Financial risk management_presentation

Private Equity & Venture Capital Risk

Agency Problem & China’s Market

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PE/VC RISK MANAGEMENT

Agency Problem & China’s Market Context

Private equity and venture capital

Definition to PE/VC

The agency problem

Interests confliction and the resolution

Domestic PE/VC

Industry in China

Adapt to China market

China characterized risks and management

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02

03

04

References App.

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01 Definition to PE/VC

Private Equity (PE) Private equity is an asset class consisting of equity

securities and debt in operating companies that are not

publicly traded on a stock exchange.

Venture Capital (VC) is financial capital provided to early-stage, high-potential,

growth startup companies. Venture capital is a type of

private equity.

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02 The agency problem

Agency Problem occurs when one person or entity

is able to make decisions that impact, or on behalf of,

another person or entity.

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Solution to agency problem

Shoulder unlimited liability and the amount of

money invested by GP

Shoulder unlimited liability

LP should invest 1% of the whole asset

The committed capital from LP should be phased

in gradually

The fact that capital from LP is phased in gradually makes

the money GP can operate be limited

Between two capital injections, GP must provide

materials of the project progress to be examined

No Fault Divorce.

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Solution to agency problem (Continue)

Restrictive clauses for GP

Profit distribution in limited partnership

Reputation mechanism

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03

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03 PE/VC in China

The amount of VC/PE institutions in China

The development trends of PE/VC financing market

The number of funds and projects are overall on the rise RMB funds are in the majority and USD funds have become increasingly concentrated

$

In 2012, VC raised $5 billion through

dollar funds

Compared with $63 billion through RMB

funds in 2012

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03 PE/VC in China

“Too much money is chasing too few deals” Capital supply is relatively abundant (2013)

Resourse: China Venture Capital and Private Equity Association

0 600 1200

PE

VC andAngle Investors

billion dollar

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03 PE/VC in China

The structure of PE market (2013)

Resourse: China Venture Capital and Private Equity Association

Growth Fund

Real Estate Fund

private investment

in public equity(PIPE)

Merge & Acquisition

(M&A) Fund

Others

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Hopu Investment Management

China Dinghui Investments

Hony Captial Held by Lenovo

Well-known domestic PE/VC institutions

China Broadband Capital

03 PE/VC in China

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04

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4.1 Characterized risks in China

Most critical problem: entry & exit

Special risks can cause time lag or rule out

international PE/VC when entering or exiting

investments.

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Legal risk: Regulation and litigation uncertainty The China Security Regulation Commission (CSRC) vs.

the National Development and Reform Commission

(NDRC)

Weak, inconsistent, and non-transparent litigation system

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Agency Problem & China Market

Historically, PE/VC were supervised by

the NDRC

Competition for dominate right of regulation between CSRC

and NDRC

Relative history

2013 Feb

2013 March

2013 June

2014 Jan

2009

2011

New framework

The State Commission Office stepped in, and appointed the duties

CSRC attempted to permit PE to invest in

public section and funds

NDRC soon denied it

CSRC attempted to amend the policy

but failed

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Legal risk: Regulation and litigation uncertainty China Security Regulation Commission (CSRC) vs.

National Development and Reform Commission (NDRC)

Weak, inconsistent, and non-transparent litigation system

Target for acquisition with bad credit Accounting fraud-2 or 3 set of books

Opaque contract-unforeseen liabilities

Poor management

Political risk: Market interference from the government

Controversy to specific acquisition deals

Political agenda and restriction to certain industries

IPO freeze and foreign exchange control

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In July 2008, Carlyle, a private equity firm, lost a three-year battle to acquire Xugong Group, a state-owned tractor manufactory. It was widely believed to reflect China's growing resistance to outside involvement, especially in the pillar industries.

Also in 2008, Coca-Cola failed its $2.4 billion deal to acquire Huiyan, the largest juice company in China. The Ministry of Commercial of PRC ruled against the acquisition, making it the first to be struck down under China’s anti-monopoly law.

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4.2 Adaption to manage risks

Build guanxi (关系) Guanxi refers to the relationships based on mutual

obligation, goodwill, and personal affection

Local government-support

Local companies-further information and network

Due diligence and structuring the deal Conducting on-site, knowing background of partners

Trial period-30%-60% up front, joint venture asset deal,

and valuation adjustment mechanism

Disputes resolution-arbitration other than negotiation

Stay off the political radar Keep an eye for political momentum

Understand the officials’ thinking

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4.2 Adaption to manage risks

How do international PE/VC institutions manage risks to exit

their investments in China market

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Risky Business: Private Equity in China, January 26, 2011,

http://www.knowledge.wharton.upenn.edu

Investment sector faces challenges, Kate Watson, April 21 , 2011,

South China Morning Post

A new era for private funds in China, September 29, 2014, Lexology

Venture capital in China: high technology investing in an emerging

economy, David Ahlstrom, Kuang S. Yeh and Garry D. Bruton

http://www.eyprivateequity.com

Private Equity at Crossroads, Special Report of Knowlegde@Warton,

April 2014

Private Equity in China: Heating up, but „Veiled in Uncertainty‟, May 30,

2014, knowledge.wharton.upenn.edu

A Brave New World for Venture Capitalists in China, April 29, 2010,


Appendix References

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Appendix References

Allan Kwan of Oak Investment Partners: The New Risks and

Rewards of Being a Venture Capitalist in China, January 10, 2010,


http://en.wikipedia.org/wiki/Private_equity

http://en.wikipedia.org/wiki/Venture_capital

焦点：中国私募基金“转正”紧锣密鼓行业转型悄然来临, April 4, 2014,Reuters

私募股权投资基金运行过程中的委托-代理问题及解决 : 基于有限合伙制的组织形式

2012 China VC/PE Industry Survey Report，China Venture Capital and

Private Equity Association

2013 China VC/PE Industry Survey Report，China Venture Capital and

Private Equity Association

The development and trend of Chinese PE/VC market, BA, Shusong

http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem

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