Ben Chang, president of Hotung International Co., Ltd., never thought that the fund-management firm his company opened several years ago in Singapore for tax-free purposes would one day become his company's springboard into mainland China--one of the brightest stars in the global economy.

The Singapore affiliate has co-organized a management-consulting firm in Guangdong Province with the local provincial government, and a similar firm in Shanghai, since August 2001 on behalf of Hotung, which currently manages over NT$16 billion (US$460 million at US$1=NT$34.8) worth of funds.

Hotung has not injected any money into the mainland ventures; funding for administrative personnel representing the Singapore firm is directly from the Singapore firm. "Should Hotung decide to put money into our mainland ventures in future, however, we will raise money overseas, not divert funding needed for operations at home in Taiwan," Chang states.


Circumventing the Law


Hotung is only one of many Taiwanese venture-capital firms that have set up operations in mainland China through branches in a third country or region. This roundabout advance into the mainland is the result of laws in Taiwan that forbid venture-capital firms financed by the Development Fund of the Executive Yuan from investing in the mainland, and a mainland ban on the repatriation of earnings on local investments.

Still, like Hotung, more and more Taiwanese venture-capital firms are expected to pan for gold in the promising mainland economy. The incentives to do so have grown sweeter as the mainland authorities move to enact regulations designed to nurture the growth of the venture-capital industry there. The global economic downturn, which has limited investment opportunities in the U.S. and Taiwan, has also fueled interest in tapping the fertile mainland market.

In order to lure foreign venture-capital firms, the mainland plans to halve the income-tax rate on such firms to below 16% from the current 33%. In addition, since March 1 this year individuals have been allowed to open VC companies, though such firms must have paid-in capital of at least US$10 million. The new rule also lowers the required capital floor for corporate investors to US$5 million.



Among the primary targets of these measures are venture capitalists from Taiwan, which has the world's second-strongest VC industry after the United States. Since the island's first VC company was founded in 1984, its VC industry has pumped nearly NT$140 billion (US$4 billion) into Taiwan's high-tech industry and created value of over NT$1 trillion (US$29 billion). "The mainland needs more than capital," comments Chang, a former vice president of the China Development Industrial Bank, Taiwan's largest VC bank. "They need our experience and global partnerships to source good deals and funnel them into the mainland."

Taiwanese venture capitalists might not yet be fully convinced by these allures, but the tremendous business opportunities in the mainland are proving irresistible to many. Acer Group Chairman Stan Shih points out that the mainland has a huge domestic market to support industrial innovations. "The mainland is now the factory of the world, but within five years it will emerge as a market leader for innovative IT (information technology) products and the world's No. 1 market for IT appliances," he forecasts. Acer's established IP Fund I, which has raised US$260 million to date, will place half of its capital in the U.S. and the other half in Asia, including investments in the mainland's wireless-communications equipment and telecommunications-software sectors.


Big Market


Hotung's Chang predicts that the mainland will soon become the world's second-largest market for venture-capital investments after the United States thanks to its massive manufacturing capability and fast-growing consumer market. "The mainland is now the world's largest market for mobile phones, with 60 million phones sold there a year, and the world's second-largest PC market, absorbing over 10 million systems annually," he adds.

Whereas Taiwan's venture-capital industry took off with the help of overseas markets, it is the home market that is driving the mainland's budding VC industry, says Chang. He believes that mainland venture capitalists should therefore put their money into industries that still have high market demand. In Taiwan, investors usually put money into enhancing mass-production technologies, whereas U.S. investors inject money into pioneering technologies. "The three parties have unintentionally formed a perfect division-of-labor network, in which U.S. enterprises develop innovative technologies and transfer these technologies to Taiwan, which commercializes the technologies and develops volume-production techniques. Taiwanese enterprises then move production to the mainland in order to cut costs and be closer to their buyers," he says.

Since 1994, the number of mainland VC firms and their average size has grown at an annual rate of 50% and 5%, respectively, to comprise nearly 250 companies and RMB40 billion (US$4.8 billion at US$1:RMB8.27) as of last year. Around a fourth of the capital has come from overseas investors. Last year, many among the mainland's top 20 venture-capital firms were subsidiaries of companies that have also opened branches in Taiwan, such as the U.S.-headquartered H&Q Asia Pacific, Walden Group, and WI Harper Group.


Roadblocks Remain


Despite the mainland's bright prospects, there are still many roadblocks holding back the growth potential of the venture-capital industry there. Among the biggest of these obstacles are rules preventing VC firms from selling shares in invested businesses on the mainland's stock markets, the need for transparent accounting, and professional market analysis to enable informed trading on mainland bourses.

Without a mechanism for investors to make a return on their investments, foreign venture-capital managers remain reluctant to put money into the mainland. Since the mid-1990s, foreign capital has dropped to around 25% of the mainland's total VC funds, compared with 30% to 40% before, according to the mainland's foreign-exchange regulator.

The mainland originally planned to set up a second board, similar to the Nasdaq market in the U.S., for high-tech startups. China's Premier Zhu Rongji suspended the plan in 2000 on fears that deregulation would further encourage speculative investing.

For those who have injected capital into the mainland, the most typical ways to retrieve profits are through share reselling, settlement and acquisitions, repurchase agreements, and initial public offerings (IPOs). Until late last year, only two IPOs were carried out--both overseas.

Last year, H&Q Asia Pacific made a widely noted deal to realize gains on its mainland investments. It resold its 10% ownership in Hainan Air of mainland China to international investor George Soros for US$6.5 million, earning US$1.5 million. Dr. T.L. Hsu, chairman of H&Q Asia Pacific, is seen as something of a guru in Taiwan's venture-capital industry for his establishment of Taiwan's first U.S.-style VC firm in 1986. Hsu first ventured into the mainland in 1996.


Chinese Economic Cooperation


WI Harper chairman Peter Liu has frequently emphasized the importance of economic cooperation among people in the greater China region. When he opened WI Harper around seven years ago in California, he gave the company the Chinese name "Zhong Jing He"-- short for "Zhongguoren Jingji Hezuo", or "Chinese people economic cooperation." To achieve the goal, his company has opened branches in Beijing, Singapore, Hong Kong and Taiwan.

One of the most prominent cases spearheaded by WI Harper in this spirit of cooperation is a deal between the mainland China's Legend Group and Taiwan's Acer Group. Several years ago, Legend chairman & CEO Liu Chuanzhi visited his counterpart at Acer Stan Shih through Liu's arrangement. At that time, Legend was planning to sell its branded personal computers to the U.S. After his conference with Shih, he learned of Acer's fiasco in promoting its brand name in the U.S. market and decided to contract Acer to make computers for it. Last year, their deal reached NT$45 billion (US$1.3 billion) in value.



Liu anticipates that the mainland government will move forward with plans to establish a second board in the coming years. "I hope the new leadership will create a favorable environment for the VC industry in the mainland within three to five years," Liu says.

To keep his company well informed in the mainland, Liu has spent a large amount of time researching the mainland investment environment. Over the past 10 years or so, Liu has visited the mainland 97 times and established close ties with the mainland's leadership. He believes that VC companies should not simply act as an investment tool, but more as a technology-development vehicle facilitating technology transfers and the exchange of talent and capital.

Recently, his company helped video-compression software developer DivXNetworks, Inc. of the U.S. set up a research center in Taiwan to develop digital-content technologies. It also assisted Aviva Biosciences in transferring biotechnology to mainland China. WI Harper holds stakes in both companies.

Before retirement, the 50-something Liu hopes to help the mainland complete the development of third-generation cellular TDMA (time division multiple access) technology. The WI Harper-invested C-Will of the United Sates is working with the mainland's Datang Telecom Technology Co. to develop the wireless technology. "Once TDMA becomes a viable industry in the mainland, its revenue will account for around 1% of the mainland's GDP," Liu estimates.

Over the past four years, WI Harper, now managing US$250 million in funds, has indirectly plowed around US$30 million into the mainland. Once the mainland ventures begin to commercialize their technologies, Liu plans to list them on the U.S. stock market to get his company's money back.


Treading Cautiously


Liu has long been optimistic about the mainland's economic prospects. However, he is still cautious about the mainland investment environment. His company has never put money into mainland-owned companies, but rather directed such investments through their holding companies overseas. "The mainland's problem now is that its regulations for nurturing the VC industry are not adequate and the second board has not yet been established," Liu comments.

"Even if the mainland establishes this market, its speculative stock market and heavily regulated capital market will not inspire confidence among foreign investors," Liu says. He estimates that it will take at least five years for the mainland to form an environment favorable to the VC industry.

Liu says that the mainland has been actively learning about the VC industry since the early 1990s, sending government officials to Silicon Valley to see how things work there, much as Taiwan did before. He notes that Taiwan has a good start in developing its VC industry thanks to full government support and the mainland can learn from the island's experience.

When Taiwan began developing its VC industry in early 1980s, it already had the Hsinchu Science-based Industrial Park (HSIP), and the government quickly drew up incentives. In the mainland, Zhongguan Village Technology Park, the mainland's version of the Hsinchu park, was founded in 1995 in Beijing. It is located near several elite scholastic institutions, such as Beijing University and Qinghua University, just as the Hsinchu park has benefited from its proximity to Chiaotung University and Chinghwa University.

"Today, however, what new initiatives and incentives is the [Taiwan] government offering for the VC industry?" asks Liu. "Policymakers have no direction now and are at a loss."

Indeed, Taiwan's government has drawn strong criticism from local venture capitalists since the elimination of a 20% tax-break incentive for the VC industry in 1999. Since then, the island's venture capitalists have urged the government to allow the four government funds, including the pension fund for public functionaries, labor-insurance fund and national-security fund, to bankroll VC funds, loosen the ceiling on investments by banks and insurers in VC funds, and allow VC firms to go public. None of these requests has been answered. Taiwan has also been suffering from the worst economic downturn in 20 years, putting a damper on investment activities and further frustrating local venture capitalists.

"I'm afraid that mainland China will win in the competition between the two sides of the Taiwan Strait if Taiwan fails to hammer out a clear strategy," Liu says.