investors must
contribute capital in the form of legal tender.
• At least three high-level managers with two or more years experience in venture
investments or related areas shall take responsibility for investment management.
When outsourcing investment management services to another VC firm or a venture
capital management advisory firm serving as a management advisory entity, that
entity must have at least three high-level managers with two or more years experiencein venture investments or related areas, and shall take responsibility for investment
management.
Source:Nomura Institute of Capital Markets Research, based on Article 9 of Provisional
Rules Governing Administration of Venture Capital Enterprises

3. Law on Partnership Enterprises (2007)
The Law on Partnership Enterprises provides a legal basis for limited partnershipcorporations. Partnership enterprises include both general partnerships and limited
partnerships established within China by a natural person, juridical person, or otherorganization. Limited partnership enterprises are formed by general partners andlimited partners, with the general partner bearing unlimited liability for the debts ofthe partnership enterprise, and the limited partners bearing liability for said debts up
to the amount of their investment (Article 2). Each partner pays their own income
taxes (Article 6), thereby avoiding the problem of double (corporate and personal)
taxation.

4. Administrative Measures for Initial Public Offerings and Listing on the Second
Board (Draft, 2008)
A draft version of the Administrative Measures for Initial Public Offerings andListing on the Second Board was published in March 2008. Establishing a GEM
would fill a gap in China's capital markets by providing a market that newer growthcompanies can use to access capital. According to the draft measures, listing
requirements for the GEM would be more lenient than those for the main board(Figure 5).
Trading rules and other details for the GEM are currently being worked out. To
ensure market stability, consideration is apparently being given to restricting theparticipation of small investors, introducing mechanisms to limit price moves andtrading, strengthening the oversight of listed companies by the sponsoring securities
companies, and establishing lockup periods for controlling shareholders following
listings.
China's Private Equity Market 31

Figure 5: Comparison of listing standards
Main board(Measures for the Administration of
Initial Public Offering and Listing of Stocks)

Administrative Measuresfor Initial Public Offerings andListing on the Second Board (Draft)* A limited liability company with at least three years * A limited liability company with at least three years
doing business since establishment (Article 9)

doing business since establishment (Article 8)* No substantial change in the primary business* No substantial change in the primary business

content, the directors, or senior management, andno change in the effective controlling shareholder,within the past three years (Article 12)content, the directors, or senior management, andno change in the effective controlling shareholder,within the past two years (Article 11)* Positive net profit for each of the past three years * Positive net profit for each of the past two years,
and cumulative net profit of at least Rmb30 million
over the past three years, using the lower of net
profit before extraordinary items and net profit
after extraordinary items (Article 33)* Cumulative cash flow over the past three years of
no less than Rmb50 million, or cumulative
operating revenue over the past three years of noless than Rmb300 million (Article 33)

cumulative net profit over the past two years of noless than Rmb10 million, and continued profit
growthAlternatively, net profit (the lower of net profit
before extraordinary items and net profit after
extraordinary items) over the past year of no lessthan Rmb5 million, operating revenue over the past
year of no less than Rmb50 million, and a growthrate in operating revenue over the past two years
of no less than 30% (Article 12)* Intangible assets (excluding concessions for land * Net assets prior to issuance shall be no less thanuse, cultivation, and mining/drilling) at the end of
the immediately prior period of no more than 20%
of net assets (Article 33)

Rmb20 million (Article 12)* Total capital prior to issuance shall be no lessthan Rmb30 million (Article 33).

Source:Nomura Institute of Capital Markets Research, based on Measures for the
Administration of Initial Public Offering and Listing of Stocks and on Administrative
Measures for Initial Public Offerings and Listing on the Second Board (Draft)

IV. Private equity investment in China today
1. Methods of investing
The traditional approach to earning profit from a private equity investment in
China is to make a venture capital investment of around $5-$15 million in a company
that provides goods or services to the growing domestic market, and then take thecompany public with an IPO (Exhibit 6).
One reason for venture capital being one of the primary means of investing in
China's private equity market is the Chinese government's policy fostering smaller
tech-sector companies, since promoting venture capital investment is one way toachieve that. Another probable reason for the large presence of venture capital is
China's embrace of the entrepreneurial spirit.

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Figure 6: Methods of investing in private equity in China(based on investment amount)

Buyout, 25%

Growth capital,
16%

Note:
Source:Venture capital,
59%

Private equity investments in 2006
Nomura Institute of Capital Markets Research, based on the Asian Venture Capital
Journal2. Uncovering investment opportunities
Zhongguancun, in the Beijing suburbs, is a hotbed of private equity investment
opportunities in China. Known as China's Silicon Valley, Zhongguancun has a large
concentration of high-tech ventures. With universities like Tsinghua University and
Peking University, as well as government research facilities, nearby, its integration ofindustry with academia and government is conducive to the development of new
ventures. Consequently, Zhongguancun also has a heavy concentration of VC firmsthat invest in the growth companies based there.
There are numerous examples of private equity opportunities outside ofZhongguancun based on various types of personal connections, including joint
investments with other private equity firms, investments with entrepreneurs that haveattracted attention for a while, and informal introductions from government officials.
Nearly all of the professionals working at the private equity firms visited by theauthor of this report studied at US universities, and it seems that they have also foundinvestment opportunities through connections they made while a student. Fewer
opportunities are introduced by investment banks in China than in the US and Europe,and fewer projects are competed over by more than one private equity firm.

3. Investment by overseas private equity firms
Many of the private equity firms investing in China are based overseas. According
to Zero2IPO, 74% of venture capital investments (on a value basis) are made withforeign capital, an indication of the strong presence that foreign private equity firms
have in China's market (Figure 7). One likely reason for this is that the crowding ofEuropean and US private equity markets has created more competition for specificprojects, thereby driving European and US private equity firms to step up their private
equity investment activity in emerging markets like China and India. Another possible

China's Private Equity Market 33

reason is that local private equity firms lag behind in both access to funding andskilled personnel.

Figure 7: Breakdown of venture capital investments(based on investment amount)Both, 8%Domestic
Capital, 18%

Foreign Capital,
74%

Note:
Source:Venture capital investments in 2006
Nomura Institute of Capital Markets Research, based on Zero2IPO

Nevertheless, when foreign private equity firms invest in China, they must deal
with the inescapable problems of regulation and government intervention. One recent
example of the government intervening to block the acquisition of a Chinese company
by a foreign private equity firm was the attempted buyout of Xugong Group
Construction Machinery by the Carlyle Group, a leading US private equity firm.
In October 2005, the Carlyle Group agreed to purchase, at a price of USD375
million, an 85% stake in Xugong Group Construction Machinery, a company ownedby the city of Xuzhou in Jiangsu province and China's largest manufacturer of
construction machinery.
But in June 2006, in response to domestic critics warning about foreigners
acquiring core manufacturing companies, the Chinese government established a newrule requiring approval by the relevant organization under the State Council whenevertransferring management rights of large-scale manufacturing operations to foreign
ownership. Then in September 2006, the government implemented rules governing
the acquisition by foreign investors of domestic companies. The new rules, which
replaced provisional regulations on the acquisition of domestic companies by overseas
investors, require the submission of a report to the Ministry of Commerce when
acquiring companies that operate in key industries or own famous brands. Because"key industries" and "famous brands" are not clearly defined terms, the Chinese
government has the ability to select from among specific projects those acquisitions
by overseas firms that would be beneficial to China. The Carlyle group responded bylowering its stake and making other compromises aimed at getting approval from the
Chinese government, but the deal was finally abandoned in July when Xugong Group
Construction Machinery decided it was no longer interested.

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Nomura Capital Market Review Vol.11 No.3

4. Exit strategy
IPOs are the primary exit strategy for private equity investments in China (Figure8). We attribute this to (1) the company receiving the investment preferring not to be
sold and (2) entrepreneurs, having heard the success stories, wanting to become
wealthy from an IPO.
The number of Chinese companies undergoing an IPO has consistently risen since
2002, despite the freeze on domestic IPO activity from April 2005 until May 2006,
and the funds raised by Chinese companies on stock markets set a new all-time highin 2006 and again in 2007. It is notable that more than half of the equity financing
raised in both 2005 and 2006 came from overseas markets (Figure 9). Some highprofile examples include the outdoor advertising firm Focus Media and the Internet
portal Baidu, both of which listed their shares on NASDAQ in the US, and the online
shopping company Alibaba, which listed on the Hong Kong Stock Exchange (Figure10). Since H2 2006, however, the Chinese government has strongly discouraged
Chinese companies from conducting their IPOs on overseas markets, based on theidea of fostering growth of domestic markets and preventing an overseas exodus ofquality assets. Within this context, it will be interesting to watch the development of
the GEM, the new market for startups scheduled to be created at the Shenzhen Stock
Exchange.

Figure 8: Exit strategies for China's private equity investment (by case)

Other, 17%
M&A, 13%

Sale, 20%

Note:
Source:

IPO, 50%

Based on the 152 exits from private equity in 2006
Nomura Institute of Capital Markets Research, based on Zero2IPO

China's Private Equity Market 35

Figure 9: Funds raised from the stock market by Chinese companies(Rmb billions)
1,200

Domestic

1,000

300

Overseas

800
600

313

400

772
56

200
0

0
9

6
31

19
14

3
12

8
34

92

93

94

95

96

36
93

4
80

5
90

154

97

98

99

00

7
118
01

154

18

53

65

78

82

86

34

02

03

04

05

246

06

07
(Year)

Source:Nomura Institute of Capital Markets Research, editors, "Chugoku Shouken Shijou
Taizen" (All about the Chinese securities market), Nihon Keizai Shimbun Sha,
2007

Figure 10: High-profile examples of exits from private equity investment
in China

Focus Media
Baidu
Alibaba

Source:Listing date

Exchange

13 July 2005
5 August 2005
6 November
2007

NasdaqNasdaqHong Kong
Stock
Exchange

Offering price
(a)
US$17
US$27
HK$13.50

Initial price(b)
US$20.20
US$122.54
HK$30

Increase
(b/a)
20%
350%
120%

Nomura Institute of Capital Markets Research, based on various newspaper
articlesV. Sectors receiving private equity investment in China
Figure 11 shows a breakdown of private equity investment in China by investment
amount. These investments include a mix of approaches, including venture capital,
growth capital, and buyout. In general, the smaller the investment, the higher is thepercentage of high-tech firms, and the larger the investment, the higher is thepercentage of traditional sectors such as real estate, raw materials, household goods,
and automobiles. The figures indicate that a large number of ventures in China are
Internet related, as was true in the past with such companies as Baidu and Alibaba.
Because the Chinese government has made fostering the development of
information technology and other high-tech industries a priority, a large number ofprivate equity investments, especially venture capital investments, have been in ITrelated sectors. The IT sector is still a primary recipient of private equity investment
in China, but because of the collapse of the IT bubble and the expansion of thedomestic consumer market resulting from rapid growth in China's per capita GDP
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Nomura Capital Market Review Vol.11 No.3

(Figure 12), private equity investment has been shifting to companies that provide
goods and services to domestic consumers (companies that are primarily in the
traditional sectors noted in Figure 11).
Outside of IT, the sectors that are attracting the most attention are education, clean
energy, biotechnology, and healthcare. Because of China's one-child policy, per capita
education spending has risen sharply, and this is drawing investments into theeducation sector, which includes preschool education, cram schools to prepare forschool entrance examinations, vocational training schools, and language schools.
Most recently, interest seems to be focused on online learning and other educational
services that leverage the Internet. In the clean energy segment, there have been somenotable investments in solar energy, in part owing to the seriousness of environmental
pollution associated with China's industrialization. The rising awareness of health, theaging of China's population, and the national policy of promoting growth in that
sector has resulted in an inflow of investments into companies in the biotechnology
and healthcare sectors, including medical equipment manufacturers, hospital chains,and companies that provide outsourced R&D for overseas pharmas.

Figure 11: Sectors receiving private equity investment in China(based on investment amount)

Traditional
sector, 45%

Other, 1%

IT, 10%

Biotech &healthcare, 8%

Other tech,
3%

Service, 33%

Note:
Source:Data covers 453 investments totaling $14.78 billion in 2006
Nomura Institute of Capital Markets Research, based on Zero2IPO

China's Private Equity Market 37

Figure 12: Per-capita GDP growth rates in Asia
450
400
350
300
250
200
150
100
50
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06(Year)
China

Note:
Source:

India

Japan

Korea

Growth rate is indexed to each country's nominal GDP in 1990
Nomura Institute of Capital Markets Research, based on World Bank data

One notable aspect of China's private equity investment is the large amount ofinvestment in companies with Chinese versions of business models that have worked
in the US. Focus Media, Alibaba, and Baidu are three high-profile examples of private
equity deals in China, and nearly all of the 15 private equity firms in China that wevisited emphasized their participation in the early stages of investment in one of those
three. Alibaba could be viewed as the Chinese version of eBay, and Baidu the Chineseversion of Google. As shown by these examples, having innovative technology is lessgermane for companies receiving private equity investment in China than is having
the ability to quickly provide convenient products and services to China's giant
domestic market. Whereas, internet related business in the U.S. fits this criteria.

VI. Future outlook
Over the long term, we expect China's economy to continue to grow, and look for acontinued succession of new companies with a strong entrepreneurial spirit. As theinfrastructure for China's domestic capital markets, including private equity-related
laws and regulations, is put in place, conditions will become more favorable for thedevelopment of China's private equity market.
On the other hand, we still think that the biggest risk in making private equity
investments in China is the possibility of the authorities changing either their rules or
the way they are applied. The traditional method for exiting a private equity
investment has been an IPO on an overseas market, but with the government having
adopted policies promoting listing on domestic markets, and with the pending

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establishment of the GEM, we expect China's private equity market to turn more todomestic IPOs. During stock market corrections like the one seen recently, however,
we do not rule out the possibility that the authorities may have to revise their policy offavoring listings on domestic markets in order to improve stock market supplydemand.
Because of this, we think it is important to keep a close eye on China's regulatory
trends when pursuing private equity investments in China.

References
DLA Pipers, Chugoku Toushi Memorandamu (China Investment Memorandum),
Part II, 2008 (in Japanese)
Sekine, Eiichi, Futatabi Kyakkou wo Atsumeru Gaishikei Kigyou no Chuugoku
Kokunai JouJou ni tsuite (Listing of foreign-capitalized companies on China's
domestic markets back in the spotlight), Capital Market Quarterly, Issue 08-24 (inJapanese)
Li, Lianfa and Li Bo, Simu Guquan Touzi Jijin Lilun ji Anli (Private Equity Funds:
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