Raising a Renewable Energy-Focused Private Equity Fund
Denominated in Foreign Currencies
By
Quan Miao
MASSACHUSETTS INSTITUTE
OF TECHNOLOGY
B.S. Information Engineering, Tianjin University, 2003
M.A. Economics, Nanjing University, 2006
LIBRRIES
SUBMITTED TO THE MIT SLOAN SCHOOL OF MANAGEMENT IN PARTIAL
FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF
ARCHNES
MASTER OF SCIENCE IN MANAGEMENT STUDIES
AT THE
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
JUNE 2011
©2011 Quan Miao. All rights reserved.
The author hereby grants to MIT permission to reproduce and to distribute publicly paper
and electronic copies of this thesis document in whole or in part
in any medium now known or hereafter created.
Signature
of
Auth.
MIT Sloan School of Management
May 6, 2011
Certified by: __
Yasheng Huang
International Program Professor in Chinese Economy and Business
Thesis Advisor
Accepted by:
Faculty Director,
Michael Cusumano
aster of Science in Management Studies Program
[Page intentionallyleft blank]
Raising a Renewable Energy-Focused Private Equity Fund Denominated in
Foreign Currencies
By
Quan Miao
Submitted to the MIT Sloan School of Management on May 6, 2011 in Partial
Fulfillment of the Requirements for the Degree of
Master of Science in Management Studies at the
Massachusetts Institute of Technology
Abstract
China's private equity industry has seen rapid growth during the past decade.
Private equity funds focused on different sectors and stages and denominated in different
currencies are competing for limited investment opportunities. To succeed in the ultracompetitive environment, private equity firms need to demonstrate the ability to raise
new funds and generate satisfactory returns for their investors in the long term.
Bohai Industrial Investment Fund Management Co., Ltd ("BIIFM") is one of
China's earliest and largest private equity fund manager of RMB-denominated funds and
currently manages an RMB6.08 billion (US$900 million) fund. Now in its fourth year of
the five-year investment period, BIIFM is in the position to raise a new fund as its first
fund will soon be substantially invested. BIIFM, however, is faced with different options
in determining the specific type of fund to raise. The new fund can be an RMBdenominated one, like the first fund, or a U.S. dollar-denominated one. It can be a
generalist fund, investing across sectors, or a sector-specific one. For BIlFM to have a
competitive edge in this ever more competitive industry, a well-planned fundraising
strategy is essential.
Based on my observations of the recent development in China's private equity
industry, I believe that developing expertise in certain areas will help a fund distinguish
itself from competitors. Meanwhile, raising a U.S. dollar-denominated fund will give
BIIFM additional flexibility in investment and complement its current RMB fund.
Therefore, in this thesis I propose a plan for BIIFM to raise a U.S. dollar-denominated
fund focusing on the energy sector, especially the renewable energy area. To this end, I
discuss opportunities in China's private equity industry, best practices for raising and
managing parallel funds in China, the rationales for BIIFM to raise this new fund,
specific proposal for this fund, as well as investment opportunities in the renewable
energy sector.
Thesis advisor: Yasheng Huang
International Program Professor in Chinese Economy and Business
Acknowledgements
First and foremost, I would like to thank Professor Yasheng Huang for his
invaluable advice in preparing this thesis. I also found Professor Huang's course 15.225:
Economy and Business in Modern China and India very helpful and enjoyable. Taking
the course also definitely helped shape some of the thoughts in this thesis.
I would like to take this opportunity to thank Mr. Jonathan Li, CEO of BIIFM,
and other former colleagues at BIIFM for teaching me the basics of private equity and for
understanding and supporting my decision to come to MIT Sloan.
My appreciation also goes to Chanh Phan and Julia Sargeaunt at the Office of the
MS in Management Studies program and my fellow MSMS classmates, for making this
year a better experience for me.
I would also like to thank my parents and my sister for their love and support.
Finally, special thanks to my wife Wenjuan. Your company makes this year in
Cambridge much more meaningful, and I am sure we will always remember with
fondness the year we spent together living along the Charles.
Table of Contents
1. Introduction.....................................................................................................................
6
1.1 Background ...............................................................................................................
6
1.2 Thesis objective and method................................................................................
7
1.3 Thesis organization ...............................................................................................
7
2. Overview of China's private equity industry.................................................................
8
2.1 A rapidly growing young industry ............................................................................
8
2.2 Special characteristics of China's PE/VC industry ..............................................
15
2.3 Social impact of private equity/venture capital in China .....................................
22
2.4 A special discussion on managing parallel funds .........
3. BIIFM and the new fund................................
............
...............................
........................
......
24
..... 28
3.1 BIIFM overview ......................................................................................................
28
3.2 BIIFM 's rationale for raising a U.S. dollar fund.... ......................................
34
4. Considerations and proposals for the new fund............................................................
39
4.1 Fund structure..........................................................................................................
39
4.2 The fundraising ...................................................................................................
43
4.3 Investment process ...............................................................................................
54
5. Investm ent opportunities in China's renewable energy industry...............................
58
5.1 China's renewable energy industry: more than an emerging market................... 58
5.2 Selected investment areas.....................................................................................
60
5.3 Case study of similar funds ........................................
67
6 . C on clusion ....................................................................................................................
References..................................................................
72
- - - - 74
-........... ----..........................--
1. Introduction
1.1 Background
The life cycle of a private equity fund is typically divided into several distinct
stages, including the marketing period, the investment period and the holding period.
The marketing period is the period in which the fund is raised. The length of the
market period varies and can range from several months, as in the case of a successful
firm raising a subsequent fund, to a few years, usually in the case of first-time
fundraising.
During the investment period, the fund managers make investments for the fund.
The length of the investment period varies depending on the investment strategy of the
fund, typically between three to five years. A fund manager is expected to invest the
entire fund during the investment period. Sometimes, however, the fund manager is
allowed to extend the investment period by one or two years with the permission of the
investors. During the investment period, the fund manager usually receives management
fees calculated based on the size of the fund.
After the investment period, a fund enters the holding period, during which the
fund manager's main job is to manage the previous investment and exit the investment as
they see proper. At this stage the management fee rate is often reduced, on the ground
that less effort is usually required to manage portfolios than to make investment. The
base for calculating the management fee will also be reduced accordingly when some
investments are exited.
After a marketing period of less than two years, a total of RMB6.08 billion was
raised for BIIFM's first fund. The fund, Bohai Industrial Investment Fund I ("BIIF I"),
was launched on December 30, 2006. The investment period is set to be five years, from
December 30, 2006 to December 29, 2011. After the investment period, investors of the
fund are no longer legally bonded to honor previous capital commitment and the firm will
also face reduced management fees.
May 2011
(thesis date)
I
Marketing
Period
Holding
Period
Investment
Period
Dec 30, 2006
Dec 29, 2011
Dec 30, 2021
BIIFM is now at a critical stage as BIF I has been substantially invested and the
investment period will be over in less than a year. Given the uncertainty in the time
required to raise a new fund, it is in BIFM's interest to start the fundraising process as
soon as practical.
1.2 Thesis objective and method
This thesis attempts to discuss a plan for BIIFM to raise a new fund, specifically,
a U.S. dollar-denominated private equity fund to be invested primarily in the renewable
energy sector. The goal is to provide BIIFM research support if it decides to adopt such a
strategy later on. As this is a practically focused topic, methods I plan to employ include
industry analysis, interviews, case study, literature review and best practice review.
1.3 Thesis organization
This thesis consists of six chapters. Chapter 1 provides basic understanding of the
problem that the thesis is trying to solve and the methods to be used. Chapter 2 starts to
approach the problem by reviewing the development of China's private equity industry,
laying a ground for the macro-environment in which BIIFM's fundraising activities will
be conducted. Chapter 3 reviews the background of BIIFM and discusses the strategic
imperatives for the firm to do the proposed fundraising. Chapter 4 proposes the specific
fundraising plan for the firm. Chapter 5 examines some of the key investment areas
within the proposed investment sector. Chapter 6 concludes the thesis.
2. Overview of China's private equity industry
2.1 A rapidly growing young industry
Private equity ("PE") is a relatively new thing in China. The earliest private
equity investors in China were foreign venture capital ("VC") firms' that came to China
in the early 1990s. Founded in 1992 with the support of International Data Group and
Accel Partners 2, IDG VC Partners is widely regarded as China's first VC firm.
International Data Group was not a venture capital firm, but became a pioneer in China's
venture capital industry almost by accident. During the 1980s, International Data Group
made good profit by publishing IT related magazines in China. Subjected to foreign
exchange regulations, International Data Group decided not to transfer the profit back to
the US but instead invest the money in venture capital, leveraging on its knowledge in the
IT industry. That is how China's first venture capital firm came into being.
In 1995, Administrative Measures on the Foreign-investedIndustrialFund in
China was passed, drawing many international venture capital firms to China to seek
opportunities. Nevertheless, during the entire 1990s, venture capital investments
remained few and small in size. Private equity, lagging even behind venture capital, was
almost nowhere to be seen then.
However, starting in the early 2000s, China's private equity and venture capital
("PE/VC") industry are witnessing dramatic growth. Hundreds, if not thousands, of funds
have been started, raising tens of billions of fund from both overseas and domestic
investors. Nowadays private equity investments have frequently become headline news
and various funds are competing for potential deals everywhere. People are starting to
worry that the industry has become over-competitive. Despite the increasingly
competitive nature of the industry, it is expected that old players are here to stay and new
The line between private equity and venture capital is very blurry in China. There are few buyout private
equity funds in China, while the venture capital funds do not invest in very early-stage companies. Most
private equity funds and venture capital funds in China invest primarily in companies in their growth or
expansion stages. As a result, for the statistics used in this thesis we do not make the distinction between
private equity and venture capital.
2 International Data Group is a Boston-based leading IT media, research and exposition company.
Accel
Partners is a global venture capital firm with offices located worldwide.
8
funds will continue to come in the near future, and continued rapid growth of the industry
is expected.
2.1.1 Fundraising
Before 2005, very few PE/VC funds 3 were raised in China. During the ten years
between 1991 and 2000, only 44 funds in total were raised, mostly VC funds
denominated in the U.S. dollar. Between 2001 and 2005, fundraising activities picked up
slightly, but still only a handful of funds were raised each year. However, starting from
the year 2006, fundraising in China entered a new stage, with the number of funds raised
annually increased to more than 100 4 . During this period, while the number of VC funds
raised kept growing, PE funds started to emerge and saw tremendous growth afterwards.
Of the PE funds raised, most were growth capital-focused funds. Although official
statistics are difficult to get, it is estimated that the total number of active PE/VC funds
in China was about 100 in 2000. In 2005, the number grew to about 500 and then further
to about 1,500 in 2010, 15 times that in 2000. China now has more PE/VC funds than the
US does, and the number of funds in China is still growing while that in the US is
relatively steady or even declining 6 .
3 Domestic Chinese funds, as well as foreign funds raised outside of China but focused in China, are both
included.
4 The completion time of fundraising for many funds is not available and therefore such funds are not
included in the statistics. If these funds are included, the number of funds raised annually will be further
increased.
5 http://money.163.com/I 1/0101/01 /6P9AIGV200253B0H.html
6 According to National Venture Capital Association in the United States, the number of active funds in the
US declined from 1,0 19 in 2007 to 882 in 2008.
Exibit 2.1 Numbers of Funds Raised (2001 - 2010)
2001
2002
2003
EVC
2004
2005
2006
U PE -growth capital
2007
2008
MPE -other
2009
2010
Time not
disclosed
Source: ChinaVenture
Fundraising in dollar amount saw similar trends. Total fund raised in 2001 was
only US$280 million, and the volume stayed small until 2006, but afterwards the fund
raised surged to US$18,850 million in 2010 and reached the peak of US$21,900 million
in 2008, before dropping to US$11,380 million in 2009 as a result of the global financial
crisis. Over the ten years, a total of US$80,900 million has been raised. Although VC
funds outnumbered PE funds, PE funds raised more money than VC funds did because
the typical sizes of PE funds are much larger than those of VC funds. Of the US$80,900
million of fund raised, US$28,900 million is raised by VC funds and the rest by PE
funds, including both growth funds and buyout funds.
Exibit 2.2 Total Value of Funds Raised (2001 - 2010, US$ m)
2001
2002
2003
H VC
2004
2005
2006
U PE - growth capital
2007
2008
2009
2010
0 PE - other
Source: ChinaVenture
2.1.2 Fund Investment
From 2001 to 2010, a total of US$106.8 billion of PE/VC fund was invested in
China. The annual investment follows the pattern of fund raised, staying relatively small
before 2005 but growing dramatically afterwards. Average investment size is US$87.6
million per deal in 2010 while median size is US$15.0 million. Sizes of investments are
relatively small because most of the investments are minority deals with PE/VC funds
acquiring less than 40% of the total shares outstanding. The fact that the median size is
much smaller than the average size suggests that the investment size is heavily skewed
because there are some very large deals while most are small-sized deals.
Exibit 2.3 Total PE/VC Investment (2001 - 2010, US$M)
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2009
2010
Source: China Venture
Exibit 2.4 Average Investment Size (2001 - 2010, US$M)
2001
2002
2003
2004
-
2005
Mean -
2006
2007
2008
Median
Source: Chin nVnture
Geographically, the eastern and coastal areas are heavily concentrated for PE/VC
investments. Beijing, Shanghai, Jiangsu, Zhejiang, Hong Kong and Guangdong take the
lion's share of 51% of total number of deals. Among these areas Beijing is far ahead of
7
the others. Measured by dollar value, Beijing, the United States , Shanghai, Guangdong
and Hong Kong accounted for 67% of total investment. The situation started to change
recently, though. As deals become more and more competitive in the eastern and coastal
areas, PE/VC funds have begun to "go west" to areas less explored before in order to find
more reasonably priced targets. This happens not just to the smaller local funds: Global
big funds such as the Carlyle Group and TPG are even talking to local governments in the
western area to raise funds focused in the western area.
In terms of industry distribution, manufacturing, internet, IT, healthcare, energy
and media together account for 72% of total investment by deal numbers, while these
same industries account for 79% of total investment by dollar value.
Exhibit 2.5 PE/VC Investment by Industry
2010 VC Investment Value in China
2010 VC Investment Volume in China
(Number of Deats)
Others
Manufacturing
4
Chemica I
nternet
hemical
C
Retail
M'e ida
~ InL~flA
Energy 8
ENalhafe
IT
Manufacturing
Source: ChinaVenture
2.1.3 Exit of Investments
From 2001 to 2010, a total of 722 exits of PE/VC investments have been
announced, of which 519 were through IPOs and the rest through trade sales. Most of
these IPOs were on mainland China's stock markets, while a significant number of IPOs
were on Hong Kong and US stock markets. The Small-to-Medium-Sized Board ("the
SMS Board") and the Growth Enterprises Market Board ("the GEM Board") are the main
7 Most are companies originated from China but registered in the US or the US controlled jurisdiction, with
substantially all their business and assets still in China.
13
channels for these exits. It was also the launching of these two stock exchanges that
significantly boosted the PE/VC industry in China and lead to the "Great Leap Forward"
in fundraising and investing, because they are well-suited for the VC and growth capital
types of investment to exit.
Exibit 2.6 Numbrers of Exits (2001 - 2010)
2002
2001
2003
2005
2004
2006
2007
2008
2009
2010
SIPO I Trade Sale
Source: ChinaVenture
Exibit 2.7 Numbers of Exits by Listing Venue (2001 - 2010)
SMS Board
75
Hong Kong
230
GEM Board
64
Singapore
Shanghai
4
9
Other
S'2001-2005
Source: ChinaVenture
02006-2009
92010
Looking at the rates of return for deals exited through IPOs8 , it is not difficult to
understand why the majority of exits have been through IPOs. A calculation of rates of
return for IPO exited investments shows that average rates of returns are between 70%
and 100%, a very high return by any standard.
Exibit 2.8 Returns of Exits (2001 - 2010, US$M)
25,403
140.6%JA
c'
150.5%
20,722
20,0
9.99%
9.4%
95.2%
-95.9%
88.8%
79.5%
73.1%
51.9%
4,004
3 13
28146
52183 23
2001
2002
2003
M Money invested
909
4
1,779
2005
2004
1,859
2006
Mondy returned
2007
2008
2009
2010
Median IRR of returns
Source: ChinaVenture
2.2 Special Characteristics of China's PE/VC industry
2.2.1 VC investment in later stages
In mature markets, VC and PE funds usually have different focus. They invest in
companies in different industries and at different stages, have different fund sizes, and
even employ investment professionals from vastly different background. While VC firms
prefer people from engineering or entrepreneurship background with business savvy, PE
firms usually hire people with strong finance background typically honed in investment
banks. In China the line is not clear, as VC funds are becoming more inclined to invest in
later-stage companies that already have growing revenue and profits, while PE funds
seldom do buyout deals and are mostly doing growth capital investment.
*Only exits that have been publicly disclosed are included.
15
VC funds in China prefer late-stage investment for two main reasons. On one
hand, early-stage investments are difficult to do. Limited partners typically have a shorter
investment horizon and want to see returns on their money as soon as possible. Also, due
to China's immature legal system and business environment, enterprises at the early stage
are exposed to significant risk and therefore investment in pre-revenue or pre-profit
stages is subject to great risk. On the other hand, in such a fast-growing economy as
China, many companies that have passed the early stage but still in the high-growth stage
need much capital for further expansion, giving rise to numerous investment
opportunities for growth capital investment. As a result, many VC funds invest more and
more in growth capital deals. For example, IDG VC and Sequoia Capital China both have
dedicated China growth funds at much larger size than their VC funds, and Shenzhen
Capital Group, China's largest local VC fund, puts 60% of its total funds in growth-stage
investment and 20% in mature-stage investment, leaving only 20% for early-stage
investment 9 . As one industry veteran points out: "When you have ripe apples hanging
low in the tree, why bother trying to find the green ones?"
2.2.2 Barriers to buyout deals for PE funds
Buyout deals have been the hallmark for PE funds in the US and Europe. Buyout
firms such as KKR and TPG usually borrow a significantly amount of debt
0
(typically
accounting to 60%-80% of the total transaction value), acquire a company (oftentimes a
listed company), privatize it, cut cost by downing-sizing employees, selling non-core
businesses or tightening the company's budge, improve its operations, and then it is
expected that its bottom line will be improved and it can be sold or listed at much higher
price in several years.
But in China buyout targets are very few. China has adopted the market-economy
system for only 30 years and as a result the owners of most private companies" are still
first-generation entrepreneurs who do not want to sell their companies yet. Even if some
9 http://money.163.com/i 1/01 01/01/6P9AIGV200253B0H.html
'0 In the case of leveraged buyout
Private companies here refer to non-SOEs, not non-listed companies
16
of the first-generation entrepreneurs have reached the age of retirement, many do not
want to give up the control in the companies they founded and regarded as their
"children". Most of the sons or daughters of such first-generation entrepreneurs are
willing to assume the ownership and leadership in the companies their parents founded
and therefore there is not much need for sale of companies. For state-owned enterprises
("SOEs"), although the government sometimes wants to privatize the companies they
own and bring in new investors, taking control of an SOE is extremely complicated and
subject to heavy scrutiny. Furthermore, if the acquiring fund is a foreign one, the
transaction may be subject to political risks involving issues such as anti-monopoly and
national security. In addition, it is difficult to do corporate restructuring that involves
laying-off workers and changing the management in China, and therefore operations
improvement, which is usually a key rationale for buyout deals, is hard to do in China.
Some well-known unsuccessful cases have deterred PE funds from attempting to
do buyout deals. In 2005, the Carlyle Group tried to do a buyout deal with Xugong
Group, a market leader in heavy construction machinery. One of Xugong's Chinese
competitors was afraid that the acquisition would further boost Xugong's
competitiveness, so it raised national security issues and created much publicity noise
around the acquisition. As a result, the deal terms had to be changed many times, with the
proposed stake taken lowered from 85% to less than 50% and acquisition price increased,
but eventually the deal was still blocked by the government, and the millions of dollars of
expenses Carlyle incurred were wasted. Carlyle's recent attempts to invest in several
local banks also failed to pass regulatory scrutiny. Nowadays foreign PE funds are
hesitant to do buyout deals in China and instead focus on growth capital deals. Even
KKR, which is well known for its leverage buyout records, raised an $800 million growth
fund focused on China recently and joined the growth capital club with other major
global funds such as Blackstone and TPG."
12 http://www.washingtonpost.con/wp-dyn/content/article/ 2 010/07/1
17
5/AR20 10071500114.html
2.2.3 Lack of leverage financing and financial instruments
PE transactions in mature markets are characterized by utilizing leverage
financing. This, however, is not the case in China, where commercial banks were
forbidden to make loans to clients for acquisitions until recently. The loans could only be
used for fix asset investment or working capital. Although at the end of 2008 a new
policy was passed that allows commercial banks to make loans for acquisition in certain
circumstances, in practice it is still very difficult to get such loans. This partly explains
why buyout deals in China do not happen often.
Also, many financial instruments widely used in PE and VC deals in the west,
such as convertible bonds and preferred stock, are not available in China, creating
difficulties for PE funds to mitigate risk by deal structuring.
As a result of the lack of leverage and certain financial instruments, the structures
of PE and VC deals in China are relatively simple. The funds therefore tend to focus on
the growth potential of investment targets rather than financial engineering.
2.2.4 Rent-seeking in China's PE Industry
China's PE industry has been developing so fast that it is difficult for the
regulations to keep pace with the industry development, leaving room for rent seeking by
people who have important connections or insider information.
The financial industry has always been a relationship-based industry everywhere
in the world, but connections are so much more important in China's burgeoning PE
industry. When the industry becomes ever so competitive and good deals are extremely
difficult to get, it would definitely help if a fund has some strong connections behind it.
That is why many so-called princelings worked at PE funds or start their own funds".
Target companies also welcome investment from funds with connections because they
hope that the connections can bring them favors in terms of regulatory approvals - for
3
http://www.ft.comi/cms/s/O/e3e5 I a48-3b5d- 11 df-b622-00144feabdcO.html#axzzl DmncVewl
18
instance, better chance of their IPO being approved by the China Securities Regulatory
Commission.
Inside information exploitation is another problem, which usually involves
professionals who help companies to prepare their IPOs, such as investment bankers. One
characteristic of China's A share stock market is that historically the prices of newlylisted companies always go up significantly on the first day of their listing, hence if
someone can make an investment in such a company shortly before the IPO, the
investment is almost guaranteed to generate good return for the investor. Investment
bankers usually know the companies they sponsor well, and if they believe that the
company has a good chance of being approved for the IPO, they sometimes ask the
company for the right to invest in the company at much lower prices than the IPO prices.
They typically find other people as nominal shareholders, as the securities regulator does
not allow sponsors to invest in the companies they sponsor. In many cases government
officials are also involved, especially officials who have sayings on the approving of the
listing.
These rent-seeking behaviors lead to a new kind of business corruption connected
with the PE industry and can hurt the long-term development of the industry. Efforts
should be made to regulate the PE industry in a more effective way.
2.2.5 Fundraising in different currencies with different structures
The first PE/VC funds in China were mostly U.S. dollar-denominated, even
though many of the fund management teams are local. For example, Hony Capital is
controlled by Lenovo, a Chinese SOE, and CDH Investment is owned by its management
teams, almost all of whom are native Chinese. Nevertheless, the early funds of both Hony
Capital and CDH were U.S. dollar funds. The main reasons are two folds. First, only a
few of years ago there were no qualified limited partners ("LP") in China, and both local
and foreign funds had to turn to foreign LPs for fundraising. Second, IPOs on China's
domestic stock markets are subject to the strict approving processes of Chinese Securities
Regulatory Commission and other regulatory bodies, and there is great uncertainty in
whether an IPO will be approved, especially before 2006, thus many PE funds and their
portfolio companies turned to overseas stock markets for IPOs. In doing so they were
usually required to set up a holding company in a foreign jurisdiction such as the Cayman
Islands and the British Virgin Islands. Hence before 2006, most PE deals had the
characteristic of both investing and exiting overseas, and the industry was dominated by
U.S. dollar funds. A PE firm would raised fund from overseas LPs such as Stanford
Endowment, California Teacher's Endowment and Temasek, invest in an off-shore shell
company that would use the investment proceeds to acquire the assets of the target
investment company onshore, and exit after the portfolio company go public on an
overseas stock market. See Exhibit 2.9 for a typical investment structure of a U.S. dollar
fund.
Exhibit 2.9 A Typical Investment Structure of a US$ Denominated Fund
LPB
LPA
US$
. .I
*.l.
..*...
1US$
.. .. .. .. .. . .........
Private Equity
Fund
Original
Shareholders
NYSE
--
Off-shore listing
NASDAQ
Cayman Co
Off-shore
HKSE
On-shore
Target Co
Asset B
Asset A
The U.S. dollar fund's structure used to be the preferred structure before 2006 for
the ease of fundraising and exiting, but situations started to change after the 2006 stock
market reform. On one hand, China began to develop its indigenous private equity
industry and allowed some domestic financial institutions to invest up to a certain
percentage of their fund in private equity. Deep-pocketed financial institutions such as
20
the China Development Bank and National Social Security Fund (NSSF) are among these
institutions. For example, NSSF currently manages assets of about RMB1 trillion (about
US$150 billion) and is permitted to invest up to 10% of total fund managed in the PE/VC
fund class. This alone is about the size of total PE/VC fund raised in China in 2010.
Besides these qualified financial institutions, other players including investment banks,
corporations, endowments and high net-worth individuals are all ready to enter the
private equity industry, dramatically increasing sources for PE funds denominated in the
RMB. On the other hand, the IPO window was reopened in 2006 after the structural
problem of illiquidity was solved, and exiting via the domestic market became not only
possible, but also increasingly attractive. The opening of the Growth Enterprises Market
Board in 2009 further broadened ways of exiting domestically. Meanwhile, stock
issuances on the domestic markets usually command higher valuation than those on
overseas markets, making it more attractive to PE funds.
As a result, although the RMB funds came into the market only a few years ago,
they saw dramatic growth and overtook U.S. dollar funds as the dominating type of
funds. Investing with an RMB-denominated fund has many advantages as compared to
investing with a U.S. dollar-denominated fund in that the structure is simpler, the
domestic regulatory uncertainty smaller and the return potentially higher.
Exhibit 2.10 A Typical Investment Structure of a RMB Denominated Fund
LPA
LPB
RMB
RMB
Original
Shareholders
Private Equity
Fund
_ ........... .............
..............
....
Shanghai Exchange
_.
Domestic listing
Shenzhen Exchange
Target Co
GEM Board
Asset A
Asset B
But U.S. dollar funds do have some advantages over RMB funds, including less
uncertainty in obtaining the securities regulator's approval, more diversified and mature
LP base, and additional benefits for marketing the invested company to the global
market. Therefore the two types of funds are complementary to some degree, and it is not
unusual to see a PE firm that previously managed only U.S. dollar funds to raise RMB
funds, or the other way around.
2.3 Social impact of private equity/venture capital in China
2.3.1 Providing the much-needed financing to small-and-medium-sized
enterprises
Financing needs of small and medium enterprises ("SMEs") in China have been
long overlooked by banks and other mainstream financial institutions in favor of more
established companies, and the situation was made even worse during the global financial
crises in 2008 and 2009, when banks tended to shun smaller clients to control risk.
Venture capital provides SMEs with the capital they need for growth and this is the direct
impact of financing. However, it is argued that the direct impact is not significant, as only
a small percentage of SMEs qualify for, and have access to, venture capital investment.
The majority of SMEs, especially those at early stages, do not.
In fact, the indirect impact may be more important. For SMEs that have been
financed by venture capital investment, their credibility and credit-worthiness will be
boosted by such financing, sending positive signals to traditional financing providers
such as banks and bond investors and making it much easier for them to engage in
follow-on financing from traditional channels. For the smaller and earlier-stage SMEs
that do not qualify for venture capital or private equity investment at their current stages,
the mere possibility of exiting through trade sale to VC funds and even future listing on
the GEM Board makes them more attractive to other sources of financing, such as equity
investment or loan with convertible features from families and friends, angel investors,
government start-up funds and high net-worth individuals.
22
2.3.2 Providing incentives for SMEs to improve management and corporate
governance
Because they are small and not subject to public disclosure requirements, SMEs
in China used to imply mediocre management and corporate governance. In many cases
they are not run by professional managers, but are managed by the hands-on founders and
therefore heavily subject to the founders' experience, capability and preferences. In
addition, they usually do not have a sound corporate governance structure and many do
not even have a board of directors in place. However, to qualify for venture capital
investment, they need to meet the higher standards in management and governance
required by the venture capital investors. With venture capital fundraising in mind, many
recently founded SMEs have sound management and governance systems in place at the
very beginning, oftentimes advised by their lawyers, investment bankers and accountants.
Even if they do not have such systems at the first place, when venture capital firms invest
in SMEs, they typically ask for some control, usually in the form of board seats.
Therefore, many SMEs undertake management or governance restructurings when or
after they bring in venture capital investors to prepare for the future listing.
2.3.3 Promoting the brand recognition and corporate image of SMEs
SMEs usually have very little brand recognition because of their small sizes and
short history. Furthermore, SMEs are not held highly for their corporate image and
people often associate SMEs with poor governance, low technology and unreliable
financial data. As a result, SMEs are at a disadvantage for these "soft factors" in their
competition with more established companies. However, when SMEs are invested by a
well-know venture capital funds, they can receive a significant amount of publicity, and
many go on to be listed on a stock market and have continued coverage by research
analysts at investment banks. Therefore, the increased brand recognition and corporate
image brought by a venture capital investment will help enhance an SME's credibility,
thereby helping to level the playing field for them.
2.3.4 Boosting entrepreneurship and innovation
Experience in the United States has shown that venture capital has played
important roles in promoting entrepreneurship and innovation. Many of today's greatest
companies, such as Google and Yahoo, started in garages, turned to venture capitalists for
initial financing when bank financing was difficult to get, and got listed on the
NASDAQ, the stock market that China's GEM Board is modeled on. Similar instances
are happening in today's China. Hepalink is one of these most shining stars. A
pharmaceutical company, Hepalink was founded by a husband and a wife in 1998 with
initial capital of RMB2 million (US$30,000). Unable to get bank loans, Hepalink sold
30% of its shareholding to Yuanzheng Investment, a venture capital fund, in 1999. It
accepted financing from several other venture capital and private equity funds to meet its
growth needs, including Goldman Sachs' private equity arm. Hepalink has been doing
very well since, becoming world's largest heparin sodium producer and was listed on the
GEM Board in May 2010. The market value at its opening price on the first day of listing
reached RMB70 billion, making the founders the richest people in China then and giving
its venture capital investors extraordinary returns.
Chinese people have never been short of innovation and entrepreneurship. Now
with the demonstration effect of successful stories such as that of Hepalink, people are
better motivated to innovate and take risk. We are seeing a trend of entrepreneurship
emerging in China in a big way and the VC industry has certainly played a vital role.
2.4 A special discussion on managing parallel funds
Many established PE firms with track records for managing U.S. dollar funds
recently started to leverage their experience and the excess domestic liquidity to raise
RMB funds. Meanwhile, some PE firms that started as RMB fund managers are also
trying to foray into U.S. dollar fund management after initial success with their RMB
funds. As a result, many PE firms in China are managing funds denominated in both the
RMB and the U.S. dollar, or the so-called parallel funds.
24
Hony Capital is a good example of U.S. dollar fund manager raising RMB funds.
Before June 2008, Hony managed four U.S. dollar funds totaling about US$2.1 billion,
which had achieved tremendous success. Building on the momentum of its U.S. dollar
funds, Hony raised an RMB fund of RMB 5 billion, with the funding from the NSSF and
several other blue-chip Chinese financial institutions. Currently Hony is in the process of
raising its second RMB fund with a target size of RMB 10 billion, and by the end of
October 2010, RMB7.3 billion has already been raised'.
With its two RMB funds, now
Hony is managing more funds in the RMB than in the U.S. dollar, although it started as a
U.S. dollar fund manager.
One example of going from RMB funds to U.S. dollar funds is Dachen Venture
Capital. The Shenzhen, Guangdong-based VC firm was founded in 2000, and for the first
ten years it only managed RMB funds. The birth of the GEM Board has proved a golden
opportunity for Dachen, which saw more than 10 portfolio companies listed on the GEM
Board, making Dachen one of the shiniest stars in China's VC industry. Riding on its
stellar records in managing RMB funds, Dachen raised a U.S. dollar fund of $75 million
in 2010, although it has been perceived as an essentially local fund with no overseas
network. One reason Dachen wanted to raise U.S. dollar funds is that in the past it came
across some deals that required U.S. dollar for investment, such as the so called red-chip
structured companies, but without a U.S. dollar fund, it could not participate in such
deals. Dachen does not intend to change its positioning as primarily a RMB fund
manager, but it does believe that having a U.S. dollar fund will give it more flexibility in
choosing investment targets and will enable it to invest in certain companies that it could
not in the past.
Now most established PE firms in China are managing both RMB funds and U.S.
dollar funds. Most moved from U.S. dollar funds to RMB funds, such as CDH, CICC,
New Horizon, Sequoia Capital and even the global mega funds such as the Carlyle Group
and TPG Capital. Others, mostly newly-established fund with good track record
managing RMB funds, are adding U.S. dollar funds to their RMB funds, including CITIC
PE, Shenzhen VC and Jiuding Investments.
1"
http://www.honycapital.com/honyen/news/2 8/one/ 191 .htni
25
However, managing funds in different currencies simultaneously adds levels of
complexities to PE firms. The biggest problem is the potential conflicts of interest
between a U.S. dollar fund and an RMB fund. In the case of managing funds
denominated in a single currency, a PE firm usually only raise a new fund when the
previous funds have been fully invested or at least substantially invested. In addition,
there is usually significant overlapping of LPs composition between funds. In that way,
different funds will not compete for good deals and certain LPs will not be disadvantaged
against others. But in the case of managing both RMB funds and U.S. dollar funds, these
funds are usually managed simultaneously as they are viewed by fund managers as
different asset classes, and the LPs are seldom the same for different funds. Therefore,
conflicts of interest may arise from time to time, especially when deciding which fund to
use to make a certain investment. Many LPs of U.S. dollar funds worry that their interest
may be hurt because they believe that PE managers tend to use the RMB fund to invest
when they have a good opportunity that requires quick decision, because investing with
the RMB in domestically registered companies requires less regulatory approvals and is
therefore quicker. For this reason, some foreign LPs even decide not to invest in U.S.
dollar fund managed by PE firms that also manage RMB funds.
The principal to deal with this problem by DT Capital, a Chinese PE firms
managing U.S. dollar funds of US$500 million and RMB funds of RMB1.5 billion, is
representative of the industry's common practice. Using which fund to invest often
depends on the specific situation. In some cases, if the target company has a red-chip
structure and plan to get listed on an overseas stock market, DT Capital will use the U.S.
dollar fund to invest, because investing with RMB is subject to the approval of foreign
exchange regulations and takes longer. In other cases, if the target company is in the
category of "restricted industry"' 5 or the target company is not willing to change to the
status of foreign-invested company, the RMB fund will be used. In still other cases, DT
Capital will invest with both funds at a ratio equal to the ratio of the available fund of
both funds at the time of investment. In addition, the target company's willingness to
accept a certain currency is also an important factor to determine which fund to use. This
strategy seems to work, and according to DT Capital, the key is to reach an agreement
" Industries specified by the NDRC as restricted to foreign investment.
26
with LPs of different funds at the beginning and to ensure transparency to all LPs when
making investments.
There is also concern for the "moral hazard" problem. For U.S. dollar funds, the
fee structure is quite standard across the world, with a management fee of 2% and a
carried interest of 20% being the norm. Fee structures of RMB funds, however, can vary
to a much larger degree. In cases that the fee structures are different for simultaneouslymanaged RMB funds and U.S. dollar funds, the funder manager may have the incentive
to invest in better deals using the fund with more favorable fee structure to them for
higher potential reward. One possible solution is to set up different management team
within a firm for different funds, but that may mean significantly added cost. Trying to
standardize both fee structures may be a better solution.
3. BIIFM and the new fund
3.1 BIIFM overview
3.1.1 Background
BIIFM was born with enviable support from the government. In 2002, Mr. Dai
Xianglong, governor of People's Bank of China, China's central bank, was appointed
mayor of Tianjin, one of the largest metropolitans in China. Tianjin has been well known
for its manufacturing capacities, but Mr. Dai wanted to revitalize Tianjin's financial
sector and he believed that by focusing on the PE/VC industry Tianjin would enjoy the
first-mover advantage over rival Chinese cities. His first move was to establish an RMBdenominated PE fund and its fund manager, BIIFM, in hope that other fund managers
would follow suit and register their PE funds in Tianjin16. The fund was named
"Industrial Investment Fund" because it sounded a more politically correct name, but in
fact it is not different from traditional PE funds in any significant way.
3.1.2 Fund investors
Mr. Dai's influence and connection as a former central bank governor certainly
helped, and the fund was successfully raised at the end of 2006. It was China's first socalled "industrial investment funds" and the largest RMB PE fund then. The fund size
was approved by China's National Development and Reform Commission to be RMB20
billion, with the phase one fund of up to RMB 6.08 billion. The fund was raised from
some of China's most prestigious financial institutions, including National Council for
Social Security Fund, China Development Bank Co., Ltd., Bank of China Group
Investment Limited, Postal Savings Bank of China Limited, China Life Insurance Co.,
Ltd., China Life Insurance (Group) Company.
Table 3.1 Investors of the Fund
Tianjin did see numerous PE/VC found registered in the city afterward. Up to June
2010, more than 400
PE/VC funds had been registered in Tianjin. http://www.techweb.com.cn/commerce/2010-0613/622386.shtml
6
Fund Committed
(RMB Million)
Fund Investors
National Council for Social Security Fund
1,000
16.4%
Bank of China Group Investment Limited
1,000
16.4%
Postal Savings Bank of China Limited
1,000
16.4%
China Development Bank Co., Ltd.
1,000
16.4%
500
8.2%
China Life Insurance Co.*
500
8.2%
Tianjin Jinneng Investment Co., Ltd.** 1
500
8.2%
Tianjin Infrastructure Investment Group**
500
8.2%
80
1.3%
6,080
100.0%
China Life Insurance (Group) Company*
7
Bohai Industrial Investment Fund Management Co.
Total
Source: BIJFM
3.1.3 Fund Management
BIIFM's governance structure is different from those of most PE funds. In most
other cases a group of experienced PE professionals start a limited partnership and serve
as general partners ("GP") and then go out to raise money from investors, who will
become the fund's limited partners. In BIIFM's case, the establishing of the fund
management company (the equivalent of a GP) and the fundraising were carried out
simultaneously, and the professionals were recruited after the fundraising was completed.
As a result there is significant overlapping between the shareholder base of the fund
management company and the investor base of the fund, and the fund investors have
greater power to influence the overall strategy and management of the fund management
company through their board representation than is usually the case for PE funds formed
in limited partnership, although the investors have refrained from involving in the fund's
day-to-day operations or investment decision making.
" * Under the same control
18 **
Under the same control
Table 3.2 Shareholders of BIIFM
Capital (RMB
Shareholder
Million)
%
Bank of China International# 19
96
48.0%
Tianjin Teda Construction Group## 2 0
44
22.0%
Bank of China Investment Group#
10
5.0%
National Council for Social Security Fund
10
5.0%
Postal Savings Bank of China Limited
10
5.0%
China Development Bank Co., Ltd.
10
5.0%
China Life Insurance (Group) Company### 2 1
5
2.5%
China Life Insurance Co. ###
5
2.5%
Tianjin Jinneng Investment Co., Ltd.##
5
2.5%
Tianjin Infrastructure Investment Group##
5
2.5%
200
100.0%
Total
The governance structure is modeled on a typical listed company rather than a
limited partnership. There is a board of directors representing the shareholders of BIIFM,
as well as a supervisor. Under the board there is an Investment Committee, which makes
final investment decisions. The Investment Committee is currently composed of the
senior professionals of the management team, and a majority vote of is required for any
investment proposal to be passed. The investment advisory committee is composed of
outside experts and provides advisory in terns of industry and operational expertise to
the fund manager. The risk management committee assesses and controls risk both at the
project level and the fund level. The remuneration committee sets the compensation level
of the senior management.
'9 # Under the same control
## Under the same control
21 ### Under the same
control
20
Exhibit 3.1 Management Structure of the Fund and the Fund Manager
Fund Investor
/Shareholderof MgmtCo A
Fund Investor
/Shareholderof MgmtCo B
Fund Investor
/Shareholder of Mgmt Co C
Trustee Bank
Supervise the use of the fund
InvestmentFund
<
Fund management
Bohai Industrial
Investment Fund
Management Co.
Act as nominal shareholder for the Fund
Portfolio
Company A
Portfolio
Company B
Portfolio
Company C
Source:BIIFM
Exhibit 3.2 Governance Structure of the Management Company
Board of Directors
Investment
Committee
Investment Advisory
Committee
Risk Management
Committee
Supervisor
Remuneration
Committee
Management
Source: company website
3.1.4 Fund Investment
According the BIIFM's website, the fund should focus on investment in mediumto-large sized non-listed enterprises with an investment horizon of medium-to-long
term's time span. The fund can invest in Chinese companies across sectors, excluding the
real estate industry. Ideal target companies will be in the expansion or mature stage. The
investment will typically be made as equity investment in non-public companies with the
RMB and structured as common stock, preferred stock, convertible preferred stock or
convertible bonds.
In line with the fund size and to ensure cost efficiency, a single investment should
be no smaller than RMB300 million, with exemption allowed upon the receiving of a
waiver from fund investors. To diversify potential risk, investment in a single company
should not exceed 20% of the fund size and investment in a single sector22 should not
exceed 25% of the fund size. The fund has a life of 15 years and the first five years are
the investment period.
3.1.5 Previous investment
As of the end of 2010, BIIFM has made investment in seven companies. See
Table 3.3 for the portfolio companies.
Table 3.3 BIIFM Investments (as of October 2010)
Year
Invested
Investment
Company
Industry
2007
Company A
Manufacturing
2007,
200923
Company B
Banking
480
Largest bank based in western China
2009
Company C
Auto
500
Largest indigenous automobile maker in
China
2009
Company D
Manufacturing
312
One of China's largest special steel pipe
makers
2010
Company E
Retail
100
One of China's largest furniture retailers
2010
Company F
Chemicals
300
China's largest aniline producer
2010
Company G
Financial
200
Largest credit guarantee company in western
China
Total
(RMB M)
1,370
Brief Description
World's largest seamless pipe producer
3,286
A pitfall is that sectors are not clearly defined and this sometimes may lead
to confusions when deciding
whether two investments fell into the same sector.
2 BIJFM participated in the follow-on financing of Company B in 2009 at the previous share
purchase
price as the 2007 investment.
22
In 2007, BIIFM completed two major transactions in its first year. Then in early
2008, when the market became very competitive, BIIFM found that most deals were
priced at too high a level for it to justify the value, and then in the second half of 2008 the
financial crisis hit and BIIFM was very cautious in evaluating investment opportunities.
As a result, BIIFM did not make any investment during 2008. Starting from the second
quarter of 2009, China's economy and the financial markets began to recover at much
faster speed than commonly expected, and BIIFM started to make new investments,
completing five transactions in 2009 and 2010.
Although BIIFM is allowed to invest in any sector other than the real estate
industry, most previous investments are in traditional sectors such as manufacturing. This
has to do with the requirement that the size of an investment should generally be no
smaller than RMB300 million, although in the case of Company E, investors waived the
restriction and the investment size is RMB 100 million. In the earlier years BIIFM was
able to make relatively large-sized investment as the sole investor, such as in the cases of
Company A and Company B, but later as more and more competitors emerged, BIIFM
oftentimes had to spit the investment with other investors, thus reducing the average size
of investments.
BIIFM usually invest as a minority shareholder, typically holding between 10%
and 30% of shares in its portfolio companies. However, in most cases BIIFM will have at
least one board seat in the portfolio companies to ensure effective supervision and
management.
As of February 22, 2011, BIIFM has not exited any of the investments. Therefore,
although many of the portfolio companies have been performing well financially, it is
difficult to determine the current value of BIIFM's equity investment and hence the
return of investment cannot be calculated with precision.
3.2 BIIFM's Rationale for raising a U.S. dollar fund
3.2.1 Improving global fundraising environment
As the global economy is showing strong evidence of recovery after the financial
crisis, investor confidence is coming back and many more fundraising opportunities for
PE are expected. According to data provider Preqin , global private equity fundraising in
2010 fell to a six-year low of US$225 billion, but the figure is forecast to grow 50% to
US$350 billion in 2011, thanks to growing investor confidence and their demand for new
investment vehicles.
3.2.2 China is becoming a very attractive investment destination
China is becoming increasingly popular with international private equity
investors. The main reasons are twofold. First, China's economy has shown robust
growth soon after the global financial meltdown, and is forecasted to remain strong for
the coming years. The IMF predicts that China's economy will grow at 9.6% for 201125.
The return for China's PE industry, which is very much growth focused, has been among
the highest worldwide. Second, China is under tremendous press from foreign
governments to revalue its currency and many international investors are expecting this to
happen soon. In fact, since May 2010, the RMB started to appreciate against the U.S.
dollar. The exchange rate went down from 6.8263 on April 30, 2010 to 6.5671 on March
4, 2011, representing a 3.94% increase in the exchange rate in 10 months, or 4.72%
appreciation annualized, a nice additional return on top of the return from the investment.
24 http://www.preqin.com/item/global-private-equity-fundraising-slumps-to-six-year-low/1
25 http://news.163.com/
1/01 27/02/6RCCDGUFO0O 14AED.html
34
02/3305
Exhibit 3.1 Rmb Exchange Rates (Jan 2010 - Feb 2011)
6.9
6.8,
6.6
6.5
6.4
-
6.3
-
6.2
6.1
-
Jan-10 Feb-10 Mar-10 Apr- 10 May- 10 Jun- 10 Jul- 10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-I I Feb-II
Source: Peoole's Bank ofChina
3.2.3 Favorable supply & demand dynamics for raising a U.S. dollar fund
Starting from 2009, RMB funds quickly replaced U.S. dollar funds as the most
popular PE fundraising platform. The experienced GP teams, mostly of who previously
used to manage the U.S. dollar-denominated funds only, are busy with raising RMBdenominated funds from domestic sources. As most of the new funds are RMBdenominated, international investors, subject to the strict foreign exchange restrictions,
are have difficulties finding U.S. dollar-denominated funds managed by experienced GPs
to invest in China. As a result, the current supply and demand dynamics for the U.S.
dollar fundraising is in favor of experienced domestic fund managers planning to raise
new U.S. dollar-denominated funds.
A case in point is the newly raised Baring Private Equity Asia Fund V. Baring is a
Hong Kong-based PE firm focused on Asia, especially China. Most of its senior
managers are experienced Chinese professionals. Built on the success of its previous four
funds, raising a new fund for Baring is not difficult, and the fact that Baring is raising a
U.S. dollar fund while most of its strongest competitors are busy with raising RMBdenominated funds helped as well. Baring initially targeted US$1.75 billion for its fifth
fund, but the demand was so strong that the fund manager decided to scale up the fund
size to US$2.46 and announced the closing of the fund in February 2011, making it the
largest private equity fund launched in Asia since the global financial meltdown in 2008.
The whole fund-raising process took only five months. The successful fundraising comes
as limited partners seek to increase their exposure to tap the growth of emerging markets
in Asia. Of the 70 investors of the new fund, 30 are new institutional investors. Around
47% of the investor commitments came from North America, 28% from Asia, and 25%
from the Middle East and Europe26
3.2.4 Adding additional flexibility for investment
Although BIIFM is a China-focused fund manager and the current fund is
denominated in the local currency, having a U.S. dollar fund will give the fund manager
more flexibility to do different deals.
In the past, BIIFM had to give up many opportunities because it did not have U.S.
dollars to invest. Such opportunities mainly fall into two types. The first type is
investment targets of Chinese companies with the so-called "red-chip structure". As
mentioned in Chapter 2, these companies usually set up a special purpose vehicle
("SPV") in overseas jurisdictions such as the Cayman Islands and the British Virgin
Islands with the aim of listing overseas, and PE investors, including the Chinese funds,
invest U.S. dollars funds in the off-shore SPVs. Because BIIFM currently only manages a
RMB fund and exchanging the RMB to the U.S. dollars is time-consuming and subject to
much red tape, BIIFM was not able to participate in such deals.
The other type of missed opportunities is overseas acquisition transactions.
Although Chinese PE firms rarely have the capability to do overseas buyout deals by
themselves, they can team up with local industry partners who have the industry expertise
but need financing and/or the capacity of executing overseas deals, which many Chinese
PE firms have. The Chinese local PE firm Hony Capital, together with Goldman Sachs,
teamed with its portfolio company Zoomlion, to acquire 100% equity of the Italian
concrete equipment producer CIFA in 2008. Neither Hony Capital nor Zoomlion would
be able to do the deal alone, but together they did. Such acquisitions are an important way
26
http://www.moneycontrol.com/news/business/baring-private-equity-asia-raises-36246-bn-for-fund-
v_518868.html
PE funds add value to their portfolios, but again they requires foreign exchanges and
BIIFM is not able to do such deals with only its RMB fund.
The argument is base on the fact that the RMB is not a freely convertible currency
and the exchange of the RMB into foreign currencies is regulated. If China stops
currency control in the future, having a U.S. dollar fund will lose much of the argued
advantages.
However, under current economic and political circumstances, the Chinese
government is very unlikely to allow the RMB to be freely convertible in the near future.
First, it is believed that China emerged from the financial meltdown in 2008 relatively
unscathed partly because the government has control on international capital flows in and
out of China. Second, because the RMB is currently under great pressure for
appreciation, it is worried that the convertibility of RMB will lead to massive
appreciation of the RMB and have negative impact on China's economy. Third, the
Chinese government believes that the RIMB is not yet strong enough to be a widely
accepted currency worldwide so there is no much benefit to further "internationalize" the
RMB. Therefore, chances for switching to full convertibility of the RMB in the near
future are not big. As former governor of China's central bank put it at the Boao Asia
Forum in April 2011, it will probably take another 15 to 20 years for the RMB to become
fully "internationalized", a key feature of which is free convertibility.
Another relevant policy issue is the development of the RMB's offshore markets.
The RMB's offshore markets refer to financial markets outside of the China mainland,
for example, Hong Kong and Singapore, where financial transactions denominated in the
RMB are conducted. In 2004, banks in Hong Kong started to offer a limited range of
financial services in the RMB. In 2010, People's Bank of China signed a new agreement
on settlement of the RMB with the Hong Kong Monetary Authority, allowing a larger
variety of RMB financial services in Hong Kong. As of March 31, 2011, total savings
denominated in the RMB in Hong Kong reached RMB451.9 billion, and the number is
still growing rapidly.
27
http://www.cs.com.cn/yh/02/201104/t201
l 0418_2847232.html
37
The development of the offshore RMB markets may have some impact on the PE
industry. If a RMB-denominated fund has some of its RMB assets located in an offshore
market such as Hong Kong, it may be able to exchange the fund into the U.S. dollar
without having to obtain approvals from the regulators. However, the size of BIIFM's
RMB funds means that the firm could only raise the RMB funds from large financial
institutions located in the mainland, and this is like to continue to be the case even for the
firm's future RMB funds. As a result, BIIFM will not be able to tap the offshore RMB
markets for overseas investment and thereby avoiding going through the approval
process. It will still need a U.S. dollar fund for flexibility in overseas investment at least
in the near term.
For the above-mentioned reasons, adding a U.S. dollar-denominated fund to its
current RMB-denominated fund will allow BIIFM to explore more opportunities and
further diversify its investment.
3.2.5 The opportunity to focus and specialize
In the early stage of China's PE industry, opportunities abounded and good
returns were possible to be achieved without requiring the PE fund managers to have
special expertise, thus most funds are generalists. However, as competition is picking up
very quickly in the industry and high returns are being competed away, it is expected that
going forward PE funds need special expertise to identify harder-to-find investment
opportunities and to provide value-adding services to the portfolio companies. As a
result, we see more and more PE fund managers start new funds specialized in certain
sectors. For example, UBS Asia's vice-chairman Shan Li partnered with Ping An Trust to
start a RMB20 billion PE fund focusing on the energy sector in western China, and CCB
International raised a RMB2.6 billion PE fund focusing on the healthcare industry, not to
mention the numerous real estate PE funds. BIIFM's current fund is a generalist fund,
investing across industries. A sector-focused new fund can give BIIFM the opportunity to
build expertise in a sector with great potential growth, such as the renewable energy
industry in China, which international investors are very interested in.
4. Considerations and proposals for the new fund
4.1 Fund structure
The majority of the largest private equity funds in the world are structured as
limited partnership, with investors that provide capital serving as limited partners, and
fund managers serving as general partners. Under this structure, the limited partners'
liability only extends to the capital they contribute, while the general partners are directly
liable, although in many cases they create a corporation that serves as the general
partners. A key feature is that the limited partners do not participant in the investment
decision making of the fund, while the general partners are fully responsible for the
investment decisions. The general partners will typically invest a small percentage of
money (1% is the norm) into the fund and will be rewarded a certain percentage (usually
20% ) of the profits after meeting a certain target rate of return, usually between 6% and
10% ( 8% for most funds). The general partners also charge an annual management fee of
between 1.5% and 2.5% of the asset under management to cover the personnel and
operating expenses.
The current fund of BIIFM, however, is using a different structure, the contractual
structure. Under the contractual structure, the general partner is trusted with the investors'
funds, and a custodian bank is appointed to supervise the trusted funds. The fund is not
organized as standalone legal entity under this structure. The contractual structure is
seldom used in the industry. At the time BIIFM was been founded, partnership was not a
viable structure in China yet 2 8 and the contractual structure was chosen as a result. The
structure of BIIFM is also special in that all the investors are also shareholders of BIIFM
and thus have greater influence on the operations of BIIFM through their representation
in the board of BIIFM than typical LPs do.
A central question for the planned fund is whether the new fund should keep the
current contractual structure, or adopt the limited partnership structure instead. There are
two major concerns with the current structure.
28 Limited partnership was not allowed under China's laws until the passage of the new Partnership Law in
late 2006, when BIIFM's structure was already decided.
39
First, although the investors are not involved in the day to day operations or the
fund's investment decision-making, they do have more control over the management
team than is normally the case under the limited partnership structure. The nature of
private equity work requires a long-term investment horizon and the stability of key
management is very important. Under a typical limited partnership structure, the only
way LPs can have impact on the GPs is voting with feet, as they do not have the power to
remove fund managers from their positions. It is true that switching to limited partnership
will not change the fact that the previous investors still have the control over the
management team through their shareholding in BIIFM, but at least it can help make sure
that the new investors will remain passive investors.
Second, under the current structure the management team does not invest their
own money into the fund, and they are not directly eligible to carried interests 2 9 . They are
compensated mainly through base salaries and bonuses. Therefore, the incentives are not
as strong as in the case of limited partnership, where management put their own money in
the fund and is subject to the risk but also eligible for the potential upsides.
Considering the above-mentioned reasons, I believe that the new fund should
adopt the limited partnership structure. For better incentives, the senior management can
be required to invest alongside BIIFM in the fund and the combined percentage of both in
the fund can be set at 1%. BIIFM can provide financing to the management in loans that
should be paid back with future salaries and bonus if the management does not have the
money for the investment.
29 They may be eligible for some phantom carries under specially arrangement. The details are not
disclosed.
Exhibit 4.1 Proposed Fund Structure
BIIFM(GP)
Fund
Management
Senior Mgmt (GP)
Investors (LP)
BIIFM Fund II
(Limited Partnership)
A special consideration is that because BIIFM is controlled by Bank of China, a
SOE, BIIFM is also state-owned. It is argued that according to the Partnership Law, stateowned enterprises may not act as general partners in limited partnerships. Article 3 of
Partnership Law specifies that "State-wholly-owned companies and state-owned
enterprise shall not act as general partners in partnerships." This article, however, is
subject to different interpretation, and it is not very clear what state-wholly-owned
companies and state-owned enterprise exactly covers here. Although we have seen
previous cases, such as the state-owned fund manager CITIC PE Fund Management Co.,
acting as general partner of Mianyang Partners, it is advisable to seek the opinion of
relevant regulatory bodies before proceeding to adopt the limited partnership structure.
Another issue regarding the structure is that BIIFM needs to get confirmation
from the regulators about whether it is a foreign-invested company or not. Investment in
China by foreign companies is subject to additional regulations, and the process can be
long and the result uncertain. Furthermore, some sectors, such as military-related ones,
are not open to foreign investment. Although the fund BIIFM currently manages is
denominated in the RMB, if BIIFM is cleared to be a foreign-invested company, every
deal will be subject to relevant approvals.
There had never been doubt about BIIFM being a state-owned domestic company
before November 2010, when a news report 30 led to extensive speculation that BIIFM
was a foreign-invested company. The report argues that some of BIIFM's shareholders,
Bank of China International and Bank of China Investment Group, are registered in Hong
Kong, which is classified as a non-domestic jurisdiction. The report also argues that these
two shareholders subscribed their shares with Hong Kong dollars, not the RMB, and
Bank of China Investment Group's RMB 1 billion subscription of the fund was also in the
Hong Kong dollar. Because under the contractual structure's arrangement the fund is not
a legal entity and BIIFM holds the shares in all the investment for the fund it manages,
BIIFM's legal status as foreign invested company may determine the approval
requirement of its investment. The report accuses BIIFM of intentionally evading the
approvals and misleading invested companies by claiming to be a domestic company.
The report goes further to say that the invested companies may be affected for records of
not fully conforming to regulatory requirement in future applications for listing. How
much of this report is right is still up to debate, but it did create tremendous negative
publicity for BIIFM.
This issue needs to be cleared before raising the next fund. Although some of the
shareholders are registered in Hong Kong, they are in fact Chinese companies and cases
can be made to treat their investment as domestic investment. The main argument can be
the principle of substance over form. In addition, BIIFM was initially approved by the
National Development and Reform Committee ("the NDRC") and the State Council as an
RMB-denominated fund will help. In China approvals from the State Council can be used
to decide the legal ground for BIIFM's investment to be treated as domestic investment.
If possible, BIIFM should go to Ministry of Commerce, the NDRC or the Statue Council
to apply for a clearance about the legality of the previous investment and a waiver for
future approvals. However difficult it is, the clearance needs to be done before the
fundraising, as this will be a key question that every potential investor will ask and there
is no way to evade it.
30 http://www.eeo.com.cn/finance/funds/2010/10/23/183625
42
1.shtml
4.2 The Fundraising
4.2.1 Track records
For PE firms that have previously managed funds, the most important factor in
raising a new fund is its track record. If a PE firm has an excellent track record, for
example, internal rate of return of over 20% with several "homeruns" deals, the firm will
not have much difficulty raising another fund in normal market situations. However, if a
firm has only mediocre returns or bad track records, it will have a hard time proving that
its ability to do better another fund to manage. In this case it is likely to be even more
difficult than raising the first fund.
For BIIFM, although the proposed fund is a U.S. dollar fund and almost all
potential investors will not be among the investors of its first fund, potential investors
will still put much emphasis on the return of BIIFM's first fund. Although many of its
investments are very promising, BIIFM has yet to realize an exit. Explaining the return
will be the most challenging part in BIIFM's effort to raise the new fund.
A good case that BIIFM can study is the Gobi Partners case. A Harvard Business
School case 31 discusses the difficulties that Gobi Partners faces when contemplating
raising a new fund when their first fund had not made any exit, quite similar to BIIFM's
situation.
Gobi Partners was founded in Shanghai in 2002 and closed its first fund of
US$51.75 million. It had made eight investments up to November 2006, when it started
to consider raising a second fund. The early limited partners include IBM, NTT
DoCoMo, China Alternative Investments, Sierra Ventures, the Hillman Company,
Steamboat Ventures, and McGraw-Hill, and several angel investors. Those companies
had made good progress and two of them had even recently raised subsequent rounds of
financing at significantly increased valuation. Gobi valued its investment at 3.1 times of
the original value. However, Gobi did not have an exit yet at that time, and it believed
that an exit would be extremely helpful for the fundraising. But the partners decided that
Gobi Partners: Raising Fund II, Venture Capital and Private Equity, a Casebook, John Wiley & Sons,
Inc, 2009
3'
they should not wait any longer to raise a new fund. Fortunately for them, Gobi was able
to raise the second fund of US$150 million, three times the size of the first fund, before
the end of 2007 and only one year after the fundraising started. Almost all the limited
partners of the first fund participated in the second fund. An even more significant
achievement is that even though they still had not had a successful exit 32 by August 2010,
they managed to raise a third fund. This fund of $100 million denominated in Singapore
dollars (about US$ of 74 million) was raised in cooperation with Singapore Media
Administration and will be invested in the media sector in China. How Gobi managed to
raise the two subsequent funds without a successful exit is not well known to the public,
but it is reasonable to believe that they were able to leverage on the relationship with their
existing limited partners as well as educate the potential investors on the potential value
of their portfolio companies in the absence of an exit event. The favorable fundraising
environment certainly helped, too, as the years of 2007 and 2009 saw significant liquidity
globally and tremendous interest in investing in emerging markets, especially China. The
experience of Gobi can help BIIFM understand the difficulties it may face and plan a
sound strategy.
Not having exits does not necessarily mean not being able to calculate the value
of the investment and the returns, nor does it necessarily mean bad returns. The key is to
find an appropriate method of valuation acceptable to potential investors. In 1990, the
National Venture Capital Association (NVCA) proposed guidelines for a consistent
valuation policy, although the methods are often described as "more art than science".
The methodology is based on conservative principles. Valuing a listed portfolio company
is easy as the trading price can be used as value metrics. For private portfolio companies,
in general investment cost is used to represent the value, but valuation should be reduced
if a company's performance and potential have significantly deteriorated, and valuation
should be adjusted to equate a subsequent significant equity financing that includes a
sophisticated, unrelated new investor. This means later rounds of financing or transaction
should be used for valuation bases.
Although Gobi did manage to exit its investment in Digital Media Group by selling it to competitor
Vision Best, the sale was not a successful exit as Vision Best later sued Gobi, claiming that Gobi provided
misleading information, and refused to pay the milestone payment of US$80 million.
32
For the purpose of valuation, there are two things that BIIFM can do. First,
BIIFM should actively examine its portfolio companies to see whether any of these
companies have done later rounds of financing or share transfer, especially for the
companies in which BIIFM does not have a board seat and therefore has not monitored
closely. Valuation adjustments should be made accordingly if there are any such followon financing or share transfers. For example, BIIFM invested RMB500 million in an
automobile company at RMB5 per share in early 2009, and before the end of 2009 that
company took investment from other investors at RMB 13 per share33 , representing a
significant value appreciation over a short period of time. BIIFM should make valuation
adjustment for this investment accordingly. Second, BIIFM can consider selling some of
the portfolio holdings, partly to generate some cash return to its investors, partly to create
a valuation metric for such portfolios. It can choose to sell only part of its holding in a
portfolio for this purpose. Although as a PE firm with relatively long horizon, BIIFM
would likely to see a portfolio grow and eventually exit through a listing event, earlier
exits sometimes can offer even higher returns when taking into consideration of the time
value of returned cash.
Another benefit of selling some portfolios is that recycled fund from exits in the
Investment Period (between December 30, 2006 and December 29, 2011) does not need
to be distributed to the investors. Instead, BIIFM can choose to use this fund to make
new investment. Having funds recycled from exits will enable BIIFM to continue to
invest before the new fund is raised.
4.2.2 Potential investors
Existing investors
The first potential investors to go to are the existing investors. These investors
know BIIFM well and thus the efforts for due diligence can be reduced, and most of
BIIFM's the existing investors are among China's most important institutional investors
with tremendous assets under management and are actively looking to increase their asset
3
http://www.pedaily.cn/Item/203972.aspx
allocation to the alternative investment class. However, they are all Chinese investors and
most may not have U.S. dollar fund available to invest. Also, because their investment in
the BIIFM's first fund has not been returned, it may be difficult for them to decide to
commit additional investment in BIIFM's new fund.
Other Chinese investors
Some Chinese domestic investors have significant U.S. dollar fund to invest in
private equity funds. For example, China Investment Corporation (CIC), which manages
part of China's foreign exchange assets, has assets under management of US$320
billion 34 denominated in the U.S. dollar. CIC, whose employees include many Chinese
professionals with Wall Street experience, understands the private equity industry well
and is willing to allocate a significant portion of its asset to the private equity asset class.
Previous investment of CIC in private equity includes investment in global private equity
funds such as Blackstone and AXA. Nevertheless, other than CIC, not many established
Chinese investors have U.S. dollar fund to invest, therefore such Chinese investors may
only be a limited source for the new fund.
Overseas institutional investors
Overseas institutional investors are the most important source for U.S. dollar
funds. They are sophisticated investors with global investment horizon, and surprisingly
many understand China very well. Some of them already have experience investing in
Chinese private equity funds and are stilling looking for investment opportunities.
Take some of the established Chinese funds as example. According to CDH
Investment's website, their investors include more 100 domestic and foreign investors
across the globe, including university endowment funds, family funds, sovereign funds,
pension funds and funds of funds. See Table 4.1 for a list of the representative limited
partners of CDH Investments.
3
http://www.soufun.con/news/2 01 1-03-31/4786815.htm
46
Table 4.1 Representative Investors of CDH Investments
Category
Investors
Endowment/Family
Stanford University Foundation, Carnegie Corporation
Foundation, The Rockefeller Foundation, LGT Capital
foundations
Partners
Institutional investors
AXA, Adam Street, Horsley Bridge, CommonFund,
Pension funds
CPP Investment Board, CalPERS, ALP Investments,
Sumitomo Trust
Sovereign
funds/International
Government Investment Corporation of Singapore,
International Finance Corporation, Abu Dhabi Investment
organizations
Authorities
Source: CDH real estatefund prospectus
The list includes many of the world's most prestigious limited partners, showing
that investors of Chinese PE funds share similar investor base with established global
funds. These investors will be the most important fundraising targets for BIIFM's new
fund.
4.2.3 Working with placement agents
It is a common practice for established PE firms to hire a placement agent to help
it raise a new fund. A placement agent is a company that specializes in finding
institutional investors to invest in private equity funds. A good placement agent does not
simply introduce a PE firm to an investor. They have good understanding of both the
potential limited partners and the market appetite, hence they are able to advise the PE
firms and help them prepare marketing materials, determine optimal fund sizes and
develop a fundraising strategy. A good placement agent can save the investment
professional tremendous amount of time and let them focus on the investing and portfolio
managing side of the job. A placement agent can be a fundraising arm of an investment
bank or an independent agent. They typically charge between 1% and 2% on total fund
raised.
Without prior experience of raising U.S. dollar funds, it is in BIIFM's interest to
engage a placement agent and leverage its network and expertise. The ideal agent should
have global network as well as significant Asia and China exposure, so that it can better
understand and articulate BIIFM's investment philosophy.
Table 4.2 Potential placement agent candidates
Credit Suisse
The largest placement agent. The bank's current and recent clients
include Arlington Capital, Cowen Healthcare Royalty, Lovell
Minnick Partners, White Deer Energy and Wynnchurch Capital
Crossroad Capital
Raises money for all types of alternative-investment funds with an
emphasis on buyout vehicles that focus on mid-size deals.
Evercore Partners
Clients encompass a mix of private equity funds seeking $500
million to $2 billion each, with six currently in the market.
First Avenue Partners
Markets a variety of vehicles in Europe, the Middle East and Asia,
while teaming up with other shops to reach investors in North
America. Clients include India Equity Partners and JZ International
Fitzgibbon Toigo
Associates
Works with managers in Asia, where activity has picked up, along
with clients in North America and other regions. Runs up to three
campaigns at a time
Jefferies & Co.,
s
Handles 5-10 campaigns per year across the private equity fund
Cspectrum, working in the U.S., Europe and Asia
Sixpoint Partners
Pitches 4-6 funds at a time for established managers looking for
more than $300 million, working in the U.S., Europe and Asia
Thomas Capital
Group,
Conducts 2-3 simultaneous marketing drives for managers in the
U.S., Europe and Asia.
UBS
Remains atop the fund-marketing world with Credit Suisse. Just
completed a fundraising for Baring Private Equity Asia for a total of
US$ 1.75 billion.
XT Capital Partners
Raises capital for private equity and real estate funds that invest in
emerging markets, including Russia, Eastern Europe and China.
Source: PrivateEquity Insider
4.2.4 Investment theme
Sector focus
The new fund will focus on investment in the renewable energy industry, and
opportunities in the sector will be discussed in the next chapter. However, traditional
energy sources such as coal and natural gas will continue to play a key role in China
because China's demand for energy will keep outgrowing its supply capacity, and the
new energy sector, still in its infant stage, will not be able to completely fill the gap in the
near future. In addition, the landscapes of certain traditional energy sectors are
undergoing dramatic changes and opportunities may arise as a result. For example, the
coal sector in China's coal-rich Shanxi Province is going through a large-scale
consolidation process as the local government is becoming more concerned about
pollution and mine safety. PE firms have the opportunity to work with industry players in
the process of sector consolidation. Shan Li, President of the newly-founded PE firm
Taoshi Investment and Vice Chairman of UBS AG Asia, believed that the financing gap
for restructuring Shanxi's coal sector is over RMB 100 billion, and his firm is raising a
RMB10 billion energy-focused fund aimed mainly at coal opportunities in Shanxi 35 .
Besides opportunities in renewable energy, BIIFM's new fund should also be open to
special opportunities in such traditional energy sectors discussed.
Investment stage
The renewable energy sector is seeing tremendous growth in China and new
companies are founded on a daily basis, but most are still in relatively early stages. As
BIIFM core capability lies in PE-style investments in companies at growth or mature
stages, this new fund should continue to leverage BIIFM's past experience in PE
investment as opposed to early-stage, VC-style investments. As few companies within
this sector are in mature stage now, the new fund may find most targets in the growth
stage. The goal should be to provide capital to growth-stage companies to ramp up their
capacity or make acquisitions, as well as bring sector expertise and network to the
invested companies. Earlier-stage companies can also be considered, but should be
scrutinized more carefully for their higher risk.
Regional focus
35 http://hi.baidu.comi/annyOO88/blog/item/ea27e4Icbec884e41 ad576af.html
49
Not only will China's huge potential demand drive the growth of the renewable
energy market in the future, but China is also expected to ride the worldwide growth in
the sector and become an important manufacturing base for key components. Therefore,
it is logical for the new fund to focus on investment opportunities in the Greater China
area. Nevertheless, the new fund should be encouraged to pursue opportunities that fit the
strategy outside of China. For instance, the fund can work with its portfolio companies to
acquire other companies in the renewable energy sector for the technology,
manufacturing facilities or potential market. Nevertheless, China is expected to be the
area where most of the funds are deployed to, given the attractive potential in the market
and BIIFM's expertise in this region.
Management of the portfolio companies
The Chinese business community at the current stage is not quite open to buyout
deals, and the majority of the deals we see today are minority deals without changes of
control. Furthermore, managing companies in the renewable energy industry, which
usually have complex technology and specialized markets, requires considerable industry
expertise. Therefore, the fund should aim to make investment mainly as minority
shareholder, and manage the portfolio companies mainly through board-level strategic
management.
4.2.5 Targeted fund size
There are two approaches to determining the fund size. One is the top-down
approach, starting from assessing the market appetite for new funds. BIIFM should
consult the placement agent's advice on the market's interest in this specific type of
private equity in the specific region, and market's perception in BIIFM's ability to
manage such a fund should also be taken into consideration. BIIFM may also need to
meet potential limited partners to understand each other's interest in working together for
the new fund. The other is the bottom-up approach, in which BIIFM decides how large a
fund it can manage without over-stretching itself. Assuming that each year the new fund
makes three investments with average size of US$30 million over an investment period
of five years, the optimal fund size is estimated at US$450 million, which serves as a
good starting point. Both the top-down and the bottom-up approaches should be
employed to determine the optimal fund size.
As BIIFM's first U.S. dollar fund, ideally the size should be set at an appropriate
level and the fund manager can scale it up in the future after demonstrating sound track
record. A size of between US$400 million and US$800 million can be appropriate, and
the exact target size should be set in consideration with other factors.
4.2.6 The team
Most large PE firms managing multiple funds do not have designated teams for
each fund or each sector. Instead, all funds are usually pooled and managed by the same
team investing across sectors 6 . There are two main reasons for this structure. First, PE
firms are typically very lean in terms of employees and it is usually too costly to maintain
a separate team for each fund or sector. Second, in most cases the funds are raised in
sequence, thus when a new fund is raised, the previous funds usually have been or will
soon be substantially invested, so the team's efforts are mainly spent on the most recent
fund. However, for certain sectors that require significant industry expertise to invest in,
many funds establish dedicated teams. For instance, most large funds that invest in the
real estate sector have dedicated real estate teams.
BIIFM currently follows the generalist approach and team members are not
allocated to specific sectors. However, the renewable energy sector may represent a
different situation because the sector is very specialized and sector expertise is highly
valued. Therefore it would be advisable for BIIFM to establish a dedicated team for this
new fund. The initial team members can come from within the firm, comprising primarily
investment professionals with prior experience in this sector. The firm can also hire some
people with investment or operational experience in the renewable energy sector for the
new fund. However, the team for the new fund should be loosely defined so that
However, sometimes PE firms classify funds into different classes and have separate teams managing
each class of funds. For example, the Carlyle Group has dedicated teams for both the buyout funds and the
growth funds, but a team of a certain fund class manages multiple funds within that group.
36
51
flexibility should be maintained to allow moving human resources across the firm and
ensure the operational efficiency.
4.2.7 Relationship with the RMB fund(s) under management
Although the current RMB fund managed is expected to have been completely or
substantially invested by the time the new U.S. dollar fund is raised, BIIFM is likely to
raise subsequent RMB funds in the future. Therefore how BIIFM balances the
relationship between the RMB fund(s) and the new U.S. dollar fund and avoid possible
conflicts of interests will be a key concern of potential investors during the marketing
process.
To be fair to investors of the RMB fund(s) and the U.S. dollar fund, future
investment can be allocated to both funds with a certain proportion. The proportion can
be set based on the size of each fund. However, to compensate the investors of the U.S.
dollar fund for not having the opportunity to invest in companies in sectors outside of
energy, the proportion can be set in favor of the U.S. dollar fund. In cases where only one
currency is accepted, the fund denominated in that particular currency should be used for
the investment. Such cases include the "red-chip" structured companies, which only
accept U.S. dollar-denominated investment because of the foreign-registered status of the
company and the intention to list overseas, and some domestically registered companies
that favor investment in the RMB for concerns of delaying in the foreign exchange
approving process.
4.2.8 Proposed key terms of the fund
Based on the above-discussed key considerations, the key terms of the new fund
are proposed as follows. Note that those are only the author's personal recommendations
and they only serve to describe the general ideas, not the specific phrasing of the terms.
Fund structure
The fund can be structured as a limited partnership, with BIIFM acting as general
partner and other investors as limited partners.
Investment strategy
The fund will make investment mainly in the energy sector in China, with
renewable energy a focus. The ideal investment targets will be operating businesses that
look for growth or expansion capital. Overseas investment with strategic significance will
also be considered. Portfolio investments are generally expected to range in size from
US$10 million to US$50 million and can be made in various instruments including
preferred stock, common stock and convertible bond.
Targeted fund size
The fund size is targeted at between US$400 million and US$800 million, and the
final fund size is to be determined later on. BIIFM should commit 1% of the total fund
and the rest should be raised from limited partners. The minimum commitment to the
fund by a limited partner should be US$5 million.
Investment restrictions
To properly diversify investment and control risk, without the consent of the
Limited Partners' Advisory Committee, the fund should not: invest more than 25% of the
aggregate commitment to the fund in any single portfolio company; invest more than
25% of the aggregate commitment to the fund in the market outside of China; invest in
any blind pool investment vehicles3 7 that charge management fees.
Term
The fund will be terminated ten years from the date of its final closing, but its
term can be extended by no more than two years at the discretion of BIIFM. The
investment period will be the first five years since the final closing of the fund, during
which capital call can be made to the limited partners. During the investment period, the
returned capital from disposition of investments can be re-invested.
Management fee
37 Such as another private equity fund.
During the investment period, the management fee will be 2% per annum of the
aggregate commitment of the fund. After the investment period, the management fee will
be 1.5% of the aggregate funded commitment 38 .
Hurdle rate and carried interest
The hurdle rate will be 8% per annum. After 100% of the capital contributed and
the preferred return of 8% per annum is distributed to the limited partners, BIIFM will be
distributed 20% of the fund returned as carried interests.
4.3 Investment process
For a PE fund to be successful, a standardized investment process should be
followed strictly to ensure the quality of the origination, execution and management of
deals. A four-stage investment process is proposed based on industry best practice.
4.3.1 Deal origination and pre-screening
Deal originations
The channels for deal origination vary: PE professional can actively approach
potential targets through their own network; target companies may contact the PE fund if
they are seeking financing; intermediaries such as investment banks often refer deals to
PE funds; senior management of existing portfolio companies can also refer potential
investment targets. Of all channels, proprietary deals usually fit a fund's investment
strategy the best and should be the most encouraged way of deal sourcing.
Pre-screening
After a deal is sourced, it should be internally pre-screened for the soundness of
the business model, the viability of the underlying technology, the fitness to the fund's
Commitments to the fund under the subscription agreement which have been drawn down and paid to the
fund.
38
investment theme and the valuation, among other. The majority of deals reviewed will be
screened out at this stage.
4.3.2 Internal analysis and initial negotiation
Internal analysis
If a target company passes the initial pre-screening, the deal team should work
with companies to gather further information after signing a non-disclosure agreement.
The deal team typically should interview company management, industry experts and
consultants to assess the market and the company. The deal team should also start to
build a preliminary valuation model to gauge the potential value of the company.
Initial negotiation
Based on the internal analysis, the deal team should start to negotiate with the
company and/or its shareholders on the key terms to be included in a term sheet3 9, which
is non-binding except for certain non-commercial terms4 . The investment committee
may be consulted for advice in the process of the preliminary negotiation.
Preliminary internal approval
An investment memorandum, along with the term sheet, should be prepared and
presented to the investment committee for approval. The materials should include the
deal structure, investment highlights and risks, market outlook, the business, the
financials and valuation of the company, among others. Investment committee's approval
should be required to proceed with further due diligence.
4.3.3 Due diligence and deal execution
Due diligence
3 A term sheet lists the main terms of a deal.
* For example, the confidentiality term is usually binding.
55
A thorough due diligence should be conducted at this stage. The deal team can
fully rely internally for the due diligence, but in most case they choose to engage some
outside advisors, such as lawyers, accountants and business consultants, for part of the
due diligence. The due diligence should cover many aspects, including the industry, the
legal compliance, the financial records, the taxation compliance, the technology, the
operations and the management team.
Continued negotiation
During the process of due diligence, the deal team usually continues to negotiate
with the company or the shareholders and a share purchase agreement will be drafted
with the assistance of lawyers.
Investment committee approval
The deal team will prepare an updated investment memorandum that incorporates
the due diligence findings and the final agreements for the investment committee to
approve. The investment committee may provide its comments that require the deal team
to do additional due diligence work or re-negotiate the agreements, so more than one
investment committee meeting may be needed depending on the investment committee's
initial feedback on the investment memorandum.
Deal closing
After the agreement is reached and approved by the investment committee, the
deal team should work on the closing of the deal, including calling capital, securing
financing, monitoring the conditions precedent and executing the share transfer. A
closing procedure memo can be helpful for deals with complex structures.
Documentation
All key documents should be filed carefully, including management agreements,
purchase agreements, operating contracts, financing agreements, updated investment
committee memorandums and term sheets.
4.3.4 Portfolio management and exits
Investment monitoring
Timely monitored reports should be created to help the communication between
the fund and the portfolio companies. Portfolio companies' financial statements and
operational updates should be closely monitored along with industry development.
Board representation
The fund should seek board representation on the portfolio companies, and boardlevel strategic management will be the main form to manage the portfolios.
Fund report
Standard fund reporting procedures should be conducted with the help of outside
accountants, and the result should be reported to limited partners.
Exit
The fund should closely monitor portfolio performance and market conditions to
evaluate possible exit opportunities. Outside advisors may be engaged to help plan and
execute exit strategies.
5. Investment opportunities in China's renewable energy industry
5.1 China's renewable energy industry: more than an emerging market
As a result of its rapid economic growth, China topped the list of C02 emitting
countries in 2006, surpassing the USA by an estimated 8 percent. China strives to keep
the promise it made in November 2009 at the Copenhagen Conference to cut its carbon
dioxide emissions per unit of GDP by 40 to 45 percent by 2020 compared with the level
in 2005. China's long term shortage of energy is also well known. Therefore, it is
generally believed that China will have to turn to renewable energy to meet its future
energy demand and emission reduction target. However, it is less known that China is
now already a center of gravity for renewable energy investment.
According to a report by the PEW Charitable Trusts, China surpassed the United
States as the number one nation for installed clean energy capacity in 2009, further
solidifying its position as the world's clean energy powerhouse. In 2010, China continued
its growth momentum in clean energy investment, growing 39 percent to attract a worldrecord $54.4 billion. China has also established itself as the world's leading clean energy
manufacturer, producing almost 50 percent of all wind turbine and solar module
shipments. Total investment in the renewable energy sector has seen an average growth
rate of 88% in the past five years.
Table 5.1 Key statistics of China's renewable energy sector (2010)
Total Investment (2010)
$54.4 billion
G-20 Investment Rank (2010)
1St
Total Investment as Percentage of G-20 Total (2010)
27.5%
5-Year Annual Average Growth Rate (2006-2010)
88%
Total Renewable Energy Capacity (2010)
103 GW
Total Capacity as Percentage of G-20 Total (2010)
27%
5-Year Growth Rate (2006-2010)
106%
Source: The PEW CharitableTrusts
The Chinese government plans to keep building up the capacity in the renewable
energy sector. Its planned capacity for wind power in 2020 is 3.5 times that in 2010, and
25 times for solar power.
Exibit 5.1 China current capacity and planned capacity
for wind and solar power (MW)
150,000
" Wind
* Solar
43,410
800
2010
2020
Source: The PEW Charitable Trusts
Among all the financing sources, venture capital/private equity investment
accounts for only 4% of total investment in the renewable energy sector worldwide. This
is partly due to the early-stage status of the sector, but venture capital/private equity is
expected to be playing a much bigger role as the industry scales up, providing
tremendous opportunities for venture capital/private equity to participate in the rapid
growth of China's renewable energy sector.
As the industry makes great progress, the investment community's confidence in
the renewable energy sector is improving dramatically. In a 2009 survey conducted on
major PE/VC firms, who were asked to list the sectors they will focus on in the next two
years, 79.5% listed environmental protection and new energy, ranking the highest among
all the sectors.
.
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,
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Source: CVCA 2009 China PE Industry & Regulatory Environment Survey Report
Not only has investment in the renewable energy industry picked up, some earlier
investors are also starting to see more exits opportunities for their investment, especially
after the launching of China's GEM board. See Table 5.2 for the VC-backed IPOs of new
energy companies on GEM. Up to December 2010, 27 investors in 10 new energy
companies have had the opportunity to exit. Those IPOs are priced at 72.6 times earnings
on average, giving the investors a return of 12.9 times of the initial investment, after on
average less than three years' of holding period. The IPO valuation and return not only
are very high, but also compare favorably to VC-backed non-renewable energy IPOs on
the GEM, which have an average IPO price-to-earnings ratio of 65.8 times and average
return to VC investor of 10.6 times of initial investment. This may suggest that the
renewable energy companies are commanding higher valuations for the high growth
potential.
Table 5.2 VC-backed IPOs of new energy companies on GEM (as of Dec 10)
Company
IPO date
P/E at IPO
Price
NanFang Ventilator Co.,Ltd.
10/30/09
71.53
EVE Battery Co.,Ltd.
10/30/09
EVE Battery Co.,Ltd.
Beijing Cisri-Gaona Materials &
Technology Co.,Ltd.
Beijing Cisri-Gaona Materials &
Technology Co.,Ltd.
Xiamen Savings Environmental
Co., Ltd.
Xiamen Savings Environmental
Co.,Ltd.
Xiamen Savings Environmental
Co.,Ltd.
Beijing Originwater Technology
Co.,Ltd.
Beijing Originwater Technology
Co.,Ltd.
Beijing Originwater Technology
Co.,Ltd.
Beijing Easpring Material
Technology Co.,Ltd.
Beijing Easpring Material
Technology Co.,Ltd.
Beijing Easpring Material
Technology Co.,Ltd.
Henan Xindaxin Materials Co.,
Ltd.
Henan Xindaxin Materials Co.,
Ltd.
Investor
Date of
Investment
Investment
(RMB M)
Return at
IPO price (x)
08/12/07
8
11.87
54.56
Guangdong Tongying VC
China Merchants Tech
Investment
08/22/07
10
7.13
10/30/09
54.56
Fortune VC
08/22/07
5
7.05
12/25/09
75.12
12/01/03
21
13.78
12/25/09
75.12
Shenzhen Dongxin VC
Guosen Hongsheng
Investment
05/19/09
14
4.88
02/26/10
102.81
Shenzhen Capital Group
06/01/08
10
10.54
02/26/10
102.81
Xiamen Sanwei VC
11/19/08
12
7.57
02/26/10
102.81
Xiamen Torch VC
06/01/08
3
10.54
04/21/10
94.52
Tripod Capital
09/18/06
20
28.46
04/21/10
94.52
Shanghai VC
08/27/08
6
28.46
04/21/10
94.52
Shenzhen Hechen VC
08/27/08
0
27.03
04/27/10
78.26
Shenzhen Capital Group
11/30/07
6
26.82
04/27/10
78.26
Shenzhen Capital Group
11/30/07
16
26.81
04/27/10
78.26
11/30/07
7
26.81
06/25/10
68.89
Shenzhen Cowin Capital
Shenzhen Hongshu
Investment
11/29/07
10
10.82
06/25/10
68.89
Shenzhen Cowin Capital
09/15/08
2
9.30
Risen Energy Co.Ltd.
09/02/10
50.18
Shenzhen Capital Group
08/10/08
45
8.59
Risen Energy Co. Ltd.
09/02/10
50.18
08/10/08
30
8.61
Risen Energy Co. Ltd.
09/02/10
50.18
Mairi Investments
Shanghai Kesheng
Investment
08/10/08
20
8.61
Risen Energy Co. Ltd.
09/02/10
50.18
Huijin Lifang Capital
08/10/08
20
8.61
Risen Energy Co. Ltd.
Dalian East New Energy
Development Co.,Ltd.
Dalian East New Energy
Development Co.,Ltd.
Dalian East New Energy
Development Co.,Ltd.
Shanghai Taisheng Wind Power
Equipment Co.,Ltd.
Shanghai Taisheng Wind Power
Equipment Co.,Ltd.
Shanghai Taisheng Wind Power
Equipment Co.,Ltd.
09/02/10
50.18
Sichuan Caep VC
08/10/08
10
8.62
10/13/10
89.72
Boxin Capital
09/10/09
40
6.88
10/13/10
89.72
Beijing Dingyuan VC
09/10/09
12
6.88
10/13/10
89.72
Dianlian Hairong VC
09/10/09
10
6.88
10/19/10
47.99
Shanghai Zhongling VC
01/07/08
18
9.04
10/19/10
47.99
Yongjin Group
01/07/08
14
9.04
10/19/10
47.99
Shanghai Xuhui VC
01/07/08
10
9.04
Source: Baidu Wenku
5.2 Selected investment areas for the new fund
5.2.1 Wind Power
Wind is currently the largest and fastest-growing generation source of alternative
energy power, as technological advances have made wind cost competitive as well as
scalable for utility-sized wind farm operators. Wind power is one of the most promising
sources of renewable energy for China. China has rich wind resources: according to the
estimation by China Meteorological Administration, total wind power 4 ' that can be
utilized for power generation is about 1,000 GW. In theory, wind resources alone, if fully
utilized, can satisfy the total consumption demand for electricity of China. Currently only
about 1.25% of the total resources is being utilized. The cost of wind power generation is
much less than many other means of renewable energy such as solar power.
The Chinese government is very supportive of the wind power industry. Many
favorable policies are in place to encourage investment and operation in this sector. The
government is planning to develop six wind power bases each with installed capacity of
over 10 GW, including bases in Gansu, Xinjiang, East Inner Mongolia, West Mongolia,
Hebei and Jiangsu. Many generation plants with capacity of over 1 GW are under
construction or have already been completed. It is planned that by 2020, total installed
capacity of wind power will be more than 150 GW, accounting for between 7% and 9%
of total power generation capacity of the country.
41 41
Including wind resources both on the land and offshore.
Exhibit 5.2 China's Total Installed Capacity of Wind Power
son New capacity (MW) w Total capacity (MW)10000
9000
New capacity growth
200.00%
-150.00%
8000
7
7000
60005000
100.00%
-
50.00%
4000
0.00%
3000-
2000
1000
0 -
-50.00%
,-- ---- -A , 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-100.00%
Source: CITIC Securities Research
Successful PE investment case of winder power: Goldwind
Founded in 1998, Xinjiang Goldwind Science & Technology Co., Ltd.
(Goldwind) is one of the largest wind turbine manufacturers in the world, with operations
in Asia, Australia, Europe, and the Americas. As of the end of the second quarter 2010,
over 6,000 Goldwind turbines are in service. Goldwind's integrated business model
encompasses research and development, manufacturing, and comprehensive turnkey
solutions including wind resources evaluation, feasibility studies, sitting calculation,
project management and diagnosis, project financing and O&M. The company captures
close to 8% of the global market and rank among the top five global wind companies in
terms of market share in 2009. The company had revenue of RMBI.53 billion, net profit
of RMB319 million and domestic market share of over 80% in 2006. Its IPO in China's
stock market was a "home run" for its PE investors, especially China-Belgium Direct
Equity Investment Fund ("China-Belgium Fund"). China-Belgium Fund, founded in
2004, is the result of a cooperation agreement between the Chinese government and the
Belgium government. In September 2005, China-Belgium Fund invested RMB40 million
in Goldwind for a stake of 80%, or RMB 1.1 per share. On December 26, 2007,
Goldwind was listed on China's Small-to-Medium Board. The IPO price was set at
RMB36, but the price was pushed to RMB131 at closing. The closing price means a 119
times of return for China-Belgium Fund after investing for only two years 42
5.2.2 Nuclear power
Nuclear power is another renewable energy sector with tremendous potentials.
China was slow in developing nuclear power: of all the more than 400 operating nuclear
power plants in the world, only four are in China, with total installed capacity of 9GW.
But the government recently decided to speed up the development of nuclear power and
revised its plan for the nuclear power industry by increasing the targeted total installed
capacity. Now the plan is to have operating capacity of 40 GW and capacity under
construction of 18 GW. At present more than 10 nuclear power stations are under
construction.
Not only will the total capacity see dramatic growth in the future, but the
government also requires the new plants to purchase the majority of the equipment from
Chinese producers, while the percentage of domestic purchasing for the early plants was
as low as 10%. This creates enormous opportunities for Chinese equipment
manufacturers.
However, the Japan earthquake in March 2011 and the subsequent nuclear
leakage have spillover effects on China nuclear industry. Although all the Chinese
nuclear plants use the third-generation technology, which in theory is 100 times safer
than the second- generation technology used by the Japanese nuclear power station in
Fukushima, all the nuclear plants under construction in China were under review after the
Japanese nuclear leakage. The construction plans are unlikely to be stopped, but this
event does pose risk for the future plans of nuclear stations construction and policy
development should be closely watched and policy risk evaluated.
But China-Belgium Fund had to lock up its shareholding for a period of time and could not sell the shares
on the first day of listing, so its actual return is subject to Goldwind's stock price performance later.
4
64
Exhibit 5.3 China's Total Installed Capacity of Nuclear Power
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
-1
-0.8
-0.6
Nuclear capacity (MW))
-
1-8
-6
Nuclearas %total power
-
1.4
-1.2
4 000
- 0 .8
0.4
0.2
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Dongfang Securities Research
Successful PE investment case of nuclear power: Nanfeng Ventilator
Nanfeng Ventilator Co., Ltd is not large, but it has a unique market position in
China's emerging nuclear power equipment industry. Nanfeng is the largest producer of
ventilators used in nuclear power stations, while its ventilators are also widely used in
other industries. A local venture capital firm, Tongying Venture Capital, invested RMB8
million in Nanfeng for a 5.93% stake at RMB1.93 per share in December 2007 before it
went public in 2009. Nanfeng is in fact not a pure "nuclear play" and most of its revenue
comes from sales of ventilators used in subways and tunnels. However, because the
market loved its nuclear concept, its IPO price of RMB22.89 was pushed up to
RMB40.25 at closing, giving Tongying a nice 20 times' return based on Nanfeng's firstday closing price.
5.2.3 Electrical vehicles and rechargeable batteries
China's automobile industry has seen rapid growth driven by the consumer
demand. In 2009, when the world's auto sales suffered significantly as a result of the
financial crisis, China's auto industry emerged from the crisis with a 45% growth in car
sales and became world's largest auto market. Driven by its ambitious plan to reduce
65
reliance on oil and cut carbon emission, the Chinese government proposed to build
production capacity of 500,000 electrical vehicles before 2012, and implemented policies
that provided subsidies in 13 pilot cities across the country.
However, many problems remain to be solved before electrical vehicles can be
widely accepted by the Chinese consumers. First, the price of an electrical car is much
higher than a regular car, mainly because of the expensive battery system. Second, huge
investment is needed to build extensive and convenient recharging systems for the
electrical vehicles. Third, the performance and reliability of the batteries needs to be
improved. Despite these obstacles, electrical vehicles represent a trend of the automobile
industry and will see significant growth once it was able to scale up and pass a certain
threshold.
Exhibit 5.4 Projected electrical vehicles sales
EV
0.
=3
_.7
646
19
38
2011
2012
0 4' 0.8%"
PHEV
r !.
2013
at
i
2014
2015
I(1.1%)
CTIE)
11
192
2016
380
274
il
2017
=22' =12%,C
2018
)(K7i)
G
507
1 1
2019
2020
=7.60 =9-3'A
1,016
791
587
26
54
2011
2012
83
2013
418
128
193
7288
7
2014
2015
2016
2017
2018
2019
2020
%inwiPV salesvume
Source: Roland Berger Estimation
Note: PHEV refers to plug-in EV
Lithium-ion batteries are key components of electrical vehicles. In addition,
lithium-ion batteries are also widely used in areas other than electrical vehicles, such as
mobile phones and computers. As a result, lithium-ion batteries are more mature than the
electrical vehicle industry in terms of market stage. Investment opportunities can be
identified in all parts of the value chain of the lithium-ion battery industry, from the raw
materials to the different components such as positive electrodes, negative electrodes and
electrolytes. The market size is expected to grow exponentially once the electrical vehicle
industry takes off.
Successful PE investment case: Easpring
Beijing Easpring Co., Ltd.("Easpring") is a high-tech enterprise established in
2001 by researchers of a famous research institute. The company is mainly engaged in
the R&D and production of new energy materials, including lithium cobalt oxide, multielement oxide, lithium manganese oxide and other cathode materials for small lithium
batteries and power batteries. Today, the company is a leading specialized supplier of
cathode material for lithium-ion batteries. In November 2007, Shenzhen Capital Group
("SZVC") invested RMB21.75 million in Easpring in exchange for 27% of its shares and
became its second largest shareholder. The share-purchasing price was about RMB3.03
per share. When Easpring went public on China's GEM Board in April 2010, the stock
was priced at RMB35 and closed at Rmb62.58, representing an over 20 times of return
for SZVC after investing for only two and a half years.
5.3 Case study of renewable energy funds
Private equity investment in the renewable energy sector is relatively new in
China, and most of the investments have been made by generalist funds. There are,
however, some pioneering funds focused on this sector.
5.3.1 Tsing Capital
Founded in 2001, Tsing Capital is the first venture capital firm focused on clean
technology in China. With USD 350 million under management through its China
Environment Funds (denominated in the U.S. dollar) and Yiyun Cleantech Fund
(denominated in the RMB) series, Tsing Capital works intimately with its portfolio
companies across China in areas of renewable energy, energy efficiency, environment
protection, new materials, sustainable transportation, smart grids, sustainable agriculture
and cleaner production.
Over the 10 years, Tsing Capital has raised three U.S. dollar funds and one RMB
fund. The U.S. dollar funds will be used when a target company in an offshore structured
company, while the RMB fund will be used when investing in an onshore company that
does not plan to take foreign investment. For onshore companies that are indifferent
about the currency of investment, Tsing Capital will try to invest with both the RMB fund
and the U.S. dollar funds.
Table 5.3 Tsing Capital funds
Fund
China Environmental Fund 1
China Environmental Fund 11
China Environmental Fund 111
Yiwu-Tsing Fund
Size (US$M)
15
30
250
60
Total
Currency
US dollar
US dollar
US dollar
RMB
Vintage year
2002
2004
2008
2009
355
Source: Tsing Capital Website
In its first years Tsing found both fundraising and investing challenging because
clean technology was still an emerging business, but Tsing was able to leverage its firstmover advantage in riding the rapid development of the industry and established itself as
a leading investor in the clean technology area. Over the past years Tsing has made more
than 20 investments in the clean technology area, and has made four successful exits via
IPOs or trade sale.
Table 5.4 Tsing Capital portfolios
Company
Neo-Neon
Category
Energy
Description
World leading vertically integrated LED manufacturer (Ticker:
efficiency
1868.HK)
Net Power
Energy
efficiency
Provider of large capacity zinc-bromide flow battery technology, with
applications in peak-shaving on commercial properties and power
Nobao
Energy
Integrated energy management solutions for buildings with multi-
efficiency
source heat pump technology in both EMC and EPC model
Energy
Pioneer and leading private EMC player in water cooling systems in
arbitrage in the electricity market
PowerU
BGB
Dong Jiang
efficiency
China
Environmental
Microorganism technology to convert kitchen waste into microbial
protection
protein feed and microbial fertilizer additive
Environmental
Industrial hazardous waste treatment and waste detoxification
protection
ESG
Environmental
Outsourcing cleaning and pest control services in HK and China with
protection
over 30 branch offices
Haiyuan
Group
Environmental
protection
Environmental
protection
TGBS
New materials
CHC
Clean energy
China
Clean energy
Giant Hemu
Black liquor solution provider to small pulp mills, converting it into
lignin and organic fertilizers
Largest manufacturer of automatic hydraulic pressing machines of
wall bricks by utilizing fly ash, mineral slag and inorganic solid
wastes.
Provider of biodegradable polymer PHA and related applications,
with world class and proprietary IP and technology
Fast-growing consolidator and operator of small hydropower plants in
China, lead by an international management team
World leading solar cell manufacturer and world record holder for
conversion efficiency
Sunergy
Vertically integrated solar manufacturer in Jiangsu with strong market
ET Solar
Clean energy
LDK
Clean energy
Largest manufacturer of multi-crystalline solar wafers in Asia
Longmen
Clean energy
Leading company in coal bed methane processing with significant
Sound Puhua
Clean energy
Smart grid equipment manufacturer and producer of reactive power
Sunpreme,
Ltd.
Top Gain
Clean energy
Fengguang
Bio-fan
Giant Hemu
Sustainable
Agriculture
Sustainable
Solar cell developer with disruptive technology enabling use of low
cost MG-Si to act as substrate and light absorber
Casting, machining and welding of wind turbine components
including rotor hub, nacelle body, spindle and bearing box
Developer of bio-fans for aquacultural applications, improving water
quality via natural resources
Black liquor solution provider to small pulp mills, converting it into
Agriculture
lignin and organic fertilizers
Sustainable
Agriculture
Sustainable
Transportation
Sustainable
Transportation
Largest organic vegetable supplier in Shanghai
position in solar tracking systems
concessions
compensation devices for use on wind turbines and wind farms
Tonys Farm
Atieva
SureAuto
Clean energy
Specializing in the design and manufacturing technologies of Li-ion
battery systems primarily for EVs
Purchases, reconditions and resells used cars with extensive and
industry-leading services including warranty, maintenance, insurance
and repurchase guarantee
Source: Tsing Capital
5.3.2 Clean Resources Asia Growth ("CRAG") Fund of CLSA
CLSA Asia-Pacific Markets ("CLSA") is one of the leading independent
brokerages in Asia. CLSA is also the Asia-Pacific brokerage arm of the Credit Agricole
Group, the world's ninth largest bank by tier one capital. CLSA Capital Partners is the
wholly owned asset management business of CLSA and manages over $2.6 billion in a
group of diversified, theme-focused funds established to take advantage of investment
opportunities in the Asia-Pacific region.
The Clean Resources Asia Growth Fund, which was launched in 2009 by CLSA
Capital Partners, has seen a first close on an undisclosed amount in 2010. The fund is
targeting commitments of $200 million to invest in Asia's clean technology sector.
International Finance Corporation (IFC), the private investment arm of the World Bank is
considering a $25 million investment in the fund, according to its website. Asian
Development Bank's Board of Directors approved equity investments of up to $20
million each in the Clean Resources Asia Growth in the fund.
The fund intends to make private equity portfolio investments primarily in
operating businesses within the clean technology sector which have revenues and
operations in or a strong link to Asia-Pacific markets. Generally at the growth or
expansion stage of development, private equity portfolio investments are expected to
range in size from US$10 million to US$30 million and may be made in a wide range of
instruments including preferred stock, common equity, warrants and convertible debt
instruments.
The fund's strategy is to identify and invest in:
" Proven clean technologies (sourced globally) for application to Asian markets
*
Critical elements of the Asia-based supply chain for clean resource
technologies
*
High growth clean technology companies expanding sales volumes and
production capacities
In 2010, the fund invested US$8 million in Aqualyng Holding, a global provider
of desalination solutions, for a minority stake. Aqualyng's patented technology, the
Recuperator, provides energy efficient desalination solutions based on reversed osmosis
technology. Headquartered in Norway, the company has recently shifted its focus to Asia
and is currently building one of China's largest desalination plants. As part of the
transaction, the fund has representation on the boards of Aqualyng and its Chinese
subsidiary Aqualyng China. 4
5.3.2 Nature Elements Capital
Nature Elements Capital is a specialist investment manager in the Clean Energy
and Cleantech sectors. Nature Elements Capital is named after the five elements of nature
43
http://www.infrastructureinvestor.com/Article.aspx?article=58041
70
as per the ancient Chinese philosophy - gold, wood, water, fire and earth. Nature
Elements Capital is led by Dr. KK Chan, who was Managing Director and Head of
Investments for Greater China at Climate Change Capital, a renewable energy-focused
PE firm managing fund of over US$1.5 billion.
Nature Elements Capital mainly looks for opportunities in the following areas:
" Renewable energy, including small hydro, solar, biomass, bio fuels and
geothermal;
e
Energy efficiency, including distributed generation, power storage, cogeneration, control improvement, efficiency services and building efficiency.
*
Waste treatment, including waste to energy, solid water treatment, waste
water treatment and waste recycling
Nature Elements Capital uses a different approach to fundraising. The firm is
planning a fundraising target of US$400 million, which may include fund in both the
RMB and the U.S. dollar. On April 18, 2011, it was announced that the firm successfully
partnered with the government of Chongqing, a municipality in western China, and
completed the first closing of RMB250 million for the fund. Nature Elements Capital will
work closely with Chongqing government's venture capital arm to identify investment
opportunities and Chongqing will be a key area for the fund.
Although all Tsing Capital, CRAG and Nature Elements Capital invest primarily
in renewable energy or clean technology areas, they each have different features. Tsing is
a local Chinese firms investing in a wide variety of sub-sectors; CRAG is a pan-Asia
fund investing from outside of China and research-driven; Nature Elements Capital has a
local team with international investment experience and support from local government
for fundraising and deal sourcing.
The three funds, being China's leading PE/VC funds focused on the renewable
energy industry, are in fact relatively small compared to average generalist funds. They
also target primarily on investments of smaller sizes, in most cases no larger than US$30
million. As more and larger investment opportunities emerge as a result of the rapid
development of the renewable energy sector, there will be greater room for larger fund
targeted on more mature companies in the industry.
6. Conclusion
Successful private equity firms have long-term horizon and are able to leverage
their track record to scale the business up. They know when and how to raise new funds
when managing existing funds, and they also know what kind of funds to raise based on
their expertise and market appetite. All the leading private equity firms have continuously
raised series of funds that fall into different fund categories. It is this ability to constantly
repeat the past success that makes successful private equity fund managers standout.
Now close to the end of the investment period of five years for its first fund,
BIIFM is at a critical point. Whether or not it can successfully market its experience in
managing the first fund to potential investors and raise a second fund relatively quickly in
this economic environment is crucial to its future success.
The first question BIIFM needs to answer is what kind of fund to raise. Given that
foreign investors are having increasingly bigger appetite for investment opportunities in
China, it would be a good option for BIIFM to raise a U.S. dollar-denominated fund,
which can well complement the current and future RMB-denominated funds it manages.
Sector focus is also a trend in the private equity as more furious competition requires
fund managers to go beyond the investment side to develop sector expertise that enables
them to add value to the invested companies. China's continued demand for energy and
its ambitious plan to reduce emission lead the author to believe that a new fund focused
on the energy sector, especially renewable energy, will give BIIFM a competitive edge
among the fund managers, and BIIFM's previous experience in such sectors can be very
useful.
BIIFM faces many challenges for its new fund. Should it adopt the well-proved
limited partnership structure or continue to use contractual structure? How should it
explain the return for the first fund without an exit? Which investors should it turn to
when all of its existing investors are Chinese institutions without sizable asset in U.S.
dollar to invest? How should it define the relationship between the new U.S. dollar fund
and the RMB fund(s)? Those key questions, among others, are what this thesis tries to
explore and find answers to.
Fundraising, like other aspects of private equity, is never science and will not
have defined answers. Specific strategies are required in different circumstances, and
they may be revised constantly in reaction to changes in the environment. Although this
thesis is just the reflection of the author's personal ideas, the author certainly hopes that it
can be helpful for considering the fundraising strategy.
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