“Do you know a company called [name redacted]?” the colleague asked on the phone. “Yes,” I replied. I had been familiar with the firm and its business model for several years. It is a relatively small outfit based in Shanghai, not widely known and not particularly relevant to private equity. So what about it?
"Well," the colleague continued, "they want to raise a renminbi fund to invest in SMEs."
I wasn't particularly surprised - it seems that everyone in China has sought to leverage slivers of proprietary intelligence on companies into a capital-raising event. We all know how it works: Identify the target; corral a few business associates and get them to stump up some cash; invest in the company and, within 24 months, take it public; walk away with a 15x return.
Only it doesn't work - or it doesn't work nearly as well as before. A combination of rising entry valuations and lower exit multiples on the public markets have contrived to deflate the China private equity bubble. Those who can pick entrepreneurs with potential, put capital to work and deliver sustained growth will still make money. Those in it for a quick buck will not.
Unless there has been a smart bit of recruitment in recent months, this firm seeking to raise a fund falls into the latter category. Rather than ask, "Why?" I asked, "Why now?"
According to AVCJ Research, renminbi fundraising ballooned in 2010, as 162 vehicles attracted $17.7 billion, up 181% year-on-year. In 2011, a similar number of funds raised $28.1 billion. As we approach the midpoint of 2012, China fundraising is slower for renminbi and US dollar vehicles. A total of $11.8 billion has entered local currency funds, not a disgraceful showing but well off last year's pace. The number of funds raised is more alarming: just 28.
Renminbi fundraising has been a thoroughly polarized affair - as we were reminded when sifting through the candidates for the 2012 AVCJ Private Equity & Venture Capital Awards China.
At one end of the spectrum sit the government-backed funds. Innovation Industrial Investment Fund is a good example. It is managed by a consortium of predominantly government agencies and funds with a remit to turn Shanghai into an R&D hub. Its capital: RMB26.9 billion ($4.17 billion) from state coffers. This vehicle accounted for more than 25% of the total raised by the 70 largest renminbi funds that achieved a final close in the qualifying period for the AVCJ Awards (April 2011 to March 2012).
At the other end of the spectrum are the independent players, raising relatively small sums from groups of business acquaintances. The line between GP and LPs is blurred, the fund horizon is short and little thought is given to creating a sustainable PE franchise. Even the larger, more professional of these funds are seeing defaults as wealthy individuals lose interest in the asset class.
In the middle are a few established firms that operate in a more institutional manner. It just so happened that none of the big names - Hony Capital, CITIC Private Equity, et al - closed a renminbi fund in the relevant time period. However, full credit to award winner Cowin Capital and nominees CCB International Asset Management, NewMargin Ventures and South River Capital. Each one can point to a track record, brand name or marquee individual that stands out from the pack.
As for the next 12 months, we can expect this pack to thin out, which is no bad thing. Furthermore, it is to be hoped that a rebalancing of the domestic GP pool will ultimately be matched by the emergence of a broader class of LPs able to invest in PE. The development path may be bumpy, but there is every reason to expect that, domestically, the asset class can deliver in the long term.
To ride out the peaks and troughs, and also to handle a more PE-savvy group of entrepreneurs, fund managers must envisage a world beyond multiple arbitrage.
"What do you make of their chances?" the colleague asked, referring to whether the aspiring GP would attract capital. "Close to zero," I replied.
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