PE, VC firms cautious in China ventures

Global limited partners are cautious about private equity and venture capital investment in China this year but they believe exit channels have become increasingly smooth, according to a report by ChinaVenture Group.

The study was based on responses from 90 limited partners with businesses in China and abroad, of which 24.4 percent were foreign. Investors in PE and VC funds are known as limited partners.

According to the report, 48 percent of the limited partners surveyed believe there is some risk in the Chinese PE and VC market and they are cautious about investments in the country. Nine percent of them said opportunities in China are limited. Another 24 percent of respondents had a positive outlook for the market this year.

Liu Yan, a partner at PricewaterhouseCoopers China, said a large number of domestic private companies took part in Chinese PE and VC investment as limited partners, partly encouraged by the good investment return of foreign LPs in earlier years in China.

"But as the investment cost is higher and the market conditions are worse, their investment return is expected to be small, so they are hesitating about continuing their investment in 2014," said Liu.

About 46 percent of the respondents said they are confident about an exit from their positions in China because there are diverse approaches to it. As many as 27 percent said they will try their best to exit soon.

Initial public offerings in the A-share market restarted in January this year after more than a yearlong freeze. The United States has been popular again among Chinese high-growth companies as a venue for going public.

The resumption of IPOs may bring limited partners confidence and encourage them put more money into PE and VC funds that have Chinese investments, said Gao Jianbin, a partner at PwC China.

Gao added that LPs will choose PE and VC funds that are able to cash out from deals in a timely fashion and bring them benefits.

More than 70 percent of the respondents said they will invest in funds with operating cycles longer than five years, which shows LPs in China have been more patient, said the report.

Venture and growth funds were the most favorable among respondents and were chosen by almost 70 percent of them, followed by buyouts. Funds for buyouts, potentially high-return mezzanine investment in which debt capital gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full, real estate and funds of funds are increasingly popular this year compared with 2013.

There are fewer good opportunities in pre-IPO deals. Companies at an early development stage may have great potential, which explains the popularity of venture and growth funds, according to Li Xin, an analyst at ChinaVenture Group.

As the second generation take over private companies from their aging elders, many of them are keen to sell their companies or be controlled, so buyout funds can do a lot of businesses in China, Li said.