ENGINEERING A VENTURE CAPITAL MARKET: LESSONS FROM CHINA Lin L in• This article analyzes Professo r Ronald Gilson's theory of "simultaneity" in engineering a venture capita.l market in the context of China. Based on both quantitative and qualitative data collected by the author, this article analyzes how China has created the fastest developing and the largest engineered venture capital market in the world within thr ee decades. It concludes that the rise of venture capital in China is attributabl e to (I) increasing capital supply through various governmental programs, easing regulatory barriers towards institutional and foreign investors, providing tax incentives, and improving the exit environment; (2) enhancing the availability of financial intermediaries by introducing the limited partnership that creates an efficient relationship between venture capitalists and investors; and (3) encouraging entrepreneurship by improving the regulatory environment for small businesses. Through these measures, China has facilitated the simultaneous availability of capital with the appetite for high-risk, long-term investments and the emergence of a class of entrepreneurs with the skills and incentives to put that capital to work. One key factor of the rapid development of the Chinese mark et has been its increased reliance on market forces in allocating capital. On the other hand, a residual degree of bureaucratic involvement in capital allocation prevents the Chinese regime from being fully efficient. China serves as an (imperfect) model for other governments in the world where unfettered market forces have not brought about successful venture capital markets. • Assistant Professor , Faculty of Law, National University of Singapore (NUS). This article was selected as one of ten invited papers for the 8th Stanford International Junior Faculty Forum. I am deeply grateful to Michael Klausner for his ext reme ly constructive and helpful comments on this article. I owe si ncere st thanks to Ronald J. Gilson , Lawrence M. Friedman , Zenichi Shishido , William H.J. Hubbard , Yu X.ingzhong, Anupam Chander, Nora Freeman Engstrom, Jonathan S. Masur , Hans Tjio, Dan Puchniak , Wee Meng Seng, Umakanth Varottil, and Wu Wei for their insightful feedback and suggestions to earlier drafts of this article. I thank the participants of the Stanford International Junior Faculty Forum and the Chicago Coase-Sandor Summer Institute for Law and Economics Colloquium for providing insightful observations. Many thanks to th e Stanford University Arthur and Toni Rembe Rock Center for Corporate Governance , National Taiwan University Law School, Helsinki Law School, and National University of Singapore East Asia Institute for inviting me to present earlier drafts of this article. I also thank interviewees from China and Singapore , who generously shar ed their knowledge and insights with me. Int erviews were conducted anonymously. All errors remain my own. The research is supported by the NUS Start-up Grant (WBS No: R-241-000-134-133). 160 2017] ENGINEERING A VENTURE CAPITAL MARKET 161 INTRODUCTION ....................................... . ............................................................... 161 I. TACKLING THE SIMULTANEITY PROBLEM IN' CHINA .......................................... 166 A. The Difficulty Overseas ..................................................... ....................... 166 B. Capital ................................. ..... ............................. .................................... 169 1. The Need for Ventw·e Capital in China .............. .................... .......... 169 2. Increasing Capital Supply via Government Guidance Funds .......... 171 3. Increasing Capita l Supply from Institutional Investors .................. 173 4. Increasing Capital Supply from Foreign Investors .......................... 1 77 5. Tax Incentives .... .......................................... .......................... ............. 178 6. Improving Exit Environment ............ ................................................. 179 C. Investment Vehicle ................................................................................... 180 1. Adoption of the Limited Partnership and Its Popularity ................. 182 2. Introduction of Foreign-Invested Limited Partnership .................... 185 D. Entrepreneurs ....................... ................................................................... 186 1. Policies and Tax Reliefs to Strengthen Entrepreneurship ............... 186 2. Entrepreneur-Friendly Company Law Reforms ............................... 187 E. The Venture Capital Response to Governmental Actions ............. ......... 189 II. ROOM FOR IMPROVEMENT AND SUGGESTIONS ................................................... 192 A. Problems with Public Funding ....................................................... ......... 192 B. Problems with Investment Vehicle .......................................................... 201 C. Problems with Entreprenew·s ....................... .......................................... 203 III. LESSONS LEARNED ........................ ..................... ........................................ ... ... 204 A. Capital. ............................. ............. .......... .................. .......... ...................... 205 1. Incr ease d Domes tic and Foreign Capital Supply ............................. 205 2. Tax Incentives .......... ...... ................... .................................. ................ 207 3. Active Stock Market ................. .......................................................... 208 B. Investment Vehicle ............................................. ......... ............. ................ 208 C. Entrepreneurship ............................ .................. .......... .............. ............... 210 CONCLUSION ......... ..... .... ....... ..... ... ......................................................................... 210 APPENDIXES ................................ . .......................... .................................... ..... ... .... 213 I NTRODUCTION Venture capital ("VC'') is widely recognized as a powerful engine that can drive a nation's innovation, job creation, knowledge economy, and macroeconomic growth. 1 As such , governments from various jurisdictions around the world, including Germany, 2 Australia, 3 Japan, 4 1 Ronald J. Gilson , Engineering a Venture Capital Markel: Lessons from the American Experience, 55 STAN. L. REV. 1067 , 1068 (2003). On the importance of VC, see generally Marco Da Rin et al., The Law and Finance of Venture Capital Financing in Europe: Findings from the RICAFE Research Project, 7 EUR. Bus. ORG. L. REV. 525 (2006). 2 See Gilson, supra note 1, at 1094-1096. 3 See THE TREASURY AND THE DEPARTMENT OF INDUSTRY, INNOVATION, SCIENCE, RESEARCH AND TERTIARY EDUCATION OF AUSTRALIA, REVIEW OF VENTURE CAPITAL AND ENTREPRENEURIAL SKILLS (2012) , available at http ://bit.ly/2t1Iz3c. • See Zenichi Shishido , Why Japanese Entrepreneurs Don't Give Up Control to Venture Capitalists {Mar. 30, 2009) (unpublished manuscript), available at http://bit.ly/2w8Jrd.A. 162 COLUMBIA JOURNAL OF ASIAN LA Ii [Vol. 30:160 Israel ,5 Chile ,G Taiwan 7 and Singapore ,s have all tried to promote the development of VC mark et s. Generally , government programs have not been especially successful.9 However, China's efforts seem to have borne fruit. Over three decade s, China has created the world's second largest VC market in terms of annual VC investment, 10 second only to the United States (U.S.). Thi s article will explore the elements of China's experience in engineering a national VC market, as well as concerns about its continued growth of the market. In a ground-breaking article , Professor Ronald Gilson explained that a VC market requires three key elements to thrive: (1) providers of capital with appetites for high- risk, high-return mvestments: (2) specialized financial intermediaries-VG firms-that properly incentivize all participants in the VC market; and (3) entrep reneurs. 11 This much is straightforward, but as he further e>..'])lained, the~e three elements must emerge simultaneously. The simultaneous emergence of all three elements is difficult to envision with or without government involvement. For example , if there is no capital available in an economy for high-risk bu sinesses, how will entrepreneurs emerge to form such businesses, and how will in termediaries emerge to identify the best of those entrepreneurs and channel investment funds to them? Gilson refers to this as the "simultan eity problem. "12 He attributes the success of the U.S . VC mark et in solving the simultaneity problem to private ordering ,13 explaining that the "U.S. VC market developed organically, largely without governm ent assistance and certainly without government des ign. "14 Inst ead, it was the "idiosyncratic'' history of the U .S. VC market that encouraged the simultaneous emergence of entrepreneurs, inv esto rs, and th e right vehicles that served as the "nexus of a set of sophisticated contracts. "16 This raise s the question of whether it is possible for governments to successfully engineer VC mark ets. Most governments have tried to address the simultaneity pr oblem by creating government programs to provide capital , encourage entrepr eneurship, and attract knowledgeable 6 See Gilson, supra note 1, at 1097. See also JOSH LER.--.'ER, BOULE\'ARD OF BROKE~ DREAMS: WHY PUBLI C EFFORTS TO BOOST ENTREPRENEURSHlP A."ffi \'E1\i'L1IB CAPITAL HA VE FAILED-AND WHAT TO DO ABOUT IT 42 (2009). 6 See Gilson, supra note 1, at 1098. 7 Christopher Gulinell_o, Engineering a Venture Capital Market and the Effects of Gouernment Control on Prwate Ordering: Lessons from the Ta· E · G w ASH. INT'L L. RE V. 845 (2005 ). ~wan xpenence, 3 / EO. 8 LERNER, supra note 5, at 42. 9 Gilson, supra note 1, at 1070; LERNER, supra note 5 t 192 10 See ERNST & YOUNG, BACK TO REALITY· GLOBAL VE' aN""URE. C 3 0 2 (20 6) "l . • • APITAL TRE:SDS 2015 1 -1 1 , aum able at http s://go .ey .com/lQifExd [hereinafter B • ' 11 Gilson, supra note 1, at 1076-78 , 1093 _ ACK TO REALIT'i]. 12 Id. at 1093. 13 Id. at 1069 , 1093. 14 See id. at 1070 . 10 Id. at 1069 , 1093 . 2017) ENGINEERING A VENTURE CAPITAL MARKET 163 financial intermediaries. For the most part, however, these programs failed because they could not adequately respond to the problems inherent in VC financing: uncertainty, information asymmetry, and agency cost.16 China offers a fascinating case study of how a VC market can be engineered: its VC market is one of the fastest developing and largest engineered markets in the world. 17 Before 1985, VC did not exist in China. 18 But after three decades of development, China now receives the second largest annual VC investment in the world.I9 In 2016, 636 new VC funds were set up in China, collectively raising more than USD 50 billion of fresh capital for investment. This represented a 79.46% increase over the previous year. 20 Additionally, there were 3,683 VC investment deals closed in 2016, an increase of 6.91% from 2015, and of 91.2% from 2014. 21 Total VC investment in China was USD 48.9 billion, surpassing VC investment in the entirety of Europe combined. 22 Also, of the top five VC deals worldwide in 2015 , three were made in China. 23 While the United States dominated global VC activity by deal quantity and value in 2015 with 3916 investment deals (in total valued at USD 72.3 billion), two out of three top deals were China-based. 24 VC exits were also impressive , with the amount raised from exits via !PO and M&A reaching USD 8.2 billion and USD 11.5 billion respectively, in 2015.25 For context, VC exits via !PO and M&A in the United States raised USD 6 billion and USD 54 billion respectively in the same period.26 As of the end of 2014, VC investments contributed directly and indirectly to 9.3 % of China's GDP. 27 These figures underline the 16 Id . at 1070. 17 Anette Jonsson , Venture Capital Continues to Flow into Chinese Startups, WALL ST. J. (Apr. 28, 2015), http://www.wsj.com/articles/venture-capital-continues-to-flow-into- chinese-startups-1430244889. Venture Capital Soars and Investor Expectations Follow, NIKKEi ASIAN REV. (Feb. 18, 2016), http://asia.nikkei.com/Politics- Economy/EconomyNenture-capital-soars-and-investor-expectations-follow; Lucinda Shen, China is the Biggest Venti,re Capital Firm in the World, FORTUNE (Mar. 9, 2016) , http://for.tn/2tZyM0S. 18 See text accompanying note 59, infra. 19 See BACK TO REALJTY, supra note 10, at 3, 10-12. 20 Qingke Yanjiu Zhongx.in (ffl#-li}f,l;rp,i:,,) [Zero2IPO Research Center], Qingke Yanjiu Niandu JuZhi (rrl.fiHiff'1:~f.l'.t§1fi1J) [Zero2IPO's Yearly Mangum Opus], Touzijie (N: !JiJn [PEDAILY] (Jan. 21, 2017), http://bit.ly/2sZtjFD. 21 See Zero2IPO Research Center, Venture Capital Annual Report 2014, ZER02IPO PUBLISHER (2015), http ://research. pedaily .cn/ report/free/130 l .shtml. 22 See BACK TO REALITY, supra note 10, at 3, 10-12. 23 Id. at 10. 21 Id. at 3. "'Id.at 10. 26 Id. at 6 . . 27Niu Fulian (4''ii'lll.i) & Wang Jingjing (::Efafa), Jujiao Xin Changtai Xia_ Fengxian Touzi Gaige Yu Chuangxin (Xia) (~~ffi'ii\"~rJxl.~NJ1ii&.i$:.!,jB~ffiCF)) [Focusing on the Reform and Innovation of Venture Capital under the New Normal (Part II~] , Zho_ngguo Jingji Shibao (If' l'i!H&b'fll-fffl.) [ClllNA ECONOMIC TIMES] (Jul 10, 2015), http://b1t.ly/2uJilSe. 164 COLUMBIA J OURNAL OF ASIA,\" LAW [Vol. 30:160 significance of the Chinese VC mark et and its influence on China's economy . . The growth of the VC market in China over the pa~t dec~de is without precedent. In the U .K. , VC investments peaked m 200 1 and have remained relatively stagnant ,28 totaling USD 4.8 billion m 2015 (0. 168% of U.K. 's 2015 GDP). 29 The value of VC investments in Germany and France amounted to USD 2.9 billi on (0.086% of GDP) and USD 1.9 billion (0.078% of GDP) respectively in 2015. 30 In stark contrast , China's VC market h as maintained rapid growth since 2002, with fund raising , investments , and exits r eaching a record high in 2015 (0.450% of GDP). 31 In contrast to the U.S., China's VC market did not emerge as a result of market forces alone , bu t was instead consciously and strategically designed by the state from the outset. Specifically, governmental policies and actions facilitated the development of the VC market in order to encourage inno vat ion and technological development, and to stimulate structural reform s of the economy. China's fascinating experience challenges the orthodox view th at top-down governmental efforts to promote VC are unlikely to be su ccessful. Moreover, despite doubt as to the effectiveness of privat e or d ering in China32 due to its weak investor protection 33 and lack of judicial independence,3, 1 China has succeeded in building a VC mark et. The pivotal question is: how did China manage to create the second lar gest VC market in the world despite its immature legal infrastru ct ur e? Based on quantitative and qualit ative d ata, 35 this article analyzes 28 Annual Value of Venture Capital In vestments on the UK Market from 2007 to 2015, STATISTA, http: //bit.l y/2s349 9m (last visited May 24 , 2017). 29 BACK TO REALITY, supra note 10, at 3, 10-12. so Id. at 9. 31 Zero2IPO Research Center, supra note 20. 32 See generally Jiangyu Wang, China: Legal Reform in an Emerging Socialist Mark et Economy, in LAW AND LEGAL INSTITUTIONS OF AslA: TRADITIONS, ADAPTATIO:-s A.'\"D INNOVATIONS (E. Ann Black & Gary F. Bell eds. 2011); Donald Clarke Peter Murrell & Susan Whiting , The Role of Law in China's Economic Development, in CHJ:-;A'S GR~AT ECONOMIC TRANSFORMATION (Loren Brandt & Thomas G. Rawski eds. 2008). 33 See generally Nicholas C. H~wson & Vikramaditya S. Khanna, The Deuelopment of Modern Corporate Governance m Chma and India, in CHINA, INDIA A.'-"D THE b'TER.'IATIONAL ECONOMIC ORDER (Muthucumarasawamy Sornarajah & J W eds., 2010) (on investor protection). iangyu ang ~• See generally Chapter 4 of JI ANFU CHEN, LEGAL INSTITUTIONS L"1 CHINESE LAW: CONTEXT AND TRANSFORMATION 147-70 (2008 ). :.s The e mpirical study consi sts of: (I) a st udy on a samp le of fift VC . Y agreements. These agreements are obtamed from leadi ng law firms and VC firms · B . C · 1 · C · 1 Sh C , 1.e. an:,:an ap1ta , Jubilee ap1ta , enzhen edar Capital, Shiyue Hualong Capital, So h y . Capita l, Chengwei Capital, I s land Peak Innov ation King & \\'ood ,.1 nllg e u(Bean~~g s h · d Sh h ffi ' " a esons tJmg, L hanLg ruFa~ (Ben~ en od cSehs), Fangda Law Firm (Bei jin g and Shanghai offices), Zhong un aw rrm e1Jmg a n enzhen offices) Global Law Firm (B · ·· ffi ) J" h Tongda & Neal Law Firm (Beijing office) Ch~ngqing Zhonghao L etJFt~g O Yee ' Tmc Laeng . , aw irm, uan a1 ,v Offices, Deheng Law Ft.rm (Shenzhen office) , and Shenzhen H h L F" . · · ·th · . . uas ang aw t.rm, (II) mterv1ews w1 s1JCty ve ntur e cap1tabsts legal counsels repre tati f • • • • , sen ves o mstttut1onal 2017] ENGINEERING A VENTURE CAPITAL MARKET 165 how China has addressed the simultaneity problem. The Chinese government has helped solve the problem by laying down the necessary legal and institutional infrastructure for a VC market, including: (1) providing public capital through various government programs and increasing private capital by easing regulatory barriers towards institutional investors, providing tax incentives, and improving the exit environment; (2) enhancing the availability of financial intermediaries and fund raising by introducing the limited partnership, a new and popular business vehicle that creates an efficient relationship between venture capitalists and investors; and (3) encouraging entrepreneurship by revising the country's corporate and securities laws and streamlining the process of establishing businesses and doing business. The Chinese government's role in allocating capital, however, is not without flaws. The VC market's rapid growth stemmed largely from the fact that the central government has laid down the institutional and legislative infrastructure to increase the role of market forces in the capital allocation process. But there are institutional obstacles, including the flawed cadre appointment system and flawed incentives for government officials, that prevent local governments from achieving the delicate balance of allowing local government funding to operate based on market forces while concurrently pursuing the governments' policy goals. The lesson to be learned from the Chinese experience is that the optimal role of a government in engineering a VC market should be to provide the necessary enablers, while playing only a limited role in the capital allocation process by simply providing seed funding and leaving specific capital allocation decisions such as selection of portfolio companies and designing investment strategies to private VC firms with the right incentives. This is a lesson that could be valuable to other countries, such as Japan 36 and Germany, 37 that have attempted to promote the development of a VC market without significant success, and to other countries that are attempting to promote the formation and growth of a VC sector. The remaining parts of this article are structured as follows. Part I examines the Chinese experience of engineering a VC market. Part II identifie s the institutional impediments in China and suggests room for future reforms. Part III critically discusses the lessons learned from investors and entrepreneurs. The interview ees come from the six cities that are the major places of VC in China, namely Beijing, Shanghai, Tianj in, Shenzhen, Chongqing, and Guangzhou ; (III) a study of official data published by the leading servi~e providers, i.e. ~he annual reports published by the Zero2IPO Research Center, the China Venture Capital Yearbook published by China Venture Capital Research Institution, and the annual reports published by the VentureChina.c n. 36 See Shishido, supra note 4. 37 See Ronald J. Gilson & Bernard S. Black, Does Venture Capital Require an Active Stock Market ?, J. APPLIED CORP. FI:-!. 36, 36-48 (1999) . 166 COLUMBIA JO URNAL OF ASIAN LAW [Vol. 30:160 China for other jurisdictions. A brief conclusion follows. I. TACKLING THE SIMULT ANEITY PROBLEM IN CHINA A. The Difficulty Overseas The key challenge for governments seeking to engineer a VC market is ensuring the simultaneous availability of three factors-a challen~e that Gilson termed the "simultaneity problem. " The first factor 1s investment capital. Venture capitalists provide a special type of capital for early-stage, high-growth, high-risk , often high-technology firms that need equity capital to finance product development or growth. 38 Because of venture capitalists' appetite for high-ri sk, high-return investments, and because of their managerial skills and industrial connections, venture capital plays an important role in commercializing cutting-edge science and innovation. 39 The second factor is the availability of specialized financial intermediaries that serve as the "nexus of a set of sophisticated contracts" and that implement an effective incentive structure in a VC cycle. 40 There are two main contracts that place financial intermediaries between sources of capital and innovative businesses. The first contract arises at the fund-raising stage between the investor and the VC fund, which is typically organized in the U.S. as a limited partnership . This contract alleviates the agency costs between the investor and fund manager and incentivizes the latter through mechanisms such as a fixed term, mandatory distributions , and structuring of the fund manager's compensation. 41 The second contract arises between the VC fund and the portfolio company. This contract addresses the uncertainty, information asymmetry and agency costs between the VC fund and entrepreneurs and incentivizes both participants through mechanisms such as staged financing, allocation of control to the fund, structuring of the entrepreneur's compensation and incentivizing exit. 42 The interaction, or ''braiding," of the two contracts enhances the efficiency of each in terms of incentivizing exit and constraining opportunistic behavior by the VC fund against entrepreneurs.4 3 The last essential factor for creating a national VC market is the availability of entrepreneurs. Gilson assumes that the su 1 of t . th " 1 f · " PP y en repreneurs 1s e so e unction of the availability of capital and 38 Id. at 36. 39 Gilson, supra note 1, at 1068. See also LERNER sup t 5 ( h · · h · f ' • ra no e at 181-182 emp as1zmg t e importance o a large dome stic market with · '. - risks with younger firms in the development of a VC market). mveatars willing to take 10 Gilson, supra note 1, at 1069, 1093. 11 Id. at 1087-90. 12 Id. at 1078-87. • 3 Id. at 1091-92. 2017) ENGINEERING A VENTURE CAPITAL MARKET 167 specialized financial intermediaries. In his view, by providing funding through the right contractual vehicle, government can encourage a supply of entrepreneurs.44 International experience reveals that resolving the simultaneity problem is not an easy task. Over recent years, many governments have sought to engineer a VC market but have encountered difficulties to varying extents. In Germany, funding remains the major issue for start-ups, and governmental efforts at resolving the issue have not been sufficient. 45 Germany 's Deutsche W agnisfinanzierungsgesellschaft (''WF G")46 proved a failure due to the interference by the government: capital allocation was determined by WFG 's board committee, which was largely comprised of bureaucrats. 47 It also failed to incentivize venture capitalists to choose portfolio companies because the government provided a guarantee and insured up to 75% of WFG 's losses and because profits were limited by the entrepreneur's call option. 48 Further , WFG personnel were not incentivized to provide technological or management assistance to portfolio companies because of the restriction of profits placed on WFG.49 The Indian government has faced challenges in ensuring the availability of capital and specialized financial intermediaries. Although VC fund regulations were enacted in India to encourage the funding of early-stage companies, this goal has been compromised because VC funds have primarily been used as a vehicle to invest in more mature companies, rather than start-ups. 50 Further, VC funds in India are typically organized as trusts because the limited partnership vehicle is not available. 51 Participants in the Indian VC market are thus unable to ••Id.at 1102-03. 16 MARTIN SELTER & THOMAS PRUEVER, LIQUIDITY MEETS PERSPECTIVE: VENTURE CAPITAL AND START-UPS IN GERMANY 36 (VC TRENDS INITIATIVE BY EY 2015) http s://go.ey.com/2tljvd8. See also Gilson, supra note 1, at 1094-1097. As of 2013, the average VC investment in Germany stands at merely ¤780,000, compared to ¤6m in America. See A Slow Climb, The Economist (Oct. 15, 2013) , http://econ.st/lsYYdea. •6 Deutsche Wagnisfinanzierungsgesellschaft "translates roughly to 'German Venture Financing Fund." Gilson, supra note I , at 1094 n.66 (citing Ralf Becker & Thomas Hellmann, The Genesis of Venture Capital: Lessons from the German Experience, in VE~"TURE CAPITAL, ENTREPRENEURSHIP, AND PUBLIC POLICY 33 (Vesa Kanniainen & Christia n Keuschnigg eds., 2005)). • 7 See id. at 1094-97. ,t/Jid. Id. See also Ralf Becker & Thomas Hellmann, The Genesis of Venture CapitaL· Lessons from the German Experience, in VENTURE CAPITAL, ENTREPRENEURSHIP, AND PUBLIC POLICY 33 (Vesa Kanniainen & Christian Keuschnigg eds., 2005). oo Akil Hirani, India, in GLOBAL VENTURE CAPITAL TRANSACTIONS: A PRACTICAL APPROACH 229 (Beat Brechubul & Robert J. Wooder eds., 2004). 01 Abhinav Surana & Apurva Kanvinde, Private Equity in India: Market and Regulatory Review, WESTLAW UNITED KINGDOM, http: //t msnrt .rs/2tlKuoT (last updated Nov. 1, 2016). 168 COLUMBIA JOURNAL OF ASIAS LAW [Vol. 30:160 take advantage of the efficient contracting structure for specialized financial intermediaries prevalent in the U.S. While the government of Singapore has enhanced the availability of funding for start-ups through various programs and introduced the limited partnership to provide a new business vehicle for venture capitalists and investors, concerns have been raised about the government's significant role in the capital allocation procet>!--.62 The imposition of various eligibility requirements on the entrepreneurs, types of portfolio companies , and industries may dampen incentives for participants in the VC market. 53 There is also a "lack of a large ba~e of entrepreneurs" due to the perceived high opportunity costs of becoming an entrepreneur in Singapore. 54 Nevertheless, some government programs , such as the Israeli Yozma Program and the Chilean Corporation for the Incentive of Production ("CORFU') Program, have achieved a certain degree of success.55 These successes highlight the shortcomings of other countries and are consistent with the success of the Chinese government's efforts. For example, the Israeli Yozma program did not make investment decisions and provided no guarantee against loss. 56 These investments were made by highly incentivized private fund managers who bore the inve stme nt' s risk and po~sessed the control rights to directly monitor the portfolio companies. 57 VC has had a much shorter history in China than in the C.S. 58 The concept of VC was first officially introduced in China in 1985 in the central government's Decision to Reform the Science and TechnologJ System. 59 The industry only began to emerge in the same year when the first VC firm, the China New Technology Venture Capital Company (zhongguo xinjishu chuangye touzi gongsi) was set up as a government- initiated project. 60 Prior to that , and before the launch of the open-door 52 Newley Purnell, Singapore Aims to Become Southeast Asia 's Silicon Valley, \\' . .\LL ST. J. (Feb. 26, 2014) , http://on.wsj.com/llcA35S . . • 53 See id. See also interview with Mr. K, company founder of a Smgaporean start-up, LO Smgapore (Sept. 9, 2016). ,.,. Wi~ston T.H. Koh & P~h Kam Wong, The Venture Capital Indu stl)· in Singapore: A Cor~par?tiue Study with Taiwan and Isr ael on the Got ·ernment's Role 25 (National Uruvers1ty of Smgapore Entrepreneurship Centre Workin p p N \\'P200- -09 2005), http://bit.ly/2tqafVF. g apers, aper • o. .> • 55 See Gilson, supra note 1, at 1097-99. 00 Id. at 1097. 57 / d. 58 See LERNER, supra note 5 at 8 Th U 'ted S · in VC. ' · e m tates has over 70 years of expenence 59 Zhonggon g Zhongyang Guanyu Kexue J· h T' hi G · · , m.,,.-f W~tt~#:t~al(ia~ & ' p. 1 · Y s • Q . F d x· di . Lifa J' h . . ~lit), Zhonghua Renmin Gonghe Guo Hehuo 1ye a e rn ng. me eng Ziliao Huib"a ( cr+...u-.A.""-H· ~,... ·' #;itJ::ei!!!f~j[~) [COLLECTION OF I n T""F "'-7.;~11)frfkft:~?'!) (1(1,;.1, :ll MATERIALS RELAT_I::>IG TO THE A.\IB;-..-imE:S"l' OF THE 2017] ENGINEERING A VENTURE CAPITAL MARKET 169 policy and economic reform (gaige kaifang) in 1978 , there were no private enterprises, let alone start-ups or VC. The Chinese VC market developed slowly and was dominated by state-owned VC firms and VC funds in the 1980s and 1990s due to the lack of a developed stock market and unfamiliarity with the new concept, 61 as well as the limited choices of business vehicles available at that time. 62 The market began to develop rapidly only after 1998 when Cheng Siwei, then vice chairman of the National People's Congress Standing Committee, presented a groundbreaking "No. l Proposal " urging the development of a VC market.63 After the proposal, a series of policies and laws were promulgated, including the Strategy of Invigorating China through Science and Education (kejiao xingguo) and the Law on Promoting the Transformation of Scientific and Technological Achievements. 64 As discussed below, the Chinese government has helped to tackle the simultaneity problem effectively within three decades. 65 B. Capital l. The Need for Venture Capital in China Today, there is a strong demand for high-risk, high return VC in China, with the increased number of small businesses and the improved innovation and IT infrastructure. In the first nine months of 2015, over 3 million small businesses were registered, accounting for 96.62% of the total number of new registered businesses. 66 In Beijing's Zhongguancun district, the so-called "Chinese Silicon Valley ," an average of 7 new companies were registered every minute from March 2014 to May 2015.67 Beijing has become Asia's largest hub for entrepreneurship. 68 PART~ERSHIP ENTERPRISE LAW] 4 (2004). See also Lu Haitian et al., Venture Capital and the Lau: in China, 37 Hmm KONG L.J. 229 (2007). s1 See Lin Lin , Venture Capital Exits and the Structure of Stock Markets: Lessons from China, 12 Asian J. Comparative L. 1, 7 (2017). 62 Limited Partnership was not available under Chinese law in this period. 63 Cheng Siwei (fJxJl!.16:.), Zhongguo Fengxian Touzi de Lisbi yu Xianzhuang ('POOJxt~ tl/:~(j/JJJ].le~JJ.il:/.R) [The History and Status Quo of China's Venture Capital], in Cheng Siwei Lun Fengx:ian Touzi (li.lt.\!/.1fl:~Jx1.~tl/:l1f) [CHENG SIWEI ON VENTURE CAPITAL] (2008). &1 See Appendix 2, infra. &; See Part I.B.E, infra. oo Press Release, Zhonghua Renmin Gongheguo Guojia Gongshang Xingzheng Guanli Zongju(rfl $.A. ~Jt~ IJ.100*I iffi frllil(~l~IL@J,;i) [State Administration for Industry and Commerce], Gongshang Zongju: Quanguo Xin Dengji Qiye Baochi Gaowei Zengjiang Cf.il'li .~Jai: -td'ilffiHi2.~idli(f.¥miflL±ttE:) [State Administrat ion for Industry and Commerce: Country-Wide, Newly-Registered Businesses Maintain High Levels of Growth], (Oct. 15, 2015), http://bit.ly/2snfq3H . .. Zhang Lulu, China's Startup Boom: 7 New Firms Every Minute , CHINA.ORG.CN (Jun 9, 2015), http://on.china.cn/1B2Rt59. 68 Zheng Lipeng (~;l!Jffl), Na Shenme Zhengjiu Ni: Zai Tanlan Zhong bei Wanhuai de Zhongchou Nazhi Zhu <*~.z.H#-1$, ~1dli'Pt!ilii)'.f(lgi):§6Jlll~ffi) [How to Rescue ECF? 170 COLUMBIA JO URNAL OF ASIAN LAW [Vol. 30:160 However, the growth of start-ups and sma ll and medium size firms ("SME") has long been constrained by a substantial capital gap in China as China 's stock markets are unable to serve as viable financing channels for SMEs. Apart from dealing with the prohibitively high costs and long waiting times (caused by the current approval system) involved in an IPO, start-ups and SMEs, by virtue of their youth or size, also face difficulties meeting the stringent listing requirements set by the two Main Boards. 69 Moreover, unlike state-owned enterprises ("SOEs",) that are able to receive low -interest loans from state-owned banks (in part due to administrative influence), private companies face enormous difficulties in securing bank loans. 70 Statistics show that among 56 million micro and small enterprises in China's indu strial and commercial areas, only 11.9% are able to obtain loans from banks .71 Further , these micro and small enterprises receive less than 25% of the loans extended by state- owned commercial banks. 72 Such problem s with securing debt financing are exacerbated for start-ups, which typically have insufficient collateral to offer as security. 73 This inadvertently contributed to a high demand for VC as an important means of start-up financing. In addition , China's Gross Domestic Produ ct ("GDP ") growth rate fell from 10.4% in 2010 to 6.918 % in 2015, 74 with traditional economic sectors such as manufacturing and real estate showing signs of weakening. 75 Also, with a population of 1.3 billion and a labor force of 900 million, China faces strong pressure to address an increasingly significant unemployment issue. 76 It is thus imperative for the government to foster the development of high-t echnology industries and a knowledge-based economy to enhance competitiveness and promote The Indu stry Spoilted by Greed], Pintu Shangy e Pinglun (.Hi.0iilli~W~) [PLNTU360.COM) (Feb. 1, 2016), http: //bit. ly/2si4NUu. 69 Lin , supra note 61, at 18-19. 70 See Lan Yuping 01H~-'f), Fengxian Touzi ke You.tlao Jiejue Zhongxiao Qiye Rongzi Nan (Jxl.~ti~~~~-H/~cp,J,1£~/M!~~) [Venture Capital can Effectively Soke the Problem of Capital Financing of Sniall and Medium Enterprises] , Guoji Rongzi (lilij;l!I!~) [INTERNATIONAL FINAN'CING] (Sep. 8, 2010), http://bit.ly/2x2QstS . 71 Jiedai Bao Qiye Ban Heng Kong Chu Shi , Zhong Xiao Wei Q ' e Ro · Youwang Chedi Pojie (t/ar1;'!::!ii1E~~~3!tll1!!: cp,J,111'1::iE~l!l!!.rt~:fjiHVJ/d:~~) [W~~i;n Launch of Jiedaibao , SMEs' Financial Gaps May be Solv ed ], Meiri Toutiao ($:'~ [KKNEWS.CC] (Mar. 1, 2016), http: //bit.ly/2v55Yoa. 12 Id. 73 Lin Lin, Managing the Ri sks of Equity Crowdfunding: Lessons f Ch· 2 J CORP. LEGAL STUD. 327, 329 (2017 ). rom ma, · 74 GDP Growth (Annual %), WORLD BANK, http://bit.ly/2tp0aG (l · d 2017). w ast v1S1te May 24, '" Mark Magnier, As Growth Slows, China Highlights Tra ·t · f ., . S · w s ns, ion rom manufacturing to ervice, ALL T. J. (Jan 19, 2016), http://on.wsj.com/lKpyCk5 76 Press Release, Guowuyuan ( ~) [State Council] G . Tuijin Dazbong Chuangye Wanzhong Chuangxin Ruo a Zh ' uowu~an G:~anyu Dali x'f:k/Jfft:itt:k.A¤1~nAi!tlffi'6'-'fil3(jltfli""'"'J* III) [V~ . efngce Cuoshi de Y1J1an (IE~IIJE w=u, .e.;,c. iews o the State Council p li Measures Relating to Mass Entrepreneurship] (June 16 20l-) h t/b· on ° cy . ' o , ttp: 1t.ly/2tl Q90h. 2017] ENGINEERING A VENTURE CAPITAL MARKET 171 sustainable growth. Developing a national VC market is therefore high on the agenda of the Chinese government. 2. Increasing Capital Supply via Government Guidance Funds Funds for VC investment can be divided into two types depending on their source: government funding 77 and private funding. Government funding has been recognized as one of the most important sources of funding for fueling entrepreneurship across countries, after bank credit. 78 Many countries have issued various government programs to support entrepreneurial businesses, typically through setting up government-sponsored funds to make investments in start-ups . Recent examples include New Zealand's Venture Investment Fund ("NZVIF")79 and Singapore 's Early Stage Venture Fund ("ESVF") program.so In China , VC funding has been provided to tech start-ups through government-sponsored programs, particularly through Government Guidance Funds ("GGF") (zhengfu yindao jijin), which are designed to increase the supply of VC to early-stage enterprises and implement national industrial policy by directing capital into government encouraged innovative industries.s 1 The size of the government program is important to VC financing. A public program that is too small would hardly have any impact on a large and diverse economy, while a program that is too large might crowd out private funding and obstruct market forces in the allocation of start-up financing.8 2 Also, small firms typically face great difficulties in raising capital, due to information asymmetry between entrepreneurs and investors.S 3 Government funds are advantageous as they have an "a dd-on effect" in raising capital: with proper structuring, investors are willing to invest in such funds once government investors have taken the lead.84 n In this article, government funding typically refers to the capital provided by central and local governments. 78 See The EY G20 Entrepreneurship Barometer 2013, ERNST & YOUNG (2013), https: //go.ey.co m/2uqMw7b. See also ERNST & YOUNG, ADAPI'ING AND EVOLVING: GLOBAL VENTURE CAPITAL INSIGHTS AND TRENDS 2014 (2014), at 14, available at https ://go.ey.com/lgw404b [hereinafter ERNST & YOUNG-TRENDS 2014]. 19 For a detailed analysis of the program, see JOSH LERNER ET AL., A STUDY OF NEW ZEALAND VENTURE CAPITAL AND PRIVATE EQUITY MARKET AND IMPLICATIONS FOR PUBLIC POLICY (LECG 2005) , available at http://bit.ly/2ujnHqt. so Terence Lee, Singapore Government to Pump $48 Million into Six Venture Capital Funds, TECHlNAsIA (Apr. 22, 2014), http://bit.ly/2ujlpGU. 81 See Guanyu Changye Touzi Yindao Jijin Guifan Shelin Yu Yunzuo de Zhidao YiJian (~'f¤1J~jj:l:!f51#l.li:&~W:12:.:fz:~mft=l'Mli~:f:.W.) [Opinion on Venture Capital Fund Specifications and Operational Guidance] (promulgated by the St. Admin. for Industry and Commerce, Oct. 18, 2008), http://bit.ly/2s3806c. 82 LERNER, supra note 5, at 117-19. 83 Id. at 69. 84 Jd. at 70. 172 COLUMBIA JOURNAL OF AsIAN LA IV [Vol. 30:160 As shown in Figure 1 and Table 1, the size of the Chinese GGF program arguably used to be too small-only 2% of the total investable amount was contributed by GGFs. This problem was more pronounced in rural areas, where GGFs were so lacking in size that they could not play effective roles in guiding capital flow to start-ups. 85 To resolve this problem, there has been a new wave of GGFs estab lished at both the central and local levels since 2015. As can be seen from Figure 1, in 2015 alone, 297 GGFs were established with a combined investm ent amount of RMB 1.5 trillion, which was 5.24 times the amount raised in 2014.86 As of the end of 2015 , there were 780 GGFs in China, managing RMB 2183.447 billion (USD 319.7 billion). 87 Significantly , at the central government level, a RMB 40 billion (USD 6.5 billion) State Venture Capital Investment Guidance Fund ("SVCIGF") (guojia xinxingchanye chuangyetouzi yindao jijin) was set up in 2016 to support start-ups in emerging industries and foster innovation. 88 A National SME Development Fund (guojia zhongxiao qiye fazhan jijin) with 60 billion RMB was also set up in the same year to promote the development of SMEs.89 These two national funds, together with a number of local GGFs, are likely to leverage government funding to attract private investo rs to participate in the funds. 90 M Qingke Y anjiu Zhongxin (in~ lilf 1l'.. 'P ,C,,) [Zero2IPO Research Center], Qingke Paiming: 2016 Zhengfu Yindao Jijin Paiming Qidong Zaiji, Jiemi Wanyi Guimo Yindao Jijin Shichang Geju (tR:Mf.l~~: 2016 i51:Jf.f51 -lHi~f-U: Ja i;/Jf:E llP, ff~ Jj ,Q,:f.11.ffi 11 \'Hil;:&rtf ~+1}-~) [Zero21PO Ranking: 2016 Gouemment Guided Fund Ranking About to Launch, Decipher The Market Structure of Thousand-billion Level Guided Fund], Touzijie (Nl'tt-ff.) [PEDAlLY] (J an. 28, 2015), http://bit.ly/2siKMNF. See also Guojia Xinxing Chanye Chuan gye Touzi Yindao Jijin Jiang Zhengshi Touru Yunzuo (p;J*if~'ff"~i•J~Nli'F:il~~ ~:14 iE:i:ttsl:Ai:Ei-1,) [SVCIGF Will Be Operating Soon], Fujian Ribao (,llHt B m) [FuJIAN DAlLY], Aug. 26, 2016 at 7, auailable at http://bit.ly/2s2Z6Wu. 86 Zerp2IPO Research Center , supra note 85. 87 Jd. 88 Jd. 89 1 uojia Zhongxiao Qi:e Fazha~ Jijin S~ouz~ Shiti Jijin Guimo Da 60 Yiyuan (tiil *o:p,J,_1.E~~~~~:trx~-f,Hl;~:f.11.ffi:it 60 -fZ7G) [First .Vational SME Development Fund Reachrng 6 Billion in Fund Size], Zhongguo Xinwen Wang ('f'~t#rlill~) [CHL'sANEWS CoM] (Aug. 29, 2016 ), http ://bit.ly/2s38cSY. . 90 See Zero2IPO Research Center, supra note 85. 2017] ..., c (l) El (l) bf),-... ro c c ro ro ::, ::g>s i-.. Q (l) 0 "Cs Q. ;:J 6 .s (l) en < ENGINEERING A VENTURE CAPITAL MARKET FIGURE 1: GOVERNMENT GUIDANCE FUNDS IN CHINA (2006-2015)91 1,600.00 1,400.00 1,200.00 1,000.00 800.00 600.00 400.00 200.00 0.00 300 250 z 200 C ro "i 150 0 ...., "'rj C 100 [ en 50 0 -Assets Under Management (Billion Yuan) - Number of Funds 3. Increasing Capital Supply from Institutional Investors 173 Institutional investors such as commercial banks, insurance companies, trust companies, and pension funds have long been prohibited from making equity investments due to policy constraints under previous regulations. 92 This has contributed to a predominance of wealthy individuals and families in the VC market, as highlighted in Table 2. Recognizing the importance of institutional investors as a source of investable capital in long-term and high-risk investments, and in light of recent success stories in Israel and Singapore, which have had attracted global investors to their VC industries,93 China's regulators have made efforts to promote VC investment from qualified institutional investors and foreign investors. Regulators - notably including the China Securities Regulatory Commission ("CSRC"), China Insurance Regulatory Commission ("CIRC") , and China Banking Regulatory Commission ("CBRC") - have since 2008 begun to remove restrictions preventing the National Social 91 Zero2IPO Research Center , supra note 81. 9'l See Appendix 2, infra. 93 LERNER, supra note 5, at 101. 174 COLUJ\-1BIA JOURNAL OF AsIAN LAW [Vol. 30:160 Security Fund ("NSSF"), insurance companies , commercial banks, investment funds, and trust companies from making equity investments .94 For example, after the CIRC issued a set of guidelines allowing insurance companies to engage in VC investments , insurance companies have quickly built up substantial assets in the VC industry, reaching RMB 10 billion at end 2014. 95 There is also a substantial increase in investments by the NSSF. As of the end of 2015, NSSF managed RMB 1508.592 billion (USD 226.94 billion) and recorded a 15.14% return with RMB 228.704 billion (USD 34.40 billion) on investment in 2015. 96 According to the Regulations on NSSF, 10% of the total managed asset of NSSF can be used in private equity (including VC) investments.97 With the easing of regulatory barriers for institutional investors, the distribution of investors is shifting. Major institutional investors such as public p~nsion funds, investment companies, and insurance companies are gradually becoming important limited partners (LPs) in the VC market. s, Since 2008 , the NSSF has been permitted to make equity investments in certain funds. Since 2010 , insurance companies were allowed to make equity investments. Since 2014, insurance companies were permitted to make investments in VC funds. See Appendix 2, infra. 96 Gui Jieying (t'En!i~) 2015 Yi Jidu Huoyue LP Zengzbi , 14, 337 Jia , Xianzi, Yindao Jijin Qianzai Guimo Pangda (2015 -?Ji:&mi\li: LP ii~ 14, 337 ~. ~!1f, 51 ~~£mtE~ffi I¾.:k) [For the First Quarter of 2015, Actiue LPs haue Increased to 14 337· Insurance Conipanies and Gouernment Guidance Funds are Potentially the La;ges/ Inuestors) Touzijie (tit~~) [PEDAILY) (Apr. 28, 2015), http: //bit.ly/2tZcvAO. • 96 Baidu Baijia GPLP (13 &a* GPLP), Sbebao Jijin: Jiemi Touziquan Da BOSS Xuanxiu PE ~e Biaozhun (t±~~£: !i~tUi:11!:k BOSS~~ PE 1¥.J#l'!E) [Social Security Fund : Reuealmg the Big Boss Standards of Drafting PE], Touzijie (tlt~J!-) [PEDAILY) (May 9, 2016), bttp://pe.pedaily.cn/201605/20160509396982.shtml !n Quanguo Shehui Baozhang Jijin Tiaoli (~ III t± i!+l_ iJO [Regulations of National Social Security Fund], (promulgated by the State Council , Mar. 26, 2016, effective Apr. 1, 2016) , http: //bit.ly/2s377ur. 2017) ENGINEERING A VENTURE CAPITAL MARKET TABLE 1: PERCENTAGE OF CAPITAL RAISED BY LPS IN CHINA'S VENTURE CAPITAL AND PRIVATE EQUITY MARKET (BY INVESTABLE AMOUNT) (2011-2015) 175 2011( ¾)98 2012(¾)" 2013( ¾)100 2014( ¾)101 2015(¾)102 Listed companies 28.7 26.3 26.3 25.0 24.5 Public pension funds 20.4 20.7 20.3 19.2 17.8 Sovereign wealth funds 19.0 19. 1 18.7 17.5 16.O Enterprises 103 3.5 3.4 3.6 4.5 4.5 Fund of funds 5.9 6.4 6.3 6.1 5.6 Investment companies 2.8 4.0 4.1 4.5 4.7 VC/PE institutions 3.7 3.2 3.3 3.8 3.8 Enterprise annuity fund 4.3 4.1 4.0 3.7 3.4 Governmental agencies 0.4 0.9 1.0 3.4 5.9 Wealthy families and 0.7 1.1 1.3 1.5 1.6 individuals Private family funds 1.4 1.4 1.3 1.2 1.1 Trusts 0.2 0.3 0.4 0.5 Banks 3.8 10• 3.0 2.9 2.8 4.0 Asset management companies 1.7 2.3 2.3 2.3 2.4 Government-guided funds 1.8 2.1 2.1 2.0 2.0 Endowment funds 0.1 0.1 0.1 0.1 In surance institutions 1.1 1.0 1.1 1.1 1.1 University endowment funds 0.8 0.7 0.7 0.7 0.6 Others 0.2 0.2 0.2 0.3 Total 100.0 100.0 100.0 100.0 100.0 98 2011 Nian Zbongguo Simu Guquan Touzi Shichang LP Niandu Yanjiu Baogao Jianban (2011 ~'f'liP!'l.M1!2tltif1fm~ LP 4'&liffYi:=lfH!rfijl\&) [Summary of Private Equity Market LP Yearly Research Report 2011], Touzijie ( ti !it Jf- ) [PEDAILY], http://bit.ly/2uCGxtV. 99 2012 Nian Zhongguo Simu Guquan Touzi Shichang LP Niandu Yanjiu Baogao Jianban {2012 :lf:'f' li~M112tltif1£m~ LP ~&liffYi::fll'o!ffijl\&) [Summary of Private Equity Market LP Yearly Research Report 2012], Touzijie (till'i!f-) [PEDAILY], http ://bit.ly/ 2sZlejV. 100 2013 Nian Zhongguo Simu Guquan Touzi Shichang LP Niandu Yanjiu Baogao Jianban (20 13 ~'f' f:iil~JJ112tltill'i iii~ LP :lf:l!tliff'1:ffl~/llll\&) [Summary of Private Equity Market LP Yearly Research Report 2013], Touzijie ( ti ll'i !f. ) [PEDAILY], http://bit.ly/2sShJ3Q. 101 2014 Nian Zhongguo Simu Guquan Touzi Shichang LP Niandu Yanjiu Baogao Jianban (2014 'f' IE~JJJl2tltill'i fp~ LP !f.&liffYi:ffl i!r/llll\&) [Summary of Private Equity Market LP Yearly Research Report 2014], Touzijie ( ti Jf- ) [PEDAILY], http://bit .ly/2sZwGfH. 102 Qingk e Nianbao: Simutong Shoulu LP Zengzhi 15,849 Jia, Zhengfu Yindao Jijin, Shangshi Gongsi, Xianzi Cheng 2015 Zui Ri Jigou LP (n!ff,}ifcffl: ~JJ.imi&:!R LP :It~ 15,849 ~C iJ;lUf.MI-ITili!i~, ..trn~i'i'J, ~ll'i$; 2015 :Q~;ffl.¥;) LP )[Yem· 2015: Qingke Annual Report: PE LPs increase to 15,849, Government Guidance Funds, Listed Companies, Insurance Instituti ons are the most popular institutional LPsJ, Touzijie (till'i!f-) [PEDAILY] (Feb. 01 , 2016), http://bit.ly/2tBwQf9. 1oa Enterprises excludes listed companies. 1oc 1n 2011, Trusts and Banks were counted together. Summary of Private Equity Investment Market LP Yearly Research Report 2011, supra note 98. 176 COLUMBIA JOURNAL OF ASIAN LAW [Vol. 30:160 TABLE 2: PERCENTAGE OF TYPES OF LIMITED PARTNERS IN CHINA'S VENTURE CAPITAL AND PRIVATE EQUITY MARKET (BY NUMBER) (2011-2015) 2011( 0 0) 100 2012( 0 .) 1111 2013( 0 .) 11" 2014( 0 .) 1°" 2015( 0 .) 11' Wealthy families and 46.l 50.2 50.8 64.4 53.0 inruviduals Enterprises 110 19.5 17.2 16.6 14.9 14.6 VC/PE institutions 7.0 6.3 6.3 6.2 6.2 Investment companies 4 .7 5.9 6.1 8.5 9.4 Government-guided funds 3.7 2.8 2.7 2.0 2.1 Listed companies 3.0 4.3 4.2 3.9 4.7 Asset management companies 3.1 2.3 2.1 1.7 1.7 Governmental agencies 3.0 3.2 3.9 3.1 3.0 0.6 0.7 0.5 0.5 Trusts 3.6 111 1.3 1.1 0.8 0.7 Ban.ks Public pension funds 1.9 1.3 1.1 0.8 0.7 Fund of funds 1.8 1.5 1.5 1.3 1.5 University endowment funds 1.0 0.5 0.4 0.3 0.3 Insurance institutions 0.6 0.6 0.6 0.4 0.4 Private family funds 0.5 0.3 0.3 0.2 0.2 Sovereign wealth funds 0.4 0 .3 0.3 0.2 0.1 Enterprise annuity fund 0.1 0.1 0.1 0.1 0.1 Endowment funds 0.3 0.3 0.2 0.2 Others 1.0 1.0 0.9 0.8 Total 100.0 100.0 100.0 100.0 100.0 105 Summary of Private Equity Investment Market LP Yearly Research Report 2011, supra note 98. 100 Summary of Private Equity Investment Market LP Yearly Research Report 2012, supra note 99. 107 Summary of Private Equity Investment Market LP Yearly Research Report 2013, supra note 100. HIS Summary of Private Equity Investment Market LP Yearly Research Report 2014, supra note 101. 109 Year 2015: Qingke Annual Report: PE LPs increase to 15,849, Government Guidance Funds, Listed Companies, Insurance Institutions are the most popular institutional LP s, supra note 102. 110 Enterprises exclude listed companies. 111 In 2011, Trusts and Banks were counted together. Summary of Prirnte Equity Investment Market LP Yearly Research Report 2011, supra note 98. 2017] ENGINEERING A VENTURE CAPITAL MARKET 177 TABLE 3: PERCENTAGE OF CAPITAL RAISED IN THE U.S. VENTURE CAPITAL MARKET 112 (BY AMOUNT) U.S. 2014(%) 2015(%) Wealthy investors and family offices 8 10 Corporations 5 1 Public pension funds 32 31 Corporate pension funds 6 10 Union pension funds 1 2 Insurance companies 6 10 Endowments 5 7 Sovereign w ealth funds 12 6 Funds of funds 6 3 Discretionary advisers 1 2 GP contributions 1 2 Bank/financial services 9 2 Others 8 15 Total 100 101 (due to rounding) 4. Incr easing Capital Supply from Foreign Investors Since 1995, China has promulgated regulations aimed at promoting the establishme nt of foreign funds. For example, the Administrative Measures on Foreign-Established Industry Investment Funds allows Chinese firms to raise funding overseas together with foreign firms , 113 and the R egulati ons on the Administration of Foreign Invested Venture Capital Enterprises allowed foreigners intending to invest in the Chinese market to do so by setting up a Foreign Invested Venture Capital Enterpris e ("FIVCIE"). 114 112 LAURA KREUTZER, PENSIONS ARE STILL LP TOP DOGS, BUT WEALTHY INVESTORS GAIN GROUND 18 (2015), http ://bit.ly /2vc0H tl. 11a Sheli Jingwai Zhongguo Chan ye Touzi Jijin Guanli Banfa (~.:ftl,U•i-rj, !ii"'il:'.iltl51~ :i:'N-l!llhi't:) [Procedures for the Management of China's Industrial Investment Funds Abroad) (promu lgated by the People 's Bank of China, Sept. 6, 1995, effective Sept. 6, 1995) http://bit.ly/2u4009D. This regulation has since repealed. Feizhi de Guizhang he Guifanx.ing Wenjian (~.tl:1¥1:AA!~~~HtzltJt{lf) (Repealed Regulations and Standards] (prom ulgated by the People's Bank of China, Jan. 5, 2007, effective Jan. 5, 2007), art. 36, http://bit.ly/2u3tBA9. 111 Waishang Touzi Chuangye Touzi Qiye Guanli Guiding :l;WJi:'.) [Provisions Concerning the Administration of Foreign-funded Venture Invest ment Enterprises ] (promulgated by the Ministry of Foreign Trade and Economic Cooperation, the Ministry of Science & Technology, the State Administration for Industry and Commerce, t he State Admini stratio n, of Taxation and the State Administration of Foreign 178 COLUMBIA JOURNAL OF ASIAN LAW [Vol. 30:160 Since 2011 , Shanghai, Beijing, Tianjin , Chongqing, and Shenzhen have promulgated regional Qualified Foreign Limited Partner ("QFLP") progr ams to attract foreign qualified institutional investors to make equity investments in their regions. 115 Under the QFLP, foreign- invested funds and fund management companies are permitted to convert their foreign currency capital into RMB in order to invest into RMB funds.us In 2012 , the Renminbi Qualified Foreign Limited Partner ("RQFL P") program was launched by Shanghai to broaden the scope of foreign investors eligible to make VC investments. 117 Under RQFLP , qualified foreign fund managers are permitted to raise offshore RMB from offshore investors to invest in RMB funds set up in Shanghai. 118 5. Tax Incentives A favorable tax environment is an important factor in increasing the supply of private capital in a VC market. 119 Many local Chinese governments have implemented preferential tax policies for VC firms that serve as general partners (GPs), and for their investors who serve as the limited partners (LPs) in VC funds (see Table 4). 120 Today, individuals and families form the majority of LPs (by number) in the market. As of 2015 , 53% of LPs in China are wealthy individuals and families, 121 14.6 % are private enterprises, and 9.4% are investment companies. 122 As of 2014, China had the largest population of high-net-worth individuals in Asia (890,000), holding a combined wealth of USD 4.5 trillion, a 19.3 % increase from the previous year. 123 Further , the majority of leading VC firms are also both private and foreign. 124 There is also a growing number of VC funds set up by non- Exchange, Jan. 30, 2003, effective Mar. 1, 2003, revised Oct. 28 , 2015), art. 2, http://bit.ly/2t1Dh VP. 11• Ming Wang et al, CmNA'S FINANCIAL MARKETS: ISSUES AND OPPORTUNTTIES 128 (2014). 116 Sheppard Mullin Richter & Hampton LLP, Renminbi Qualified Foreign Limited Pa.rtner: An Increm ental Step Toward RMB Int ernationalization in the Private Equity Industry, LEXOLOGY (MAY 20, 2013), http: //bit.ly/2t23 BBN. 117 Mayer Brown LLP, Shanghai Laun ches New RQFLP Programme, LEXOLOGY (JAN. 14, 2013) , http://bit.ly/2s2PZEX. us Id. 119 John Armour & Douglas Cumming, The Legislative Road to Silicon Valley, 58 OXFORD ECON. PAPERS 598 , 603-13 , 617-26 (2006). 120 Gui Jieying , Cancellation of PE Tax In centives Causes a Stir amid the Trend of Market Innovation and Mass Entrepreneurship, PEDAILY.CN (Apr. 10, 2015), http://bit.ly/2t1Z6Eb. 121 The number of wealthy individual and families is big while the fund size they raise is sma ll (1.6% in year 2015). See Table 2, supra. 122 See Table 2, supra. 123 Annual World Wealth Report , CAPGEMINI & RBC WEALTH 11A.'-:AGE.,n:.,"T (2015), http://bit.ly/2tqfwwa (last visited May 24 , 2017). 12 • See The Top 50 VC Firms of the Year 2015 (ranked by Zero2ipo), PEDAILY.CX (Dec. 4, 2015), http://bit.ly /2snlpW0. 2017) ENGINEERING A VENTURE CAPITAL MARKET 179 state owned companies, 125 including Chinese internet giants Tencent and Alibaba. 126 Interviewees have stated that these tax incentives have greatly increased their interests in making VC investments.127 TABLE 4: TAX RULES FOR PRIVATE EQUITYNC FUNDS AT SELECTED LOCATIONS IN CHINA 128 Region Beijing Tianjin Shanghai Chongqing Shenzhen Tax Regulations 129 GPs and LPs pay individual income tax at a rate of 20%. 130 Individual GPs and LPs pay individual income tax at a rate of 20%. Within the Tianjin Economic-Technological Development Area, individual partners receive 100% subsidies for tax on income beyond the 20% individual income tax of individual partners. 13 1 Individual GPs pay individual income tax at a rate of 35% for income above RMB 50,000; LPs pay individual income tax at a rate of 20% for equity investment income. 132 Individual GPs pay individual income tax at progressive tax rates ranging from 5-35%; LPs pay individual income tax at a rate of 20%. Pursuant to China's Western Development program, funds organized as companies are subject to corporate income tax at a rate of 15%. 133 Individual GPs pay individual income tax at a progressive tax rate ranging from 5-35%; LPs pay individual income tax at a rate of 20%. 134 6. Improving Exit Environment The establishment of the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) in 1990 offered new exit channels for 123 See ERNST & YOUNG - 2014 - TRENDS, supra note 78, at 20. 1M Tencent and Alibaba are two top Chinese e-commerce companies. 121 Interview with Mr. Tian (anonymity requested), Partner, Songhe Yuanwang Capital, in Singapore (Dec. 30, 2016). 128 Gui, supra note 120. 129 The private equity funds in this table also include VC funds. 100 Liu Tianyong (~1J~ 1-:k), Simu Guquan Jijin Caiyong Shenme Zuzhi Xingshi Zui Jie Shui? (;fi.JJJJU5U.!i~*fflft¾-ffl.~U~:x:t:lii,H~.?) [What is the most tax-efficient structure for Private Equity Funds?] , Zhongguo Kuaji Shiye ('fl Li~if-.ll\1.ll!f) [CHINA ACCOUNTING VISION] (Oct. 18, 2016), http://bit.ly/2sni4Gx. ISi Id. IS2Jd. 133 Chen Zhonghua & Chai Nan (lilay 2013, the central government has issued at least 22 documents, including two fundamental opinions issued by the State Council to embark on the Mass Entrepreneurship and Inno vation reform. 194 This was followed by several specific measures that aimed to improve institutional mechanisms to facilitate entrepreneurship and innovation, for instance, by deepening business system reforms, strengthening intellectual property protection and establishing a mechanism for the training and hiring of talented professionals. 195 These policies resulted in the emergence of young entrepreneurs in China's VC market. 196 It is reported that 2.3% of the university graduates of 2013 have chosen to start businesses. 197 There are also an increasing number of overseas returnees (haigui)l98 who have started businesses with their technological knowhow and overseas resources. As of 2014 , the number of overseas returnees stood at 1.8 million, accounting for 51.4% of total overseas graduates. 199 In an interview conducted with 913 overseas returnees, 78.4% of whom had returned after 20 10,200 more than half indi cated that their decisions to return to China was largely based on the attractive entrepreneurial environment, 201 reflecting the positiv e effect of government policies in 194 Views of the State Council on Policy Measures relating to Mass Entrepre- neurs h.ip, supra note 76. '""ld. 100 See, e.g., id . 197 Chen Zhengfei (Wfi.iE"t), 90hou "Chuangke" Jueqi: Tiansbeng de Chuangyejia (90 £1" ¤~ ~" lilii ial: ;Ji; 1:: l'Jzj s:: ::i Q.. a, Although China has solved the simultaneity problem with a certain degree of success , in stitutional impediments may non etheless pr event the Chinese VC industry from realizing its full potential . This part discusses how the Chinese government can improve on what it has done to facilitate even greater growth ofVC. A. Problems with Publ ic Funding GGFs have not been unproblematic des pit e po sitive progress and swift development. There are GGFs at both the centr al and local levels. National GGFs are set up by the central government , while local GGFs are set up by local governments at differ ent leve ls (i .e. province , city, and county). As of December 2015 , 417 GGFs were city -leve l GGFs, and they managed an investment amount of RMB 824 .3 billion , while th ere 231 This graph is based on data from Summary of Private Equity ln L·estment Market LP Yearly Research Report 2012, supra note 99 (2002-2012) an d Year 2015: Qingke Annual Report: PE LPs increase to 15,849, Government Guidanc e Funds, Listed Companies, Insuran ce Institution s are the most popular institutional LPs , supra note 102 (2005-2016). 2017] ENGINEERING A VENTURE CAPITAL MARKET 193 were only 9 national-level GGFs, managing RMB 274.85 billion. 235 While most of these GGFs were recently established and it is still too early to test their roles in the VC market empirically, there are several flaws in the structure of the local GGFs and the rules by which they operate. First, local government intervention is prevalent within local GGFs. Local governments often mandate the sectors, companies, or locations to be funded. 236 In particular, it is common for a local government to require a VC firm to inject GGF funding in certain companies within the region. 237 This could lead to conflicts between the GGF and the VC firm, resulting in disincentives to the latter in finding promising projects and causing it to be less willing to receive funding from GGFs in future projects. There are also problematic local regulations that unduly restrict the duration of investments and size of the portfolio companies. For example, Jiangsu province specifies that the maximum duration of the GGF investment is five years, 238 which is inconsistent with the international practice of between 7 to 10 years. 239 Restricting the duration of investments and size of the portfolio companies ignores market force in the selection of portfolio companies. Investment managers may have to choose those companies that fall within the restricted categories but not the companies with growth potential and are in need of venture capital. Shortening the investment duration will encourage investment managers to choose mature or pre-IPO projects instead of early-stage start-ups. Second , the selection of managers in some local GGFs is flawed. For instance, the manager of the Shanghai Angel Investment Guidance Fund (AIGF) is not selected from the private sector, but is statutorily 235 Zero2IPO Research Center, supra note 85. 236 For example, Article 6(5) of the Implementation Rules for Shanghai Angel Investments Guidance Fund states that the investor is to invest mainly in companies within Shanghai. Shanghaishi Tianshi Tozi Yindao Jijjn Guanli Shishi Xize (.t~rfijc{ttl( !i'i 51 ~~~ff~~»fii~Ji!O, [Implementation Rules of the Shanghai Angel Investment Guidance Fund) (promulgated by the Shanghai Municipal Development and Reform Commission, Dec. 16, 2014, effective Dec. 16, 2014), art. 6(5) HUKEHE [2014) No. 49 http: //bit.ly/ 2t1V5CN. Zl7 Article 8 of the Implementation Rules of the Shanghai Angel Investment Guidance Fund, supra note 236, states that investments by the Shanghai Angel Investments Guidance Fund into each portfolio company shall be between RMB 5 million - 30 million RMB and that this amount shall not exceed 50% of the total subscribed capital of the portfolio company. 238 Article 41 of the Measures of the Jiangsu Emerging Industry Venture Capital Investment Guidance Fund states that the duration of investments made by the Jiangsu Emerging Industry Venture Capital Investment Guidance Fund shall not exceed 5 years unless approval is sought from the fund's management committee. Jiangsusheng Xinxing Chanye Chuangye Touzi Yindao Jijin Guanli Banfa (ir:;)i;11i'if)~f".'&E1J.'&N!i'iiJl i/J-tlJ.) [Measures of the Jiangsu Emerging Industry Venture Capital Investment Guidance Fund) (promulgated May 20, 2013 , effective May 20, 2013), http://bit.ly/2tZzn2D. 2-'!9 LERNER , supra note 5. 194 COLUMBIA JOURNAL OF ASIAN LA IV [Vol. 30:160 appointed. The manager currently appointed is a subsidiary 240 of another government-backed fund , the Shanghai Technology Entrepreneurship Foundation for Graduates ("EFG"), 241 that "shall exercise the rights as the investors of the Shanghai AIGF. " 242 Two questions naturally follow: First , how would EFG "exercise the rights as an investor" and operate the fund effectively since it does not hold any equity interests in the fund? Second, how would the EFG monitor the fund effectively when the fund is being operated by its subsidiary? Also, unlike the ordinary VC limited partnership model where a professional VC firm serves as the GP and is subject to various legal and contractual constraints (e.g. unlimited liability for the debts of the fund , fiduciary duties, and the LPs' derivative action mechanism) , there is no effective mechanism to constrain the behavior of the Shanghai AIGF 's statutorily mandated fund manager. Moreover, under the Shanghai AIGF Measures, 243 a steering committee comprising the deputy mayor of Shanghai and other government bureaucrats is in charge of the policy-making and supervision of the fund. 244 The lack of open selection mechanism for local cadres in charge of the GGFs may lead to problems including bureaucratic red-tape and a lack of expertise and professionalism within the GGFs. Further, the Shanghai AIGF Measures mandate the establishment of a separate investment committee comprised of extern ·a1 experts and government representatives to review and vote for investment proposals. 246 These officials may intervene directly in the decision- making process of the fund, thus causing internal conflicts. Also , while the GP of a limited-partnership type VC fund in the United States and the United Kingdom is constrained by fiduciary duties and potential 2..l)ayers' money while negotiating profit allocation, resulting in the VC firm being paid less than a 20% carried interest, 257 or in the GGFs being given priority in the distribution of profits over the VC firm.2ss Meanwhile, there is a lack of clear and detailed rules on the evaluation of the fund and the appraisal system of the GP in some local GGFs. 259 2.,3 Id., art. 11. :us, Id., art. 8 (specifing that applicants for compensation shall make a filing with the relevant registrar in charge of VC investments). Statistics show that out of more than 110 VC firms which had made filings for compensation as of Januar y 2016, most were state- owned VC firms. See Fengxian Touzi Shibai, Pingsh enme Zhengfu Lai Tieqian (Jxl.1'4~lii:k ~. }E-it¾.il;!Uf.f*l!i!itt) [tt-'hy Should the Gouernrnent Be Subsidizing Venture Capital Investment Failures], Jinri Huati ( B ii!i Iii) [IN TOUCH TODAY] (Jan. 27, 2016), http://bit.ly/2tq6PC8. 2M Under this rule, the venture capitalists are entitled to a flat 2% of total asset value as a management fee and an additional 20% of any profits earned as carried interest. See PAUL GOMPERS &JOSH LERNERK, THE VENTURE CAPITAL CYCLE 91-126 (2nd ed ., 2004). 2.w Kate Litvak, Venture Capital Partner ship Agreements: Understanding Compensation Arrangernenls, 76 U. CHI. L. REV. 161 (2009). 21>7 Zero2IPO, supra note 85. 258 Qidi Zhengfu Yindao Jijin: Sida Wenti Lanlu VS Sida Qushi "Guanfe ng" (~lit~lf.f 0 I 1--" '(/). g t_,:j 00~ c:1 80 '-' "-3 ~i i Q >"tj c 8 (IQ z ~- t:r' (!) p.. (!) < (!) c+ Cl) s-t:r' >i Cl) c+ Cl) >i g- (/J """'' c+ Cl) 8 a, a, Pl O" a, Cl) c+ .... t:r' a Cl) 'o UJ ln'"< a o Cl) H 0 £" >"tj p.. Cl) Pl §=: ~-(') r: c+ a, ~a-c+ Cl) ..... ..... S)) '< § l!; (') 8 g- >i p.. S'~ (IQ >i s s s· Cl) a, Pl S g O" r: Cl) a, (') Cl) Cl) (1) p.. 0 .... .:::! I :,. :.:: f ij ,... tO tO 200 COLUMBIA JOURNAL OF AsIAN LAW [Vol. 30:160 In light of the public nature of the GGFs, the unique party-state system, and protectionism at the local level, I suggest the following ways to improve government participation in GGFs. First, the government ceding control to market forces would mitigate operational inefficiencies arising from the incompetence and lack of professional experience on the part of government authorities. 277 Requiring matching funds from the private sector would help to reduce the dangers of uninformed decisions and political interference .278 Local governments should avoid intervention in th e se lecti on of portfolio companies and fund managers. Funding should be provided to early - stage start-ups that are in high demand of capital, instead of la ter-stage, government-linked companies that allow for the creation of quick returns. Second, the impact of government-sponsor ed funds "depe nd s not only on the design of the program but also on the selection of the" managers. 279 Instead of appointing government -link ed VC firm s, governments should select experienced, professional , and independent VC firms to manage the funds. Third, a well -designed appraisal and compensation system (such as the 2/20 rule 280) should be established to provide incenti ves to the fund 's manager. Also, more detailed rules should be provid ed on the eval uati on, regular reporting, and auditing of the GGFs to fill the legi slative gap in the existing regulations governing GGFs. 281 Fourth, the structure of the GGFs should be sim plifi ed to r educe bureaucracy and transaction costs. A "fund of funds" (FOF) approach taken by the SVCIGF seems more desirable for GGFs.2s2 U nder this model, the consolidated fund will make investments in a number of other funds, and each of these fund s will inv es t in a portfolio of companies . By doing so, the consolidated fund enjoys broader exposure to the industry and diversification of the risks associated with a single investment , in contrast to GGFs of old, in which a local fund is usually restricted to only one project .283 Fifth, under various local regulations , there are no deta iled rules governing the stage wherein investments are made into portfoli o companies .284 Giving the funds disproportionate r epr ese nt atio n or even 277 See LERNER, supra note 5, at 128-133. 21s Id. 279 Douglas Cumming & Sofia Johan, Pre-Seed Government Venture Capital Funds, 7 J. INT'L ENTREPEURSHIP 26, 26-27 (2009). 280 See the explanation in note 255, supra. 281 See, e.g., Implem entat ion Rul es of th e Sha nghai Angel Investment Guidance Fund], supra n~te 236; Measures on th e Jiangsu E merging Indu strial Venture Cap ita l Investments Gwdance Fund, sup ra note 248 . Var iou s local regulations gover ning GGFs do not provide rul es on thes e iss ues. 282 See Diagram 1, supra. 283 See Diagram 1, supra. 28• See Diagram 1, supra. 2017] ENGINEERING A VENTURE CAPITAL MARKET 201 control of the portfolio company's board of directors could help reduce agency costs at the financing stage. 285 I suggest that the GGF should appoint a representative to serve as a director on the board of the portfolio company to restrict the entrepreneur's discretion and behavior in using the GGF funding. The GGFs may also require veto rights in important matters or the power to replace the entrepreneur as the portfolio company's chief executive officer. B. Problems with Investment Vehicle Although there is little doubt that the adoption of the limited partnership in China has contributed to a more favorable environment for the VC industry and reduced transaction costs in the fundraising process, there are some special features that require further legislative attention. First , unlike other jurisdictions such as US-Delaware, 286 the U.K.,287 and Singapore, 288 which do not impose an upper limit on the number of partners in the limited partnership, the Chinese limited partnership has a requirement of at least two and a maximum of fifty partners.289 The maximum number of partners may unduly constrain the size of the fund and is inconsistent with international practice. As such, I suggest that the restriction on the number of partners be removed. Second, partners are allowed to transfer their partnership shares to outsiders (subject to various requirements) under the PEL. z9o An assignee of a GP will become a GP himself and be subject to rights and obligations in accordance with the amended agreement and the PEL. 291 This stands in stark contrast to the assignee's position under U.S. law, where a transfer in whole or in part of a partner's transferable interest in the partnership does not entitle the transferee to participate in the 285 Gilson , supra note 1, at 1082. 286 DEL. CODE ANN. tit. 6, § 17-101(9) (West 2010) ("limited partnership" means "a partnership formed under the laws of the State of Delaware consisting of 2 or more persons and having 1 or more general partners and 1 or more limited partners "). See also GOVERNMENT OF SI!'IGAPORE, STUDY TEAM OK LIMITED PARTNERSIDPS AND LIMITED LIABILITY PARTNERSHIPS, REPORT OF THE STUDY TEAM ON LJMITED PARTNERSHIPS, par. 8.4.1 (2007) , available at http://bit.ly/2tlls8o. 287 Although the UK used to impose an upper limit on the number of partners, there is no longer such a limit for all types of partnerships since 2001. GoVERNMENT OF SINGAPORE, STUDY TEAM ON LIMITED PARTNERSHIPS AND LIMITED LIABILITY PARTNERSHIPS, supra note 241, at para. 8.4.1. Section 4(2) of Limited Partnerships Act 1907 now states "[a] limited partnership must consist of one or more persons called general partn ers, ... , and one or more persons to be called limited partners ... " Limited Partnerships Act 1907, 7 Edw. 7 c 24, § 4(2) (Grt. Br.). 288 s 3(2) of Limited Partnershlp Act (Chapter 163B) states that "A limited partnership must consist of (a) one or more of general partners; and (b) one or more of limited partners. " Singapore Llmited Partnerships Act 2008 (Cap. 163B) s 3(2). 289 Partn ership Enterprise Law , supra note 126, art. 61. 200 Id. at arts. 22, 73. 29 1 Id. at art. 24. 202 COLUMBIA JO URNAL OF ASIAN L AW [Vol. 30:160 management of the partnership business. 292 Arguably, any change of the GP is likely to result in serious consequences for a fund, particularly with regard to the LPs' interests since they rely on the expertise of the GP when deciding to invest in the fund. Therefore , the PEL should not entitle the transferee, during the continuance of the partnership , to participate in the fund 's management. Third, unlike the Delaware code, the PEL does not provide any rules specifying how an existing company or partnership may convert into a limited partnership or vice uersa. 293 There is a practical need for VC limited partnerships to be able to convert into companies, especially when the limited partnership-type funds would like to expand their business.294 Currently, funds must deregister as limited partnerships and re -establish themselves as companies in order to convert to companies. Ideally, the Chinese legislature would provide a seamless process for the conversion of limited partnerships to companies. Fourth, Delaware and the UPA do not require newly admitted partners, whether general or limited , to be personally liable for the prior obligations of the partnership. 295 Logically, the newl y admitted partner ought not to bear any liability for the prior debts of the firm , since he was not a partner then and was not involved in any form of management of the firm. However , similar to a GP in a German limited partnership, 296 a GP in a Chinese limited partnership will assume joint liability with the existing partners for debts incurred by the firm before he joined the firm . Correspondingly, a new LP will bear liability to the extent of his capital contribution even if the partnership's debts were incurred before he joined the firm. 297 This restriction would reduce the attractiveness of the limited partnership to the venture capitalists and investors. I suggest that the PEL not require newly admitted GPs or LPs to be personally liable for the prior obligations of the partnership. Lastly, another distinctive feature of the PEL is the requirement that limited partnerships be dissolved in the event that the limited partnership is left with only LPs. 298 The limited partnership should be 292 UNIF. PARTNERSHIP ACT §503 (Nat'l Conference of Com m'rs on Unif. State Laws 1997). 293 See DEL. CODE ANN. tit . 6, §17-217 (West 2013). 294 Yang Guang ( ll8 ft), Renminbi Jijin Bianlian: GP Gaobili Chuzi Ji Huigui Gongsizhi Cheng Qushi (A~ifi~Slt~~ GP ~l:t~Jtl:lmlil@J!ll~ii'Jl!l1Jrot~~) [RMB Funds Change Faces: Trends of Converting Back t-0 Companies and Increasing Capital Contributions by GP], Tou Zhong Wang (N: rt,~) [CHINESE VENTURE] (Jun. 2, 2009), http://bit.ly/2sScNKr. : See DEL. CODE ANN. tit._ 6, § 15-306 (West 2011); UNIF. PARTN"ERSHJP ACT §306. The German Commercial Code § 130 provide s that a new partner is liable as the other partners for partnership obligations incurred before he joined . Hru~El.SGESETZBUCH [HGB) l?OMMERClAL CODE], §_ 130. The German Commercial Code also provides that a new limited partner shall be liable for partnership obligations incurred before he joined. Id. at§ 173. 297 Partnership Enterprise Law, supra not e 126 at arts 44 77 2!>8 Id. at art. 75. ' · ' · 2017] ENGINEERING A VENTURE CAPITAL MARKET 203 converted into a general partnership if it is left with only GPs. 299 Equivalent provisions are not found in the PEL 's German, French, and U.S. counterparts. A Chinese limited partnership with only LPs should be allowed to continue operating as a limited partnership over a grace period so as to exp lore possible options and attract incoming GPs. Also, as a typical VC fund usually lasts for ten years and makes long-term investments in a number of companies, forcing a limited partnership to be dissolved would create unnecessary costs and adversely affect the operation of the investee portfolio companies, which largely rely on the funding and management of the VC fund. C. Problems with Entrepreneurs Despite the effective policies and mechanisms put in place to promote the growth of entrepreneurs and entrepreneurial firms as discussed in the last part, more gaps in legislation must be filled to continue to address the issue of entrepreneurship in China, particularly in enhancing the protection of intellectual property rights . Interviewees stated that insufficient intellectual property protection has been a main concern for entrepreneurs and venture capitalists in China. 300 Moreover, there is a lack of personal bankruptcy law s in China. In China, there are several sanctions for debtors that default on loans: (1) the debtor will be included in the List of Dishonest Persons Subject to Enforcement and will face a series of penalties; 301 (2) the debtor may be subject to expenditure limits 302 and restrictions on international travel; 303 (3) depending on the severity of the situation, courts may fine or impose custodial sentences on the debtor; 304 (4) if elements of criminal offences are met , the debtor may be prosecuted for his refusal 299 Id. :,oo Telephone interview with Mr. G, Partner, Chengwei Capital, Shanghai (Aug. 1, 2016 ). ao1 This is of particular relevance to a corporate debtor who may face more restrictions in its subsequent business operations. See Zuigao Renmin Fayuan Guanyu Gongbu Shixin Beizhixing Ren Mingdan de Ruogan Guiding (:eitliA~7t~*r0:;(ff9;:f.!tlt tr A .i!; .¢ ffi .Q. (lE) [Several Provisions of the Supreme People's Court on Announcement of the List of Dishonest Persons subj ect to Enforcement] (promulgated by the Supreme People's Court, Jul. 16, 2013), art. 1, http: //bit.ly/2 ujY20D . a02 Zuigao Renmin Fayuan Gua nyu Xianzhi Beizhixing Ren Gao Xiaofei de Ruogan Guiding {liUli A R. 7t ll1t * T Ill,! !Ill] tit~ ti' A itli m i\'t (l. tE ¤t ~¤•] *1' flj ¤~ t9: (l(J ~? $tfr ,'i!':,: & iJ: i'- Jill t9: m ~-1ftl * '/i) [Why Taiwan Entrepreneurs Cannot Receive Venture Capital funding? Su Shizhong: Taiwan Made a Fool Out of Early-Stage Investors], Keji Baoju (flHUHa) [TECHORANGE] (Apr. 15, 2013) , http://bit.ly/2tlNqSl. 346 Id. 2017) ENGINEERING A VENTURE CAPITAL MARKET 211 financial intermediary that decides how exactly capital is to be allocated to a mere facilitator and provider of capital. Third, that private capital is becoming the major source of VC346 with the eased regulatory regime, the more liberal regulatory framework governing the VC market, the predominance of the limited partnership, and the increased number of private VC firms, start-ups and entrepreneurs. By providing the legislative and institutional infrastructure for the VC market, the government can facilitate the increased role of market forces, especially in the area of capital allocation . The Chinese experience offers several lessons to other countries: First , governments can help solve the three-factor simultaneity problem-by providing public funds through the well-designed government programs; by introducing business-friendly legal vehicles; and by improving the regulatory environment for fund raising, investments , and exits, governments can encourage capital supply, boost entrepreneur participation, and attract knowledgeable financial intermediaries to the market. Second, governments can facilitate the creation of a market premised on market forces and private contracting by restricting its own participation to being a LP, and leaving capital allocation decisions to private-sector parties with right incentives. 347 Failure to do so would prevent the industry from attaining sustainable growth. Nevertheless, there is substantial room for improvement in China. Various institutional impediments within each factor, as highlighted above, may prevent the industry from realizing its true potential. Moreover, in light of China's unique party-state system, conflicts between the central and local governments, the flawed cadre appointment system, and the flawed incentive mechanisms of government officials, it is difficult to ensure that local governments completely do not intervene in the capital allocation process. I suggest that the design of the government programs should be improved to keep such intervention to a minimum, while ensuring that the government's policy goals are still realized. Additionally, the next big challenge for the government is to further develop a VC market based on private contracting. In this regard, one key task is to ensure the effective enforcement of the various contracts covering the entire VC cycle. As the effect of private ordering in China may not be known for years to come, considerable future research will be required before meaningful suggestions can be offered. Lastly, the engineering of a venture capital market is highly specific to the context of each country. On top of capital, specialized financial intermediaries and entrepreneurs, an effective VC market also requires 346 See Table l, supra. 3-11 See generally Gilson, supra note l. 212 COLUMBIA JOURNAL OF ASIAN LAW (Vol. 30:160 a wide range of complex social, legal , and economic institutions 348 : robust stock markets, 349 sophisticated auditing and legal professions, strong investor protection, 350 effective judicial enforcement of contracts, liberal bankruptcy laws ,351 and an effective reputation market. Further research must be done in these particular areas for there to be a comprehensive examination of how the relationship between the government and the free market should be balanced and how the effectiveness of contractual design can be maximized. Ultimately, it remains to be seen whether the Chinese VC market can replicate the success c:ifthe U.S. market in the long run. a;s Armour & Cumming, supra note 119. . . ai 9 I address the correlation between the stock market and the venture capital market m Lin, supra note 61. . = Armour & Cu~g, sup~a no_te ll"9 at 597. Armour and Cumming's empirical findings show that the mvestor fnendliness of a country's legal and fiscal enviro · t · · ifi d . nmen LS afi sign cant etermmant of the supply of venture capital investment to entrepreneurial rms. 351 Id. (arguing that a more liberal personal bankruptcy law stimulates demand for venture ~ap1tal finance). ~~wever, as there is no personal bankruptcy law in China, this article will not address this issue in the context of China. 2017] ENGINEERING A VENTURE CAPITAL MARKET 213 APPENDIXES APPENDIX 1: LEGISLATIVE EFFORTS AT TACKLING THE SIMULTANEITY PROBLEM IN CHINA Capital Legislative efforts Existing & Potential Problems Private capital: (1) Removed regu latory restrictions that prevented certain institutional investors from investing in VC funds , thus broadening the investor base; (2) Tax incentives to attract private capital in VC investments; (3) Foreign investors were progressively permitted to make equity investments through various specia l schemes; (4) Regulatory environment for exits was improved to attract venture capital investments. Public capital: (1) A large numb er of GGFs were set up to inject capital into the market , with the intention of attracting matching capital from the private sector; (2) The SVCIGF scheme supports a market-oriented approach to capital al location. Public capital: (1) Certain local governments ' heavy intervention in the management of the fund and allocation of capital; (2) Governmenta l guar antees of investment losses; (3) Comp licated internal structure of local GGFs. Suggestions Public capital: (1) Governmental guarantees of investment losses should be abolished; (2) Governmental intervention in the selection of portfolio companies and funds' managers should be restricted; (3) The structure of the local GGFs should be simplified to reduce bureaucracy; (4) A well-designed appraisal and compensation system should be established to provide right incentives; (5) Continuous education of government officia ls on the nature of the VC industry. 214 Specialized Financial intermediaries Entrepreneurship COLUMBIA JOURNAL OF ASIAN LAW Legislative efforts Existing & Potential Problems (1) The limited partnership was introduced; (2) Various foreign investment vehicles were introduced to attract foreign capital. (1) The government has embarked on a policy of encouraging mass entrepreneurship and mass innovation through institutional measures ; (2) The company law, tax law and securities law were revised to facilitate setting up and doing business; (3) A large number of substantive laws were promulgated or revised to improve IT infrastructure. (1) Regulatory problems concerning the limited partnership; (2) Private ordering problems for limited partnerships: LP activism and internal conflicts. (1) Excessive tax preference treatment is given at the local level; (2) A lack of personal bankruptcy law and a lack of dual class structure; (3) A lack of dual- class stock structure under Chinese corporate law; (4) IP rights are insufficiently protected. [Vol. 30:160 Suggestions Addressing regulatory problems concerning the limited partnership vehicle such as by removing the maximum number of partners and providing more detailed statutory rules on partners ' duties and LPs' derivative action. (1) Consider promulgating personal bankruptcy law to ensure that honest failed entrepreneurs are protected and given a fresh start ; (2) Consider adopting the dual - class stock structure; (3) IP rights protection should be enhanced. 2017] ENGINEERING A VENTURE CAPITAL MARKET 215 APPENDIX 2: LEGAL DEVELOPMENTS AND THE GOVERNMENT'S ROLE IN DEVELOPING THE VENTURE CAPITAL MARKET OF CHINA 1978-2016352 Dates Feb. 9, 2006 July 6, 2007 June 5, 2008 Oct. 18, 2008 Sept. 5,2010 Law/Policy CAPITAL "Outlin e of the National Medium and Long-Term Science and Technology Development Plan" (2006-2020) published. 303 "Interi m Measures for the Management of Venture Capital Guidance Funds which support Science and Technology-based Small and Medium Enterprises" publi shed. 351 National Social Security Fund was allowed to make equity investments. 3M "Guidance on the Establishment and Operation of the Venture Capital Guidance Funds" published. 306 "Interim Measures for Equity Investment with Insurance .Funds " issued. 357 Implications for VC Market Encouraged setting up guidance funds to support start-ups in the seed stage. Introduced institutional mechanisms to encourage innovation and support high-tech start-ups. Greatly increased the VC funding. Provided clear guidance on the guidance funds. Insurance funds were allowed to invest in VC funds. 352 This table seeks to highlight the most important legal developments in relation to the development of the VC market in China. 353 Guojia Zhongchangqi Kexue he Jishu Fazhan Guiha Gangyao (2006 - 2020 Nian) (!Ei5(cp-f.(:.JVj,M~;f;!ltt*.titliH'.e:!W!:liilll! (2006-2020 ~ )) [National Medium and Long Term Development Plan for Science and Technology (2006 - 2020)) (promulgated by the Nat'! Assembly, Feb. 9, 2006, effective Feb. 9, 2006), http://bit.ly/2ssxTR2. 354 Kejixing Zhongxiao Qiye Chuangye Touzi Yindao Jijin Guanli Zanxing Banfa (Wtt !fl cp ,J, ¤tl tit m