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Background (1) According to the Economic Reference Daily, Prior to 2001 foreign venture capital investment dominated the Chinese market in terms of investment volume. For various reasons this changed, in 2001 when the Chinese venture investment for the first time valued more than foreign venture investment. Specifically, the total venture investment in China in 2001 was US$ 518 million, in which RMB funding accounted for to approximately US$ 260 million. (2) As of the end of 2001, there were approximately four times as many Chinese venture investment companies as their foreign counterparts active in China. .ox^H  0޽h ? ̙33 ` ((     C d$v   v F A. Background (3) In terms of capital under management, Chinese venture companies were much smaller than their foreign counterparts, averaging RMB 110 million, while foreign venture companies averaged well over RMB 200 million. (4) In terms of the amount of single investment, Chinese venture companies averaged US$ 1.5 million per investment, whereas foreign venture companies averaged US$ 5.70 million. (5) Sources of RMB funding gradually shifted from government to private sectors. (6) The cities where venture investment is most active are Beijing, Shanghai and Shenzhen..G6H  0޽h ? ̙33  p$%( , $ $ C $%vP   v IB. Local Rules The importance of venture capital investments is well recognized by the central and local governments alike, and they have promulgated rules meant to encourage the development venture investment. In 1999, the State Council issued a circular which outlined the direction and framework of China's venture investment development. On August 28, 2001, MOFTEC, the Ministry of Science and Technology and the State Administration of Industry and Commerce jointly promulgated the Tentative Rules on Establishment of Foreign Invested Venture Capital Enterprises. As the title suggests, these rules are meant to encourage foreign venture capital to invest in Chinese companies. Rules that have been promulgated by the various local governments, on the other hand, apply to both foreign and Chinese venture investment activities. (J9H $ 0޽h ? ̙33 [S((  ( ( C %v     SB. Local Rules The following is a comparison of the rules promulgated by the Beijing, Shenzhen and Zhuhai governments. (1) Beijing: - Regulations on Zhongguancun Science and Technology Zone (Promulgated by Beijing Municipal Government on December 8, 2000) - Regulatory Measures on Registration of Enterprises in Zhongguancun Science and Technology Zone (Promulgated by Beijing Municipal Government on March 2, 2001) - Regulatory Measures on Limited Partnership (Promulgated by Beijing Municipal Government on February 21, 2001) H ( 0޽h ? ̙33  0 (  0 0 C !v  v LB. Local Rules (2) Shenzhen: - Tentative Provisions on Venture Capital Invested in High- and New-technology Enterprises (Promulgated by Shenzhen Municipal Government on October 11, 2001) (3) Zhuhai: - Tentative Provisions on Technology Venture Capital Investments (Promulgated by Zhuhai Municipal Government on June 7, 2001) M>H 0 0޽h ? ̙33j  <(  <x < <A ??  < 0D&v zDComparison of the Rules Promulgated by Beijing, Shenzhen and Zhuhai E(2EH < 0޽h ? ̙33j @(  @x @ <A  ??@(0   @ 0&v  zDComparison of the Rules Promulgated by Beijing, Shenzhen and Zhuhai E(2EH @ 0޽h ? ̙33j D(  Dx D <A ??   D 04 zDComparison of the Rules Promulgated by Beijing, Shenzhen and Zhuhai E(2EH D 0޽h ? ̙33j H( 4b8 Hx H <A ??   H 0Y@ zDComparison of the Rules Promulgated by Beijing, Shenzhen and Zhuhai E(2EH H 0޽h ? ̙33 [SL(   L L C TP   SC. Issues 1. Financing by Banks. Banks are not allowed to invest in equities. Chinese banks by far are the strongest financial institutions, but they are generally not allowed by law to make equity investments, denying venture companies a major source of funding. The only exception is perhaps the China Development Bank, which reportedly has made a commitment to offer loans to a major venture company. I have spoken to the bank about its reported commitment; it did not sound very enthusiastic about it. 8 H L 0޽h ? ̙33d    P (  PT  P C P    tC. Issues 2. Shares Buy-back. Companies may not buy back its shares. One of the conventional exits is to require the investee company to repurchase from the investors the shares that the investors have purchased. But China s Company Law (Article 149) provides that a company may not purchase back its shares except for the reduction its registered capital or the merge with another company which already holds its shares. This provision makes it very difficult, if not impossible, to carry out the conventional repurchase of shares. Furthermore, in the MOFTEC rules, it is clear that this put right will be the subject of explicit governmental scrutiny and rule-making. 3. Non-Floating Shares. Legal person shares are not transferable through stock exchange. Although Article 143 of the Company Law permits shareholders to freely transfer their shares, the rules governing state-owned shares and legal person shares specifically provide that such shares may not float on stock exchanges, making it difficult for investors to purchase them because of the lack of liquidity.d; ~H P 0޽h ? ̙33  T6( , T T C       C. Issues 5. Capital Vesting Regime. Current legal regime for joint ventures or WOFEs does not accommodate conventional venture investment practices. For example, the current regime sets forth a fairly rigid capital vesting schedule, which is at variance with conventional venture investment practice. Furthermore, the change of the registered capital requires government approval, making it difficult for innovative structure that may avoid the rigid capital vesting schedule. Although the Rules in Beijing try to break a new trail in this regard, it is obviously at variance with the central government rules. Thus, a risk. Shenzhen and Zhuhai rules are also at variance with the central rules, albeit to a lesser extent. 6. Percentage of Investment by a Company. Article 12 of the Company Law requires that the accumulative investment of a company shall not exceed 50% of the net assets of such company. However, according to the local rules, the venture investment company is allowed to invest all its registered capitals.t &H T 0޽h ? ̙33G Xo( , X7 X C t    v WC. Issues 7. Shares Subscribed by Technological Achievements. To encourage establishment of high- and new- technology enterprises, the Regulations on Zhongguancun Science and Technology Zone provide that the percentage of shares which are subscribed by high- and new-technological achievements is not limited. This is at odds with Company Law which provides up to 30%. 8. Income Tax of Partnership Enterprises. The State Council issued a notice on June 6, 2000 which stipulates that enterprises of sole proprietorship and partnership are ceased to be subject to enterprise income tax. The Regulatory measures on Limited Partnership promulgated by Beijing Municipal Government also stipulates that the limited partnership is not subject to enterprise income tax. The partners shall pay income tax as to their incomes generated from the partnership. dX 37)H X 0޽h ? ̙33K \s( , \; \ C    ' yC. Issues 9. Liquidation or not. Once a venture company disposes of a portfolio company, conventional venture capital practice would require the distribution of all proceeds to the fund investors. 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Background (1) According to the Economic Reference Daily, Prior to 2001 foreign venture capital investment dominated the Chinese market in terms of investment volume. For various reasons this changed, in 2001 when the Chinese venture investment for the first time valued more than foreign venture investment. Specifically, the total venture investment in China in 2001 was US$ 518 million, in which RMB funding accounted for to approximately US$ 260 million. (2) As of the end of 2001, there were approximately four times as many Chinese venture investment companies as their foreign counterparts active in China. G A. Background (3) In terms of capital under management, Chinese venture companies were much smaller than their foreign counterparts, averaging RMB 110 million, while foreign venture companies averaged well over RMB 200 million. (4) In terms of the amount of single investment, Chinese venture companies averaged US$ 1.5 million per investment, whereas foreign venture companies averaged US$ 5.70 million. (5) Sources of RMB funding gradually shifted from government to private sectors. (6) The cities where venture investment is most active are Beijing, Shanghai and Shenzhen.JB. Local Rules The importance of venture capital investments is well recognized by the central and local governments alike, and they have promulgated rules meant to encourage the development venture investment. In 1999, the State Council issued a circular which outlined the direction and framework of China's venture investment development. On August 28, 2001, MOFTEC, the Ministry of Science and Technology and the State Administration of Industry and Commerce jointly promulgated the Tentative Rules on Establishment of Foreign Invested Venture Capital Enterprises. As the title suggests, these rules are meant to encourage foreign venture capital to invest in Chinese companies. Rules that have been promulgated by the various local governments, on the other hand, apply to both foreign and Chinese venture investment activities. B. Local Rules The following is a comparison of the rules promulgated by the Beijing, Shenzhen and Zhuhai governments. (1) Beijing: - Regulations on Zhongguancun Science and Technology Zone (Promulgated by Beijing Municipal Government on December 8, 2000) - Regulatory Measures on Registration of Enterprises in Zhongguancun Science and Technology Zone (Promulgated by Beijing Municipal Government on March 2, 2001) - Regulatory Measures on Limited Partnership (Promulgated by Beijing Municipal Government on February 21, 2001)MB. Local Rules (2) Shenzhen: - Tentative Provisions on Venture Capital Invested in High- and New-technology Enterprises (Promulgated by Shenzhen Municipal Government on October 11, 2001) (3) Zhuhai: - Tentative Provisions on Technology Venture Capital Investments (Promulgated by Zhuhai Municipal Government on June 7, 2001)ûлõƬûлõƬûлõƬûлõƬC. Issues 1. Financing by Banks. Banks are not allowed to invest in equities. Chinese banks by far are the strongest financial institutions, but they are generally not allowed by law to make equity investments, denying venture companies a major source of funding. The only exception is perhaps the China Development Bank, which reportedly has made a commitment to offer loans to a major venture company. I have spoken to the bank about its reported commitment; it did not sound very enthusiastic about it. <C. Issues 2. Shares Buy-back. Companies may not buy back its shares. One of the conventional exits is to require the investee company to repurchase from the investors the shares that the investors have purchased. But Chinas Company Law (Article 149) provides that a company may not purchase back its shares except for the reduction its registered capital or the merge with another company which already holds its shares. This provision makes it very difficult, if not impossible, to carry out the conventional repurchase of shares. Furthermore, in the MOFTEC rules, it is clear that this put right will be the subject of explicit governmental scrutiny and rule-making. 3. Non-Floating Shares. Legal person shares are not transferable through stock exchange. Although Article 143 of the Company Law permits shareholders to freely transfer their shares, the rules governing state-owned shares and legal person shares specifically provide that such shares may not float on stock exchanges, making it difficult for investors to purchase them because of the lack of liquidity. C. Issues 5. Capital Vesting Regime. Current legal regime for joint ventures or WOFEs does not accommodate conventional venture investment practices. For example, the current regime sets forth a fairly rigid capital vesting schedule, which is at variance with conventional venture investment practice. Furthermore, the change of the registered capital requires government approval, making it difficult for innovative structure that may avoid the rigid capital vesting schedule. Although the Rules in Beijing try to break a new trail in this regard, it is obviously at variance with the central government rules. Thus, a risk. Shenzhen and Zhuhai rules are also at variance with the central rules, albeit to a lesser extent. 6. Percentage of Investment by a Company. Article 12 of the Company Law requires that the accumulative investment of a company shall not exceed 50% of the net assets of such company. However, according to the local rules, the venture investment company is allowed to invest all its registered capitals.XC. Issues 7. Shares Subscribed by Technological Achievements. To encourage establishment of high- and new- technology enterprises, the Regulations on Zhongguancun Science and Technology Zone provide that the percentage of shares which are subscribed by high- and new-technological achievements is not limited. This is at odds with Company Law which provides up to 30%. 8. Income Tax of Partnership Enterprises. The State Council issued a notice on June 6, 2000 which stipulates that enterprises of sole proprietorship and partnership are ceased to be subject to enterprise income tax. The Regulatory measures on Limited Partnership promulgated by Beijing Municipal Government also stipulates that the limited partnership is not subject to enterprise income tax. The partners shall pay income tax as to their incomes generated from the partnership. zC. Issues 9. Liquidation or not. Once a venture company disposes of a portfolio company, conventional venture capital practice would require the distribution of all proceeds to the fund investors. This will involve a return of capital that is in effect a partial liquidation of the venture company, which is not provided for at all in any of the rules already promulgated. The End.  õ ģǶ OLE  õƬ 6> _PID_GUIDAN{12EBB5C7-3907-11D6-8157-0080C7DA2A27}Root EntrydO) =s@PicturesCurrent User)SummaryInformation(W|  !"#$%&'()*+,-./0123456789:;<=>?@ABCDEFGHIJKLMNOPQRSTUVXYZ[\]^_abcdefghijklmnoz!_T KING&WOODRoot EntrydO)ìw@PicturesCurrent User)SummaryInformation(W|  !"#$%&'()*+,-./0123456789:;<=>?@ABCDEFGHIJKLMNOPQRSTUVXYZ[\]^_abcdefghijklmnoz!_T KING&WOOD  !"#$%&'()*+,-./0123456789:;<=>?@ABCDEFGHIJKLMNOPQRSTUVXYZ[\]^_abcdefghijklmnoqrstuvwzRoot EntrydO)PicturesCurrent UserpSummaryInformation(W|PowerPoint Document(xDocumentSummaryInformation8`