Finance & Banking Consulting

Consulting Team

Jimmothy Trinh: Senior Portfolio Manager

Cynthia Leung: Business Development Analyst

Albert Angkawijaya: Senior Organizational Analyst

Fabio Schneider:Senior Management Consultant

Overview of Venture Capital

•Venture Capital Funds invest in small and medium-sized enterprises to support their growth.

Overview of Venture Capital

● 2005. Facebook needs funds to finance expansion.● May 2005 Accel Partners invests $12.7 million in Facebook, acquiring 10% of Facebook’s stock● May 2012. Facebook IPO. Accel’s share of Facebook is now worth over $10 billion.

This is Jim Breyer, Partner at Accel who worked on the Facebook deal.

Overview of Private Equity

Private Equity is in many aspects similar to VC. However:● PE funds invest in companies at a later stage, with more stable

free cash flows. ● PE funds look for companies that still have growth opportunities,

which are not exploited by the current management team. ● They acquire a controlling stake in the company, replace the

management team and work together with a new team to increase enterprise value.

● Exit Strategy: corporate acquisition or IPO (Initial Public Offering).

Overview of VCPE in China.

The growth of the VCPE industry in China began with the 2005 reform of the capital market.

Overview of VCPE in China.

The reform enhanced liquidity of the capital market, increasing the viability of exit strategies for VCPE funds.

Overview of VCPE in China.

VCPE funds captured the opportunities offered by the growing importance of SMEs, which were left out of the traditional financial system.

Overview of VCPE in China.

Finally, the third driver of growth in the VCPE industry is the support of local governments, which consider VCPE funds as the right intermediaries to support local business growth.

Shenzhen Capital Group

● Founded in 1999 ● Mission: Bridge the gap between the growing SME in

Shenzhen and the lack of financing resources● Earliest domestic private equity firms in China● Specialized in Government-backed fund (GBF)● Exit channels: public listing or M&A

Government-backed Funds (GBFs)

Successful Example of GBF

● Hailu Heavy Industry Company

o Produce energy-saving and environment protection equipmento Primary focus: water-heat boiler, nuclear container and larger size pressure vessel

Successful Example of GBF (continued)

Motivation for Hailu to join Suzhou GBF● SCGC is experienced in listing companies● Close relationship with local government● Take advantages of the network with shareholders of

the Fund● SCGC has specialist and research team in boiler

industry

Successful Example of GBF (continued)

● Suzhou Fund invested RMB 6.72M in Hailu in exchange for 3% common stock

● By 2010, the Fund had an unrealized return of 16.8 times

Corporate Expansion Problems

● Horizontal Expansion (new geographies) vs Vertical Expansion (existing geographies)?● SCGC already established funds in many of the economically developed, high-potential cities and regions.

○ Some funds in central China found it difficult to identify good deals and good candidates.○ larger network would further pressure on the already-stretched management team at headquarters.

● Diminishing Marginal Returns○ Quantity over quality leads to higher cost and lower benefits.

Source: (Cumming and MacIntosh, 2001; Giot and Schwienbacher, 2007; Cumming and Johan, 2010).

Macro- Special Economic Zones (SEZ)

Special Economic Zone (i.e Shenzhen): 1) increases per capita foreign direct investment (FDI) by 58%, mainly in the form of foreign-invested and export-oriented industrial enterprises2) does not crowd out domestic investment and domestically owned capital stock3) increases total factor productivity growth rate by 0.6 percentage points.SEZs, and many other nations being from Asia to Latin America, Europe and Africa have turned to SEZs to attract foreign capital, boost exports, create jobs, stimulate industry and improve upon existing infrastructure.Source: The Economic Impact of Special Economic Zones: Evidence from Chinese Municipalities, Jin Wang Source: World Development Report 2009: Reshaping Economic

Geography

Regional Distribution (SEZ) - High Growth

Source: 2011 SCGC Company NewsSource: University of Texas Libraries

Free Trade Zones (FTZ) - Financial Centers

● Increase China’s competitiveness in global trade, transport and shipping, insurance and financial services

● Offshore RMB Market and Internationalization.

● The FTZ give quotas to foreign institutions to participate in the domestic market financial products as well as allow participation of domestic financial institutions to transact overseas products

● Offshore RMB market to be develop in the FTZ to support the increasing use of RMB. China’s regulators will promote financial institutions in the FTZ to issue RMB-denominated financial instruments

Recommendation: Vertical Expansion

● Stock market has been a key financial channel for industrial upgrading through IPO issues of new industrial and technological focused companies in solar and wind, industrial 4.0, automation and robotics – providing financing for a changing industrial structure of the economy that highlights its strategic role of Chinese stock market in Chinese economy

o Jin and Zhong (2013), “An Empirical Study on the Effect of China’s Stock Market Financing on Regional Industrial Structure Upgrading – Base on a Dynamic Panel”

Vertical Expansion - IPOs

China’s Stock Market is also instrumental in financing the economictransition which is driven by innovative small-and-medium size enterprises

Vertical Expansion - IPOs

Source: Company Files

50% increase

Vertical Expansion - Investment Allocation

Source: 2010 SCGC Company News

● Focus investments in Advanced Manufacturing, Energy/clean technology, and consumer products

● +2% / +5% Energy● -2% / 0% ChemE● -3% / -4% IT/Chip● +6% / +3% Adv Man.● -3% / -5% Biomed● 0% / +2% Consum.

Vertical Expansion - PE/Industry Trends

● More Venture Capital investments in Consumer products, Manufacturing, and Energy/Environment (Solar) to adjust to economic trends.

● Increase investments in Pre-IPO funds and M&A transactions with existing industries in existing geographies.

● Develop Private Equity component to introduce R&D, leadership, and financial modeling to slow-growth and high-growth companies.

A Centralized Platform for Fund Management

SCGC is very centralized- HQ <-> all local offices- HQ reviews all potential deals and made

investment decisions- Postdoctoral investment R&D

- HQ controls HR- develops investment talents, handles local training

Problem: Centralization

Problem:- Strict centralization inhibits effectiveness.

- Slow response/approval times for technical/operational/non-strategic decisions.

- Distorted compensation structure does not promote intra-company competitiveness.

Problem: Centralization

Recommendation:- Set up regional HQs to manage different areas

- Main HQ still decide high-stakes issues: e.g. hiring regional heads, large investments.

- Compensation to be managed by regional HQs, to better reflect individual fund performance

Problem: CentralizationRegional HQs:- Xiangji

- 9 GBF- 1 subs

- Anhui- 9 GBF- 1 subs

- Hebei- 8 GBF- 2 subs

- Sichuan- 3+1 GBF- 2 subs

Final Recommendation

● Vertical Expansiono Special Economic Zones and Free Trade Zoneso Pre-IPO and Investment Allocationso Private Equity development

● Decentralize● GBF focus

Finance & Banking Consulting