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Silicon Valley VCs face tricky Chinese puzzle

china4.jpgInvesting in Chinese high-tech companies may be all the rage, but Silicon VCs are a tad confused by China's latest rules governing such investments.

And they'll be scratching their heads at China's latest effort to clarify things.

At issue are China's infamous "SAFE" guidelines for private investments. SAFE stands for State Administration for Foreign Exchange. And SAFE's big-footed policies reflect China's obsession for currency control, and also for making sure profits from China's companies don't all flow...

to outside investors.

Late last year and earlier this year, SAFE distributed the so-called Circulars 11 and 29, two documents that many VCs said have hampered their efforts to invest in China companies. Until those circulars, the traditional model of investing has been to transfer ownership of a company's assets to an offshore entity, say in the Cayman Islands. These are known as Wholly Owned Foreign Entities, or WOFEs. VCs invest in these entities, and are able to take a company public on the Nasdaq or somewhere else, without worrying about fighting through the legal morass, and risk, of taking a Chinese company public on one of China's domestic, fairly weak, stock exchanges.

What SAFE's circular did was to crack down on this process. What China had realized, after all the IPOs started happening last year, was that its taxing authorities couldn't keep track of, or access for taxing at rates it though appropriate, the dollars being generated by these entities. So SAFE's circulars required that all WOFEs get permission from SAFE before setting up, a step that effectively brought such investing to a standstill by confused U.S. VCs.

Scott Bohham, managing director of Granite Global Ventures, a firm run out of Menlo Park, Singapore and Shanghai, told us that his firm was basically treading water on new Chinese investments, waiting to see how things developed under the new SAFE guidelines. Granite has quietly become a big investor in China, having backed companies like Alibaba, AAC Acoustic Technologies and BCD.

So over the past few days, it emerged that SAFE had finally got together with the Ministry of Commerce (MOFCOM), and the two agreed to replace the two offending regulations with two new, improved circulars on investing, and M&As. A nice blurb on this is carried by Asian Private Equity News. It is not clear, however, how or whether things have been improved at all for VCs.

..every resident of China must now have approval by SAFE for their business plans (including such information as who owns what) for holding companies overseas; disclose all of the nefarious and clever deal structures created by their attorneys and repatriate every penny raised in the offerings of those shares overseas back into China. Did I mention that the regulation is retroactive?

...Talking into the wee hours of the night with people about the new regulations via my LCD display campfire has been like exchanging late night horror stories, with each rendering more frightening than the last. No one argues with China's right to collect taxes from its citizens, but like all scary stories, we're left wondering what's next.

The piece is interestingly entitled "Sarbanes Oxley never looked so good."


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Comments

China's tightly controlled economy requires rigid controls, and its history of downsides when this fails makes it even more exacting. The problem is that there is little long-term experience with successful foreign investment on this scale by the government of China. Exacerbating the issue too is the lack of history in China of a legal system which until recently they couldn't afford and didn't have a reason to need.

Look at this as a learning curve, and China's one of the fastest learning countries in history. But if you expect China to operate like a first world country immediately you're in for a shock - it isn't yet.

Doing business in Asia requires great patience and stamina, acquired through wisdom of experience, to get great returns. American alacrity is not valued.

But those great Chinese returns will be in China, make no mistake.

William Jolitz on October 19, 2005 10:59 AM
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Don't forget to mention China's terrible intellectual property theft and piracy. Corruption top to bottom.

chickun-wing on October 19, 2005 2:49 PM
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Hey, this post is currently the #1 ranked blog post on Blogniscient!

http://technology.blogniscient.com

Thanks for outlining some of the rules and regulations within the Chinese market that many of us were not previously aware of.

will.crissman on October 20, 2005 7:17 AM
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硅谷的风投在中国的困惑 pingback from Podcast Podium http://www.hopesome.com

Hopesome on October 23, 2005 6:33 PM
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