The four arms of Chinese private equity

On the macro side, China has gone through quite a few changes. Economic growth is likely to be the slowest in more than two decades and we are in the midst of a once-in-a-generation leadership transition, which brings with it a degree - albeit not a huge degree - of uncertainty about future policy direction.

It begs the question whether China's private equity industry is undergoing a comprehensive repositioning. Having just spent a week in Beijing and Shanghai meeting with a host of local and foreign fund managers, my conclusion is that the industry will continue to forge its own unique path in keeping with the wider needs and opportunities that arise from the Chinese economy.

For starters, Chinese GPs and LPs remain positive. Despite the forecasts for slower growth, the economy is still growing at 6-7% per annum, substantially more than the West. As one professional argues: "Growth rates of investment grade companies should be at least double that of the economy and can be translated to some pretty good returns." Local GPs must therefore focus on virtues beyond simply providing capital.

The evolution of Chinese private equity firms throws light on how the industry structure differs from that of most developed countries. As opposed to purely being classified by stage focus and sector specialization, Chinese funds can also be roughly divided into four main groups:

Affiliated funds: These are either captive or third party funds managed by affiliates of a larger institution, usually an investment bank or securities firm.

"Princeling" funds: A slightly negative term, princelings are descendants of prominent and influential senior Communist officials. With their vast networks of contacts and access to strong political clout, these funds are known for their ability to ‘make things happen.'

Independent funds: Similar to the above but with no corporate or political affiliations.

Foreign funds: Mostly US dollar-denominated funds that are headquartered outside of mainland China.

While the conventional thinking of developed markets would tend to favor independent funds, Chinese entrepreneurs lean towards the first two groups - affiliates and princelings - due to their ability to add value in terms of achieving the business owner's ultimate goal, an IPO, or at least to clear red tape with a few phone calls.

According to one manager of such a fund, these particular skills put him in a much stronger negotiating position and allow for a more balanced approach when investing from US dollar and renminbi vehicles. Most entrepreneurs don't want US dollars due to the 3-6 month wait involved in structuring a deal offshore and converting the capital into renminbi. With more bargaining chips, affiliated and princeling funds can convince business owners to take US dollars as well.

The above may be true for some deals but it is important to remember that China is a huge market. There are a large number of different companies that will need GPs of different expertise. In particular, foreign funds are able to help companies expand overseas, an important consideration for most Chinese companies and one that isn't dealt with so effectively by local managers.

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• Topics
• Greater China
• GPs
• China
• GPs