China Investment Environment Start-up/Growth Company Finance Market in China

Contact information Mikko Puhakka

Lion Partners Limited

mikko@lion-partners.com

Lion Partners

Lion Partners is a Beijing-based investment focused consulting company serving both Chinese and international clients.

Tekes – the Finnish Funding Agency for Innovation Tekes is the main public funding organisation for research, development and innovation in Finland. Tekes funds wide-ranging innovation activities in research communities, industry and service sectors and especially promotes cooperative and risk-intensive projects. Tekes’ current strategy puts strong emphasis on growth seeking SMEs.

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Executive Summary

This document summarizes the start-up and growth company finance market in China. The report is based on desktop research and interviews with VCs working in the Chinese investment environment, and start-up and growth company CEOs who have experience from getting finance from China, as well as Chinese investors who have invested in Finland. The report is further complemented by comments from the Author.

The report consists of five parts. First, analysis and views of the present state of the start-up/growth company finance market in China are presented with comments. Second, geographical considerations in select cities are summarized. Then, advise to the Finnish public sector, companies and VCs is provided. Further, views of the future trends and implications of those as well conclusions are presented.

President Xi Jinping announced during APEC 2014 that China will invest abroad 1,25 trillion USD in the next 10 years. However, it is notable from the various VC interviews and statistics that OFDI is still a challenge to most Chinese investors. Considerations have been gathered to suggest how to approach this when seeking finance into Finland. Unfortunately Finland is still a net investor to China. Chinese cumulative investments to Finland are around 100 million euros vs. over 10 billion euros investments from Finland to China.

Examples of the type of investments taking place to Finland (2013-2014) cover a range of investments from M&A to corporate investment to VC investments. So whilst the numbers might still be small, the full range is available in theory for Finnish companies. Most companies have been satisfied with the cooperation with investors after the investment despite of

some natural challenges when dealing with different cultures.

As market entry to China typically goes hand-in-hand with considering a Chinese investor comments on how to approach this are covered through the report.

One thing is certain; dealings with various types of Chinese investors will only increase in the future so Finland as a country, Finnish companies and Finnish investment community need a strategy for cooperating with Chinese investors. To do that, more coordinated activities and efforts in China are needed. Finland should consider putting more emphasis in privately owned enterprises and corporate investors as they seem to have the most resources and capabilities in investing internationally. Currently venture capitalists are still in pilot phase when looking at investments from China into international ventures.

‘’Near to rivers, we recognize fish, near to mountains, we recognize the songs of birds’’ - It is very important to make on-the-spot investigations. (Chinese proverb.)

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Present State of the Start-up/ Growth Company Finance Market in China

Statistical Considerations

Overall  Investment  Environment  Globally China has become a net Overseas Foreign Direct Investor (OFDI) last year. Unfortunately Finland is still a net investor to China. Chinese cumulative investments to Finland are around 100 million euros vs. over 10 billion euros investments from Finland to China.

Chinese ODFI in 2013 was 78 billion euros. 5,5% of this was in Europe. China’s non-financial ODFI totaled 74,96 billion USD in the first three quarters of 2014, up 21,6% from the previous year. The biggest investment targets were the Great Britain, France and Germany. The majority of Chinese investments into the EU have been relatively small in size but larger M&A deals are becoming more common and this trend is likely to continue to increase in the future.

Europe’s top 5 industries in Chinese OFDI stock in 2013 were leasing and business services (21,3%), manufacturing (20,4%), mining (18%), finance (16,7%) and wholesale and retail trade (8,5%).

The OFDI from China was started by SOE’s and followed by POE’s and wealthy individuals. Venture Capital investments from China as well as FOF type investments into foreign VCs are in ‘’pilot stage’’ but likely to grow rapidly once enough successful cases take place and sound working practices with international counterparts are found. However, there are considerations in the VC area that should be noted, and these are explained later in this report.

In terms of value, SOEs account for 75% percent of the Chinese investments made globally, but in terms of numbers POEs have made 70% of the investments. The most common investment mode is M&A. More than four fifths (83%) of Chinese M&A

projects in Europe were concluded between 2009 and 2013.

The value of overseas assets and property owned by 25 000 Chinese companies amounts to three trillion USD in 166 countries and regions. The companies have more than one million employees outside of China.

Investment  into  Start-­‐ups/Growth  Companies  Overall, it is fairly difficult to provide exact numbers on VC investment in China as the statistics from different sources vary significantly. According to some sources, Chinese VCs invested 13 billion USD in 2011 and 3,7 billion USD in 2012, but according to Dow Jones VentureSource 2014 the investment size was only 6,5 billion USD in 2011 and 5 billion USD in 2012. In any case, 2013 was a slow year, and the Chinese VC investments declined from 11% in 2012 to 7% in 2013 on a global scale, amounting to 3,5 billion USD. For 2014 official numbers were not yet available, but the outlook is good and the numbers are expected to go up: In the first half of 2014, China saw 83 new venture capital funds set up, worth a total of 6,76 billion USD, according to data from Zero2IPO Capital. In that same period, 5,3 billion USD worth of VC investments were made into start-up companies in China. (TechinAsia 15.1.2015)

In any case, the Chinese VC investment is still small compared to the US, ranging between 5 and 10% of the US VC investments but already close to European numbers. From the above numbers it can also be seen that SOEs and POEs are much more significant investors to date, and this should have an effect also in the strategies Finnish governmental organizations and companies deploy to seek finance from China to Finland.

About one third of all of China’s venture

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capital investments are made in Beijing, and a majority of that in TMT. Internet, eCommerce, Mobile Internet, Chinese consumer software for the local market are the main investment targets. The generic trend for Chinese VCs seems to be to invest at the second or later investment round, where the risk of investment is smaller and exit can be realized sooner. This of course has an impact on the size of the investments. Respectively, Chinese VCs have historically made very few seed investments. This may be partly due to the fact that very few Chinese VCs have technology/product/market understanding, a point made also by Chris Evdemon from Innovation Works.

Mickio Liu, FortuneLink (Chinese VC that invested in Jolla), also says that they are looking to invest earliest in the A round when they are looking for investment targets in Finland, and that the target company can not be too small and should already be established in the Finnish market. Also, there has to be clear understanding that there is also potential in China. He, however, continues to explain that there is a difference in market vs. tech focus, so, for example, in the gaming area many investors are interested in licensing games even before they are released.

Angel investors are gaining ground in China and are filling the gap of Chinese VCs. 55 new seed funds were started in China in 2013 alone. The combined capital of these is said to be over half a billion euros. (Kiina8 12.12.2014)

In general, angel investors are still relatively inexperienced and demand a high stake in the company. There have, however, been more experienced angel investors emerging from successful Chinese companies. William Bao Bean, SOS Ventures, summarizes; there are 10 000 angel investors in China, so the number has ballooned over the last two years, and China has become so

competitive and talent has become so scarce that the internet leaders have added the acquisition tool to their tool box.

Manmeet Singh, Angel Investor, summarizes that Government/Province/ District/City funding and support for software, biotech, hardware is available, but you need a local champion to make it happen and get the funding. This point is significant when you consider how to try to get funding from China. However, to date nearly all of the companies who have received money have been founded by ‘foreigners’ that have actually been returning Chinese.

Types  of  Chinese  Investors  

As can also be seen from the statistics above, not all Chinese investors are alike; they can be categorized by nature and background, extent of experience and commercial objectives. Also, the potential to locate investment targets can be seen as an important factor when it comes to investment to Finland.

According to the ownership and corporate governance of Chinese enterprises, Chinese MNEs with direct investments in Europe can be divided into three groups.

Figure 1. Types of Chinese OFDI investors (EU SME Centre).

State-owned enterprises (SOEs) Most of China’s state-owned enterprises are large industrial and service groups

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belonging to SASAC’s central and local administrations. In addition, there are also sovereign wealth funds, state-owned insurance companies, venture capital firms, pension funds, research institutes and government departments and agencies. The expansion of SOEs in Europe has been strongly supported by the Chinese central and local governments. Most of them often opt for the acquisition of key tangible and intangible resources and strategic assets, mainly through asset augmenting M&As.

Private-­‐owned  enterprises  (POEs)  Chinese private-owned enterprises (POEs) have successfully developed into dominant players in the industries where the monopoly of SOEs was removed or waning, such as machine tools, consumer electronics, telecom equipment, automotive industry and renewable energy. Due to the rapidly growing large-sized home market, these firms succeeded to acquire the capability to engage into large scale manufacturing activities based on state-of-the-art production facilities and cost leadership position. The direct investment of these private companies in Europe, either through take-overs of existing European companies or via greenfield establishments, is strongly driven by their search for new technology, well-known brands and efficient distribution channels.

Individual  and  family  investors  Most of Chinese individual and family investors are small-sized companies mainly involved in cross-border trading activities. These individual and family investors can often be described as international entrepreneurs or “suitcase investors” who are searching for business opportunities abroad. Such investors do not necessarily have a strong business basis in their home country and most often lack sophisticated ownership advantages. The international development of

Chinese entrepreneurs is clearly illustrated by the surge and expansion of Chinese private business in Central and Eastern Europe. Their establishment in Europe is driven by the desire to look and find opportunities of growth in foreign countries as a way to avoid the saturation of the Chinese market. Yet, some of these companies can be considered as “hidden champions”, as, despite their low profile in Europe, they are strong family businesses in China. (EU SME Centre.)

Venture  capital  firms  A fourth category of investors, missing from the above categorization of Chinese MNEs, is Venture Capital Firms. There are a large number of VCs in China, as well as Angel Investors, but the latter can be categorized under individual and family investors.

Remarks  Related  to  Different  Types  of  Investors  

Chinese SOE’s and POE’s main investment model has been M&A taking control of the investment targets, so at least partially this is likely to continue to VC type investments where the Chinese counterpart is likely to take control at least in the efforts into China. This has been seen in even very high profile cases such as Amazon and LinkedIn entering China with the support of a local VC (note: these companies hardly need Chinese investment, but they need the access to market and after having failed to do so on their own they have turned to local investors for that).

Different investors have different motivations for making an investment. For some the goal is purely return of investment or financial gains, for others there may be different motivations such as strategic (access to technology, access to market, brand). Venture capitalists by definition look at purely for

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return on investment. VC/ROI motivated cross-border investment from China to international markets has been active towards the US, especially Silicon Valley, but to a much lesser degree into the EU and especially Finland. The reason behind this is obvious, there are relatively few cases emerging out of small countries like Finland that could provide the type of returns of investments that these types of investors are looking for. For these types of Chinese investors the motivation to invest outside of the domestic market can be categorized into two options: 1) lack of deal flow in the domestic market, 2) better opportunities with bigger returns outside of the domestic market. Investors like to look at reference cases and examples that they can duplicate.

As an example of the best investment from China in recent times, Xiaomi founded in April 2010 is now four years later valued at 45 billion USD, making it the most valuable start-up in the world. There are numerous similar cases in China providing remarkable return of investment for the VCs that can access these deals. For the top VCs there is enough quality deal flow in China to be complemented with the top cases from the US. Strong support from the government into innovation and R&D and the active entrepreneurial environment in China, the success cases most likely will continue to emerge in China. In other words, there is no strong pressure for Chinese investors to go abroad. However, once thinking about expanding operations some VCs are looking to expand investment activities abroad, too.

The role of Finland in attracting these types of investors is in that there are some unique technologies that can be capitalized in such as way that they will bring exceptional returns for the investors. In reality, a country with the size of Finland can only provide a

handful of such cases at any given time. According to Legend Capital (Lenovo’s investment arm), another possibility is to work with these types of Chinese investors in finding technologies and solutions that in some way support the existing portfolio companies of the Chinese investors.

Investment  Process  SOEs are generally seen more challenging in terms of investment process and speed. Annabella Fu van Bijnen from Linklaters, for example, pointed out in December 2014 at the EU Chamber of Commerce event in China that for SOEs the decision making process is generally more inflexible and time-consuming due to due diligence being more extensive and decision-makers are usually far from the negotiation table. Also, the lack of transparency of the process can be frustrating to the parties. Private-owned enterprises are generally quicker in the decision-making process and tend to rely heavily on advisers to complete the process.

Fu van Bijnen also listed the general concerns of Chinese investors. These included, for example, lack of trust or bias towards Chinese investors, lack of understanding of target jurisdiction, investor needs vs. market practice in target country, Chinese government reviews and need for approval (due to change only to include investment in sensitive countries and industries), and integration after investment.

One significant change in the last few months is the Chinese government policy change to ease approvals for foreign investment. Before, this has prolonged the investment process considerably, so most Finnish target companies will be able to benefit from this change. Only investment into companies operating in sensitive industries still need the to go through the lengthy approval process. The

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investment process will be described further later in this report in the section titled Advise to Companies Seeking Finance from China.

Commercial  Objectives  The commercial objectives of different types of Chinese investors also have an impact on what type of investment they are looking for. SOEs can be driven by government directives, POEs by e.g. gaining market share, value chain, acquiring IP or Brand, raising profile, finding resources and assets, or just opportunity. Gaining access to the local market and an entry point to Europe seems historically a dominant motivation for most Chinese companies investing in Europe.

According to the European Chamber of Commerce in China, Chinese companies invest abroad to obtain resources (e.g. physical resources, specific skills or expertise), market share, and brand recognition in order to overtake their competition in China. They also seek strategic assets through investment abroad to enhance future competitiveness (ports, airports, logistics, transport). Specifically in the EU, Chinese OFDI seeks not natural resources, but brands, operating platforms and technologies as well as market access.

Paradox   of   Risk   Management:   Chinese  vs.  EU  Investors  European VCs want to see main investments targeted to European operations of their portfolio companies as they feel more comfortable in managing the companies interests close by but Chinese investors for their own risk management purposes want to emphasize their investment into execution of target companies’ business in China as they can best contribute to the success in China.

Main   Mode   of   Chinese   International  Investments  vs.  Domestic  Investments  

The Chinese domestic investment range is the full range available for domestic companies, everything from seed to pre-IPO/MBO/M&A. Domestic investments today for the range of scope as well as the way they are done is beginning to be quite, if not completely, similar if not the same as in the rest of the world.

Government controlled VCs and Fund of Funds (FOF) might have large allocations of funds, but they haven’t had the need to really think of how investment processes work making the practice of working with them quite challenging, especially for foreign companies and investors who don’t understand the nuances of the Chinese culture. But private Chinese VCs in their fund raising efforts have had to put together a solid plan of how they will make investments and produce profits, and they have copied a lot of the working models from the West, which makes working with them more transparent and familiar. Chinese VCs typically invest in a later stage than European or US VCs since they expect their return of investment to realize quicker.

International or cross-border investments, due to the challenges (language, culture, juridical, business culture, inexperience in international or cross-border investments) that result in complexities and increased risk limit the range of investment. Historically the types of investments the Chinese have the most experience in and feel the most comfortable doing, are investments into infrastructure, natural resources, M&A (initially started by SOEs and lately have been followed by POEs).

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Chinese VC minority investments seem to be in pilot phase in Europe, but there is no systematic presence in this yet, even though there seems to be a lot of interest in this in China, the EU and Finland. It is likely that if the trend continues, some actors specializing in China-EU investment will emerge in the next five years. Some early players are already in the market looking to claim a leading position, such as A Capital, with offices both in Brussels and Beijing and a 250 million euro denominated fund with a focus on syndicating European originated deals with Chinese co-investors. A Capital’s success cases from Europe to date include Bang & Olufsen and Club Med.

Some big name US VCs such as Sequoia Capital, Draper Fisher & Jurvetson and European players such as Atomico and DST from Russia have successfully invested into Chinese growth companies, and vice versa some Chinese VCs such as China Broadcom Capital have invested in the US (Silicon Valley) successfully.

Foreign VCs have been involved in nearly all big Chinese success stories, such as Baidu, Tencent, Alibaba, Xiaomi. There can be seen two reasons for this: perhaps in the case of Baidu, Tencent and Alibaba the large Chinese investors were not yet active in this scale or did not yet understand how attractive investments these were, and for later companies like Xiaomi the reason might be that they want value add that foreign investors can bring in the internationalization efforts they are planning at a very early stage.

Chinese  Investment  into  the  EU  

In terms of the EU, Chinese investors show a preference for investments in the largest western European countries.  Overall, China sees the EU as a stable

and predictable market and due to the current downturn of the economic market attractive valuations also make Europe a desirable destination for investments.

Different sources emphasize different areas of investment, but there is variation also based on target countries. Areas of investment include, for example, technology, infrastructure, heavy industry, goods manufacturing and services, including healthcare, finance, media and entertainment as well as telecommunications equipment.

Different EU countries are perceived as offering different strategic advantages in terms of the business environment they offer. How Chinese enterprises target which country to invest in tends to come down to a number of factors: a) Access to local market; b) Presence of a local business partner; c) Availability of certain technologies; d) Availability of skilled labor; e) Tax regime as well as availability of incentives and supportive policies; f) Logistical reasons; g) Cultural and language factors. (Chinese Outbound Investment in the European Union, European Union Chamber of Commerce in China, 2013.)

The 2013 Golden Bridge report on Opportunities for Greater China VC Investment in European Companies lists Chinese investors/investments in the EU and summarizes thoughts of European companies who have received investment from China/Hong Kong as to the success or failure of the investment process. The report states that the investment experiences have been mainly positive, but due to cultural differences the process of getting the investment has taken longer than it would from Western counterparts. This has also been the response the Author has received from Finnish companies who have received investment from China.

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Current   Situation   of   Chinese   OFDI   to  Finland  

Chinese investors regard Finland very highly as a source for innovation and a safe place to invest so this does not explain the imbalance (it is partially explained by big investments by large Finnish industrial companies into China, but China could easily in theory do the same into Finland).

There have been relatively few successful investment cases to Finland so far. Finnish efforts have been led mainly by public efforts with relatively little to show for the work. Despite attempts to coordinate and get various actors to cooperate under the Team Finland strategy, reality is still that there is competition even among fully government-funded agencies about work.

Examples of the type of investments taking place to Finland (2013-2014) include Aavi, Progman, IndoorAtlas, Jolla, Optomed, which cover a range of investments from M&A to corporate investment to VC investments. So whilst the numbers might be small, the full range is available in theory for Finnish companies.

Finnish VCs are slowly becoming active in China trying to establish contacts to the local ecosystem. Finnish VCs are frequently visiting China in order to better understand the local start-up and investor industry. Many Finnish VCs’ portfolio companies have operations in China so there is more pressure to become active in China, but so far the only VC with actual presence in Mainland China is Helsinki headquartered Inventure with an office in Shanghai. Besides syndicated and co-investments with Chinese investors, the Author’s view is that there would be good opportunities to attract Chinese

investors as Limited Partners into Finnish funds and via that establish initial formal relations to China. Further, China is a good potential destination for Exits and should be explored more for that.

Incubators/Co-­‐working  Spaces  

In the last couple of years a number of public and private incubators and accelerators have emerged in China, at least in all the main cities with heavy start-up activity such as Beijing, Shanghai, Shenzhen and Hong Kong targeting foreign teams and companies looking to enter Chinese market. So far we have not found a single Finnish team or company participating in these.

From the Finnish start-up perspective Incubators could be an important gateway for Finnish companies to gain access to the Chinese market and to get funding from China, mainly because the best incubators provide direct funding that is rarely available for early-stage companies from outside of China and they gain a real understanding that is needed to access the market, so they are better equipped to make the decision of whether to enter the market or not.

The main areas where incubators relevant to Finnish companies can be found are Beijing, Shanghai, Shenzhen and Hong Kong. In principal there are two types of incubators, public and private. Public incubators seem to typically want “bureaucracy first”, in other words you have to established a local presence and set up a physical business in order to access the incubator. Private incubators, on the other hand, are very flexible providing you a very low barrier to start and you can scale up and formalize your operations as need arises. Of course, some very flexible options are available

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also from public organizations, such as the EU SME Centre in Beijing that offers a hot-desk from a few hours up to a month, as long as you can provide a valid visa and a copy of your passport.

The emergence of co-working spaces is prominent in all hot-spots for start-up activities, such as Beijing, Shanghai, Chengdu, Shenzhen and Hong Kong. In Beijing, for example, there is already a strong incubation culture in co-working spaces: there are even cafés, such as Cheku, 3W and Beta, dedicated to start-up activity. These cafés aim to link start-up founders with potential investors and some even provide office space, resources and start-up capital. According to Want China Times, the municipal government is planning to develop the area where these cafés are located into a hub for venture capital and start-up financing (Want China Times, 16.02.2013).

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Geographical Considerations

There are geographical differences in where different sectors of industry are concentrated in China. This also has an impact on the interest of VCs from different parts of China, and the services provided in these areas. Below is a summary of select hot-spots for start-up and investment activities.

Beijing  

Steve Blank describes in his Huffington Post blog (29.04.2013): …”what made the overwhelming impression for me was finding an entrepreneurial software cluster on par with the Internet software portion of Silicon Valley. The physical heart of the Beijing startups is in Zhongguancun in the Haidian District, located in the northwest side of Beijing. Startups here are primarily in what they call the TMT (Technology, Media and Telecommunications) segment. Not only does Zhongguancun have Chinese startups, but global technology companies (Nokia, Ericsson, Motorola, Sony Ericsson, Microsoft, IBM, Sun, Oracle, BEA, Alcatel Lucent, Google) all have offices here or elsewhere in Beijing.” Beijing is the national hub for software and TMT in general.

Beijing is the capital with the big C, all the key decisions happen in Beijing. This also means that Beijng is a great place to meet both the leading Chinese entrepreneurs as well as the top leaders of multinationals and leading technology companies, as well as leading starp-ups. Everyone visits Beijing regularly even if the operations are based elsewhere. Beijing is not only a Chinese hub for business and technology but quickly becoming a global hub.

Zhongguancun in Beijing is a combination of science parks and regional policy and most of the technology companies in Beijing are in areas governed by Zhongguancun. In

total there are currently more than 20 000 technology companies under Zhongguancun’s administration, totalling revenues of 2570 billion CNY from January to October in 2014 with 19% year on year increase. They also recorded profits of more than 300 billion CNY. Out of the 20 000 companies, Mr Yang, Executive in Zhongguancun Software Park, told in June 2014 that roughly 14% are already mid-size to large companies that are looking for internationalization through investments.

There are three reasons for the success of Zhongguancun; 1) there is a strong academic hub with China’s top universities, Tsinghua and Peking University as well as many other top universities and research institutions; 2) technology and innovation are of strategic national interest to China, so Beijing being home to the government it is natural that the concentration of renewal and development is in Beijing; 3) success breeds success, growing number of Beijing based entrepreneurs have scaled up, become either valuable listed companies such as Baidu, or the most valuable start-up globally, like Xiaomi.

Shanghai  

Shanghai is historically a commercial and financial center of China. Shanghai is not only the leading container port in China, but also the busiest container port in the world in 2013. The top three industries are retail and wholesale, financial services and real estate. Other focus areas are financial services, logistics and cultural industries. Shanghai is also one of the main cities in China for heavy industry. Many investors see Shanghai as the main hub for design and related consumer products.

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Shanghai is trying to position itself as the financial hub of Asia, competing against Hong Kong and Singapore. By the end of 2013, there were 1240 financial institutions, including banks, insurance companies and securities companies, of which 215 were foreign-invested.

By 2013, multinational companies have set up 445 regional headquarters and 366 R&D centers in Shanghai. The city is also the home of the China (Shanghai) Pilot Free Trade Zone (see more below). Shanghai is an attractive destination for Finnish companies also because the Finnish business community is the largest in China in Shanghai, and there are many services, such as FinChi, available for start-ups and growth companies. Several foreign investors summarize Shanghai to be very different from other areas in China because it is so westernized. This makes it easier to operate in China.

Shenzhen  

Shenzhen has lately been labeled the Silicon Valley of Hardware, which has grown in 30 years from a fishing village to a 10 million people city, thanks to being the first Special Economic Zone in China. Shenzhen is very much the hardware capital of China, together with the whole Pearl River Delta. Shenzhen’s close proximity to Hong Kong also makes it a convenient location if you are in the hardware business. It is also the home to, for example, the technology giant Tencent, and a base for numerous other multinational companies.

Shenzhen is a very good destination for start-up or growth companies that need to develop hardware on a budget, since there are numerous factories and

design firms in Shenzhen that support agile development and fast production of even small quantities of hardware products. There are even generic designs available for smartphone, tablet, smart watch etc. hardware and casing. Modification of existing designs on the fly is easy together with the experienced engineers that these factories have.

Shenzhen is also becoming a popular place for hardware incubation and investment. This is an outcome of the growth and success of the local hardware industry, and especially in a situation where low-cost manufacturing is moving inland, factories are prone to more co-design processes and innovation.

Chengdu  

Chengdu is rapidly becoming one of the main technology hubs for China and the city has ambitious plans to gain importance on a global scale from just high-tech manufacturing to software development and innovation. When interviewing VCs their first comment was every time that Chengdu is best for gaming related development in China.

One of the things that makes Chengdu attractive for Finnish start-ups or growth companies is that there is already a solid presence of Finnish companies in the city. Like Beijing and Shenzhen, it is also a base for many multinational and large Chinese companies, like Intel, Foxconn, Dell, Philips and Huawei. Overall there are over 1000 foreign companies in the Chengdu Industrial Hi-Tech Development Zone and it is said that there are over 50 000 companies in total. Labor costs are still cheaper than in many other large cities, and there are many good universities providing a competitive talent pool.

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Hong  Kong  

Hong Kong as one of the World’s most significant finance districts is an attractive option for Finnish companies. It is fast and inexpensive to found a company in Hong Kong, taking from a few days to a week, compared to the six month to a year process it takes in Mainland China. Hong Kong is also a convenient and important gateway to Mainland China. Further benefits include the relatively Westernized culture, English as one of the spoken languages, and money transfer is quick and easy to/from Hong Kong and also relatively easy between Mainland China and Hong Kong.

Hong Kong’s combined fund management business amounted to 2,05 trillion USD at the end of 2013 (up 27% from 2012) while assets under management under private banking totalled 353 billion USD. Hong Kong is an important hub for VCs and other private investors. Hong Kong also has an active start-up scene with a growing number of incubators.

Free-­‐Trade  Zones  

The China (Shanghai) Pilot Free Trade Zone (PFTZ) is a free-trade zone in Shanghai established in 2013. Officially launched in September 2013 it is the first free-trade zone in Mainland China. PFTZ is used as a testing ground for a number of economic and social reforms. The PFTZ offers various benefits for companies and makes company establishment within the zone much faster and easier, and there is no minimum registered capital. According to the Shanghai Statistics Bureau, close to 10 000 businesses had registered within the PFTZ as of June 2014, 661 of which were foreign-invested enterprises.

PFTZ also introduces a number of reforms designed to create a preferential environment for foreign investment. As of June 2014, the PFTZ had finished 51 projects of overseas investment, foreign investment of 1 272 billion USD covering 14 countries and regions, mainly in trade, management, consulting and other service industries. PFTZ also does cooperation with the neighboring cities to offer lower cost options for production, etc. and have made various policy renewals to ease import/export operations.

In December 2014 the Chinese government approved the establishment of free-trade zones in Tianjin, Fujian and Guangdong.

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Advise to the Finnish Public Sector, Companies and VCs

Advise  to  Finnish  Public  Sector  

There have been made reports made by Finnish public organizations regarding issues and problems related to attracting investments from China to Finland. Below there is a summary of a couple of reports made on the EU level addressing generic problems.

According to a survey made by the European Chamber of Commerce in China, they recommend the following improvements at the EU/national/local level:

a) Provide tax incentives It was commonly stated that the establishment of tax incentives and preferential policies to lower costs would work to encourage greater future investment from China. b) Provide better advice and support in relation to the legal environment Common recommendations focused on support and advisory services that Chinese enterprises felt would be of assistance in investing in Europe. This included requests for a centralized source of EU27 legal, regulatory and financial information in English, providing regular seminars on issues such as tax and labor law and also providing certain legal and management training for individuals. c) Relax restrictions on visas and work permits Recommendations relating to the easier granting of visas and work permits to Chinese employees were common. d) Relax labor laws Recommendations were frequently made relating to the relaxation of labor laws. It was noted that in practice this might be easier to enforce just for expatriate employees, rather than local hires. e) Provide preferential policies for HR and R&D expenditure Other preferential policies were recommended to encourage investment in local HR and R&D.

f) Simplify approval processes Recommendations relating to an easier regulatory regime and approval process were made. g) Improve EU-China trade and investment relations The maintenance of a stable and open trade and investment environment for Chinese enterprises in Europe was also regarded as a priority. h) Establish business-to-business platforms The establishment of various platforms to foster business relationships between Chinese and European enterprises was recommended. The perception was noted that other regions do this more successfully in China than the EU. i) Lower antitrust investigation requirements Recommendations were made to reduce the burden of antitrust investigations. (Chinese Outbound Investment in the European Union, European Union Chamber of Commerce in China, 2013.)

The EU SME Centre provides the following advise for attracting investment for SMEs:

• Raising awareness of local SMEs about the opportunities and challenges when linking up with Chinese direct investors;

• Developing special programs that facilitate networking and matchmaking opportunities for local SMEs and Chinese investors, or providing databases on suppliers and business alliance;

• Taking measures that encourage local SMEs to link into different stages of the GVC of Chinese MNEs and the knowledge creation stage in particular;

• Providing tax incentives for Chinese MNEs to localize their R&D activities;

• Promoting technology transfer between local SMEs and Chinese MNEs;

• Encouraging public-private partnerships between local research centers, universities and Chinese MNEs;

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• Providing support for SMEs that wish to expand their international market through linkages with Chinese MNEs;

• Facilitating cooperation (e.g. SME consortia) for joint marketing or joint bidding in the procurement contracts of Chinese MNEs;

• Organizing competency training and cultural awareness programs for SMEs that facilitate their communications with Chinese MNEs. (Chinese Outward Foreign Direct Investment in the EU, EU SME Centre, 2014.)

Business-framework, and operating, market and infrastructure related difficulties are obstacles that must be tackled if we wish to attract more investment. The European Chamber of Commerce in China lists related difficulties when companies are trying to enter the EU:

Business-framework related difficulties

a) Residence and work permits: The issue of visa, residence and work permits for Chinese employees of enterprises that are investing in the EU. b) Labor laws (social security, unions, contracts): This is particularly relevant in M&A cases where such laws maybe hinder planned restructurings and are perceived by some Chinese enterprises to be inflexible. c) Tax regulations and accounting

Operating, market and infrastructure difficulties

a) Human resource-related issues: This includes cultural differences in terms of management style, personnel cost, and issues with hiring and retaining the right staff. Management style- related issues would particularly be an issue in M&A cases. Other cultural issues include issues relating to overseas Chinese

community and suitable schooling facilities. b) Currency risk c) Perception and image: Concerns about the quality of Chinese products, lack of brand recognition and a general negative perception of Chinese enterprises. (Chinese Outbound Investment in the European Union, European Union Chamber of Commerce in China, 2013.)

Advise   to   Companies   Seeking   Finance  from  China  

When  to  Seek  Finance  from  China  You should not look for finance from China just for the sake of financing your operation. Rather, it should be viewed as a way to either access or accelerate growth in China. Typically Chinese investors are not interested in cases where there is no China strategy as China is what they understand the best and there they can potentially also provide most added value through their contacts.

However, if you are looking to take the first step into China with an investor they are most likely going to look for a way to control the business in China, and often also globally if there is reason to believe decisions elsewhere will affect the way business is conducted in China, via e.g. majority ownership as they are quite rightly skeptical about the ability of newcomers to succeed on their home turf. As a compromise, some Chinese investors have suggested to foreign companies to move their headquarters to China.

So in many cases this means potentially selling up all of the operations to the Chinese buyer, who wants both new products and technologies as well as better reach to new market areas via acquisitions, which is a model they have

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historically done most investments and they have most understanding of.

However, in China everything is always open for negotiation; anything is possible when seeking for a solution for a mutually agreeable and beneficial deal, or as Chinese like to refer as win-win, but in the end there is the ‘’Golden Rule’’; the one with the Gold makes the rules whether that is IPR or money or something else of value, so you must make sure you have all aspects of your business interests covered and do not come to China as a last resort to find financing or customers.

Manmeet Singh, Angel Investor, for example recommends: “Don’t come to china just expecting to get money, come here first to learn how things work, then decide if you want to go for it. Some larger funds are OK for getting funding, but it’s not easy.” Todd Embley, Chinaccelerator, continues to say that you need to know how to navigate and operate in China before taking money. Also other investors say that for start-ups it is not easy, since offering and needs rarely meet, and Chinese investors are much more likely to invest in growth or larger companies.

How  to  Seek  Finance  from  China  Pablo Recio, Gold Millenium Group, gives simple advise on how to approach the Chinese market to attract investors. He says that Chinese companies lack knowledge about EU countries. The key is to find the real competitive advantage and offer something unique and useful to Chinese companies. This means building competitive advantage where you can, not necessarily where we want. Often this kind of advantage can only be found on a sector, or even company level.

Below is an overview of the key points of the process for seeking finance:

1) Define your China strategy, you

must show real understanding of the business environment in China and preferably proof of that through pilot customers.

2) Protect your IPR in anyway you can locally according to local laws.

3) Define where is your best access point to China (the right customers), and how you scale up to meet the investors expectations.

4) Define what type of investors can best help you reach your business goals (e.g. POEs for access to customers or VCs for something else).

5) Send a key executive to China for 3-6months to validate your plans and to establish connections and justification for an investment into China (most likely accessing Chinese investor will mean that initially you have to finance the first steps with company’s existing funds).

6) Prepare a ‘’long list’’ of potential investors, preferably investors that you can access through some trusted party’s introduction.

7) Start negotiations, use outside help in the form of consultants or lawyers, or both, that have done this in China before and have references to back that up.

8) Nothing is a ‘’done deal’’ until you have money in the bank. This is true everywhere, but even more so in China.

Depending on how ‘’ready’’ you are the process takes 6-18 months and quite a bit of investment to cover investment from management and fees from outside help such as lawyers and consultants.

Of course, there are other options than just seeking finance if you have enough capital to seek entry into the Chinese market. Some investors recommend, for example, franchising if you have a ready consumer product, or a rep office with some staff to make connections and learn first, then see if you can start leveraging through some big players in Finland.

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Notes  on  VCs  Here are links to some venture capital and private equity associations that already list hundreds of venture capitalists active in China. One can use this as a starting point in preliminary studies to map out venture capitalists in China. In the above section there was more specific information on how to find the right type of investor.

China Venture Capital and Private Equity association http://www.cvca.com.hk/aboutcvca/profile.asp

Zhongguancun Venture Capital and Private Equity association http://www.zvca.org/Enindex.html

Shanghai Venture Capital Association http://www.shvca.org/ (in Chinese)

Hong Kong Venture Capital and Private Equity association http://web.hkvca.com.hk/en/index.aspx

Examples   of   Incubators   Suitable   for  Finnish  Start-­‐ups  Chinaccelerator: Chinaccelerator, based in Shanghai, has been referred to as number one incubator in Asia. Once a start-up is accepted into the program the company gets 30 000 USD in cash for up to 7% of equity, plus services such as free rent for six months and attendance at the 8x8 conferences in Beijing and Shanghai. After graduation Chinaccelerator exposes start-ups to a wide variety of funding sources. They have 150 mentors who are business leaders and entrepreneurs and many become investors in the companies they mentor. They also have close relations with AngelVest, the largest angel group in North Asia, as well as a network of other angel funds and early-stage investors. Todd Embley from Chinaccelerator says that their goal is to get 50% of the companies funded after the program.

FinChi Shanghai and Shenzhen: FinChi Shanghai has been quite successful in providing soft-landing services to Finnish companies for many years already. FinChi provides office space and various services, which make it easy for Finnish companies to enter China with decreased risk and take time to test the market. FinChi can also be seen as a place where start-ups and growth companies can spend some time, while looking for investment opportunities from China.

Zhongguancun Software Park Incubator: Zhongguancun Software Park (Zpark) in Beijing is the National Software Industry Base and National Software Export Base of Zhongguancun National Innovation Zone in China. It is China’s premier science park that wants to attract Finnish companies to China and has an office also in Espoo. Companies seeking entry to China can get advise from Zpark Finland. The incubator in Zpark provides assistance for companies registering their operations in Zpark. In Zpark there will also be a FinChi Beijing providing softlandin services. Further, there is Cloud Valley, which provides softlanding as well as investments for select cloud computing companies and has already done such notable cases as Evernote, Amazon web services and LinkedIn from the US.

HAXLR8R: Haxlr8r Is a hardware incubator that brings engineers and entrepreneurs from around the globe to Shenzhen for a crash course in prototyping and manufacturing. The fifteen week program offers hands-on help, mentoring and networks. They have 60 mentors and an extensive team. Haxlrl8r gives those chosen to participate 25 000 USD for a 6% equity in the company, or 100 000 USD for 9%. There are also other services and benefits available.

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Througout China there are many science and technology parks that are already in place or are looking to set up new types of programs and incentives to get more local and foreign companies to locate or re-locate into their premises. You need to consider carefully whether the incentives provided are worth setting up your business over there as the main concerns should be proximity to key customers and availability of talent. Almost all first and second tier cities seem to have one or more of these initiatives either in place or in the plans but before making a final decision you should do your due diligence. ”All” public initiatives seem to have some very high level support, but whether that is realized into practical benefits for your business is a question.

Advise  to  Finnish  Venture  Capitalists  

As Chinese technology market is maturing and can be considered in most cases in par or even excelling over its European counterparts, the Venture Capital market is still very much going through adolescence and learning by doing while Fund of Funds activities are even younger and more immature for the most part.

From the Chinese VC industry you can find some very professionally run VCs that are comparable to western counterparts but also a wide mix of players who want to invest into something that somehow will make profits very quickly.

Below are a few key points from a recent China VC/PE industry Survey Report (2013-2014):

- Limited Partner’s diversified their investments

- Over half of the LPs realized a book value of 10% to 25% on portfolio investment

- Over 60% of the LPs enjoyed special preferential terms not listed in the fund agreements

- Default on LP’s capital commitment increased significantly compared with earlier surveys

- Over 40% of General Partners encountered situations in which LPs transferred their stakes in the funds GP managed.

As all the research shows there is more than enough money available from various sources that are also very willing to invest. However the ones that have the biggest funds and therefore also the most pressure also to look at investment targets outside the domestic market (Government, SOEs and POEs) typically have relatively weak teams for analyzing and processing investments whether that is as an Limited Partner or as a direct investor. The VCs that have most capable teams have so far mostly concentrated on the domestic market.

For Finnish VCs there are several opportunities:

1) Increase the size of their funds by having Chinese investors join in as LPs but as noted in the China VC/PE Survey a Chinese LP might be challenging to work with, so money should not be the only consideration of having a Chinese LP.

2) Exits of portfolio companies, Chinese are comfortable with the idea of M&A and getting more skillful in that so exit to China should be a must option to look at.

3) Doing syndicated deals with Chinese VCs or having them take an active role in growth rounds especially if the portfolio company’s main target is in China is an option, as a number of successful cases between US and China have shown. European VCs might look into ways US VCs have succeeded in that. China’s ties to Silicon Valley and key players over there have obviously played a big role, but Europe has its own strong points

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that it should emphasize e.g. a more friendly attitude towards Chinese investments, the strong reputation of the Nordics and Finland for innovation etc.

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Views on the Future, Key Trends and Expected Implications

Chinese  Government’s  Goals  President Xi Jinping announced during APEC that China will invest 1,25 trillion USD in the next 10 years abroad. The Chinese OFDI is expected to grow 10% annually over the next ten years as demand for industrial products and infrastructure surges in developed and developing markets. China will continue to increase the flexibility of OFDI procedures to allow domestic companies to gain more control of their overseas business.

The Chinese Government has just announced that they will set up a state venture capital fund worth 6,5 billion USD to invest in the country’s start-ups. It covers tech startups in innovative areas, as well as young companies venturing into new fields in things like green energy and biotech. The “establishment of the state venture capital investment guidance fund, with the focus to support fledging startups in emerging industries, is a significant step for the combination of technology and the market, innovations and manufacturing.” (TechinAsia 15.1.2015) This further supports and emphasizes the goal of switching China’s operational goal from made in China to innovated in China.

Key  Trends   for   the  Coming  Five  Years  (Authors  View)  

Below are some key trends of the Chinese Investment Market for the next five years:

1) Chinese OFDI will keep growing as the government has announced.

2) The investors will include investors from all sectors (Public and Private) into all sectors ranging from infrastructure to start-ups and funds.

3) Strong emphasis on M&A will continue, but all other investment modes will also become more

prominent as Chinese investors learn the more about the way international investments are made and managed.

4) M&A with Chinese counterparts will become business as usual for European and Finnish VCs.

5) Strongest performing European and Finnish VCs will attract lot of interest from potential Chinese VCs.

6) Few strong partnerships will get established between European and Chinese investors specializing in cross-border deals.

7) China will continue to grow in importance for Finnish and European VCs’ portfolio companies in terms of target market as well as competition.

8) All Finnish and European VCs will have a China strategy and most will have also either direct or indirect representation in China to serve their portfolio companies’ needs.

Expected  Implications  and  Recommendations  

1) Both investors and companies will be increasingly faced with dealings of either Chinese investors or companies; you should have at least a preliminary China strategy.

2) A lot of initial contacts will be clumsy (equal confusion by both Western and Chinese counterparts), best practices in China are different from best practices in the West. This is especially highlighted in complex transactions and documentation that investments require. Therefore, you should expect longer negotiation times.

3) Chinese investors might seem to be improvising their strategy when they are negotiating with you and sometimes they are, since they are newer to investments they often don’t have as formalized strategies in place and tend to look at cases very opportunistically. You should be aware of this and check constantly whether your goals are aligned.

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4) While opportunities to cooperate with Chinese investors increases so does competition, the window of opportunity is slowly opening, so the first steps for Finnish VCs to seek cooperation should be taken relatively quickly between now and in the next couple of years. Once Chinese investors have either learned to operate independently or secured a partner the completion will be much fiercer.

5) We will see some really big exits to China from European backed VCs in the next couple of years. This will result in some peak in China activity at the expense of the US, but that will level off where China will grow at the expense of the US but will remain much smaller than the US for a number of years.

6) As China will grow in importance as a source of capital, markets and exit destination and will have a place next to the US and EU for Finnish VCs, they should start to look at how they will balance their strategies to have a global strategy.

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Conclusions

OFDI from China is growing and expected to remain strong for years to come. Besides China’s economy becoming larger and therefore a more attractive market, access to the market is challenging, and money is only a part of the solution. Chinese investors are a relevant option to consider not purely from the financing perspective but as a way to access the local ecosystem.

Examples of the type of investments taking place to Finland (2013-2014) cover a range of investments from M&A to corporate investment to VC investments. So whilst the numbers might still be small, the full range is available in theory for Finnish companies. There is one thing that most companies share; they already have a presence in China or have a clear strategy in place to enter the market.

China is a challenging market but one should not make it too hard, aim to enter the market where both the investment as well as relevant industry ecosystem is already mature enough and is relatively easy to access, e.g. in the hot-spot areas of Beijing, Shanghai, Chengdu, Shenzhen and Hong Kong.

The paradox of China is that it is very large but also very quick to implement change when need arises. New policies can be introduced and implemented with such pace that it is hard to really understand (or react to) it from the outside. In the past year this has particularly impacted the investment industry with a number of policies loosened (and some policies became stricter) as to what you can or cannot do, and the still challenging bureaucracy has been streamlined in special economic areas, such as the China (Shanghai) Pilot Free Trade Zone.

In recent years a number of Public and Private incubators and co-working spaces have emerged and these should be taken into consideration by Finnish

companies as they can be an effective platform for getting into the market and to start building your business and accessing finance.

Challenges for smooth cooperation between Chinese and Finnish investors as well as companies exist, partially because cross-border cooperation is always challenging, and we still have very few reference cases. Therefore, both Finnish and Chinese are still learning by doing.

However, as the Chinese investment industry is maturing and taking big steps into international markets there are more opportunities than ever before to find win-win between Chinese investors and Finnish companies and Investors.

Whether China and working with Chinese investors is the right choice for any particular company or investor can only be evaluated by giving it a serious effort. Market studies and short visits are not enough. ‘’All the cats love fish but fear to wet their paws’’ (Chinese proverb).