China Venture Capitalist Confidence Index

(Bloomberg ticker symbol: CVCCI) First Quarter 2012

(Release date: April 26, 2012)

Mark V. Cannice, Ph.D. Ling Ding, MBA The quarterly China Venture Capitalist Confidence Index (Bloomberg ticker symbol: CVCCI) is based on an on-going survey of Mainland China and Hong Kong venture capitalists. The China VC Index measures and reports the opinions of China-based professional venture capitalists in their estimation of the high-growth venture entrepreneurial environment in China over the next 6 - 18 months. In publishing a recurring confidence index of China-based venture capital investors, we intend to utilize the local knowledge and insight of our respondents to provide an essential perspective and an on-going leading indicator of the dynamic Chinese entrepreneurial business environment. Furthermore, by tracking what local venture investors project about the high-growth venture environment rather than what has already occurred in terms of capital flows, we aim to provide actionable insight for all market participants. The China Venture Capitalist Confidence Index for the first quarter of 2012, based on a March 2012 survey of nine Mainland China and Hong Kong venture capitalists, registered 3.56 on a 5-point scale (with 5 indicating high confidence and 1 indicating low confidence). This quarters reading bounced back from the historic low point recorded in Q4 2011, marking a 15% increase in confidence level over the previous quarter. The increase ended the longest downward period in our Indexs history and could signal a turning point in venture capitalists sentiment. Please see Graph 1 for trend data.
Gr aph 1 Tr end l i ne of Chi na Vent ur e Capi t al i s t s Conf i denc e ov er r ec ent 28 quar t er s
5. 00

4. 50
Conf i denc e I ndex

4. 00

3. 50

3. 00

2. 50
Q3 20 Q 06 4 Q1 20 Q 07 4 Q1 Q2 Q3 20 Q 08 4 Q1 Q2 Q3 20 Q 09 4 Q1 Q2 Q3 20 Q 10 4 Q1 Q2 Q3 20 Q 11 4 Q1 Q2 Q3 20 Q 12 4 Q1 20 05 Q2 Q2 Q3

Ti me

As the global economy continues to recover, venture capitalists showed more confidence in the future high-growth entrepreneurial environment in China. With concerns over the European debt crisis easing somewhat and U.S. companies reporting stronger earnings, global stock markets warmed up and paved the way for more IPO events. According to a recent report from Dow Jones Venture Sources, 20 companies, including Yelp and Brightcove, completed their IPOs and raised $1.4 billion, making the first quarter of 2012 the most active quarter for IPOs since Q4 of 2007.1 As a result, Lucas Wang of WI Harper Group asserted that the successful IPOs of major US Internet start-ups will bring up the heat again. And, it is about time for early Internet domestic companies to get ready for IPOs which will help them acquire external growth More M&A exits can be expected and those will inspire more start-ups. Chinese entrepreneurial activities remained at a high level and sufficient venture capital is available for qualified deals. Two participating venture capitalists who provided their comments in confidence indicated that they continued to observe strong deal flows. Additionally, another venture capitalist who requested anonymity shared that despite continuing issues with exits and excessive valuations, there is still significant fund capacity available in China. Maturing Chinese entrepreneurial talent supported venture capitalists optimism. After more than a generation of entrepreneurial efforts, Chinese entrepreneurs are better able to apply their experiences and insights to new ventures. In addition to greater knowledge in building successful enterprises, entrepreneurs have become aware of what they should look for from venture capitalists. For example, Johannes Schoeter of Victoria Capital Limited indicated that an increasing number of entrepreneurs learned that undisciplined and unprofessional capital cannot add the value which they need. Despite all the positive signs showing that the venture capital market will warm up in China, some venture capitalists remain conservative due to uncertainty in the political system and the economic growth outlook. Tony Luh of DFJ Dragon Fund China stated that there are uncertainties in the transitioning of power at the top level of the communist party here in China. These uncertainties will likely continue through the fall or even through the end of this year. At the same time, Marvin Lai of iTM Ventures Limited was concerned that the China GDP forecast for 2012 has been lowered to 7.5% and that signifies the potential slowdown of the Chinese economy this year. In addition to the above participating VCs concerns, two main issues discussed in our previous report, increasing difficulties in the venture exit channel and decreasing investment returns, continued to weigh on venture fund raising and venture investment.2 According to Zero2IPO, venture fund raising dramatically shrank from $6.93 billion in fourth quarter of 2011 to $957.66 million in Q1 2012, recording a decline of 86%.3 The difficulties in raising funds caused venture capitalists to become more cautious in investment. As a result, start-ups only received $865 million
1

Dow Jones: Q1 2012 Most Active IPO Quarter Since 2007, Source: Dow Jones Venture Source, April 2, 2012, http://www.redherring.com/finance/dow-jones-q1-2012-most-active-ipo-quarter-since-2007/ 2 China Venture Capitalist Confidence Index Fourth Quarter, 2011, by Mark Cannice and Ling Ding, February 17, 2012 3 VC 9.58 2009 , Source: Zero2IPO, April 5, 2012, http://research.pedaily.cn/201204/20120405323705.shtml

in VC funding in the past quarter, a 70% drop from $2.93 billion in the preceding quarter, recording the lowest point in two years.4 The disappointing IPO market has clearly discouraged venture capital fund raising and investment. China Ventures recent research indicated that the number of venture-backed IPO events in global markets dropped five quarters in a row.5 In Chinas domestic stock market, stricter regulations made it harder for start-ups to go public. During the first quarter of 2012, 81 companies applied for IPO, only 80% of which were approved.6 Moreover, the new 2012 version of Growth Enterprise Market regulation will become effective on May 1st. The revised regulation will force public companies to withdraw from the stock market if the listed companies have negative net asset for two years due to retroactive accounting adjustments cased by accounting errors or fraud, are censured by the stock exchange three times during the recent 36 months, or have market prices lower than the par value of their stocks.7 At the same time, investors in the US stock market remained cautious in investing in Chinese companies due to lack of financial transparency of some of the Chinese IPO events. For example, after reducing the planned amount of total fund raising several times, Vipshop Holdings Limited finally became the first Chinese firm to go IPO in US since August, 2011.8 According to Yahoo! Finance, the stock price declined from an initial offering price of $5.5 to $4.26 during the first 10 days. The declining investment returns also deterred venture capitalists. As of April 10th, 195 companies listed on Growth Enterprise Market reported 2011 earnings, 48 of which experienced decreased profit.9 The disappointing performance of Growth Enterprise Market led to lower investment returns. According to Jiangsu Economy News, VC/PE investment return recorded as low as 4.61 during the first quarter of 2012.10 In summary, as venture capital exiting activities remain difficult and investment returns continued to shrink, venture capital fund raising and investment cooled off during the first quarter of 2012. Furthermore, upcoming changes in the political system and slowing economic growth have caused some venture capitalists to delay investments. The majority of our participating VCs, however, remain optimistic about the entrepreneurial environment in China over the next six to eighteen months. Even though China lowered its 2012 GDP forecast to 7.5%, data from Chinese government showed that Chinas economy expanded at an annual rate of 8.1% in first quarter of
4

VC 9.58 2009 , Source: Zero2IPO, April 5, 2012, http://research.pedaily.cn/201204/20120405323705.shtml 5 IPO 5 , by Isaac Wang, Source: ChinaVenture, April 1, 2012, http://report.chinaventure.com.cn/r/f/521.aspx 6 81 IPO 65 80%, by Limei Yan, Source: Yangcheng Evening News, April 5, 2012, http://news.chinaventure.com.cn/2/20120405/81659.shtml 7 5 1 , Source: China Securities Journal, April 20, 2012, http://news.chinaventure.com.cn/2/20120420/83560.shtml 8 IPO 5 , by Isaac Wang, Source: ChinaVenture, April 1, 2012, http://report.chinaventure.com.cn/r/f/521.aspx 9 , by Jieyun Peng, Source: First Financial News, April 11, 2012, http://news.chinaventure.com.cn/2/20120411/82498.shtml 10 VC/PE 4.61 IPO , by Xiyan Zhu, Source: Jiangsu Eonomy News, April 12, 2012, http://news.chinaventure.com.cn/2/20120412/82654.shtml

2012.11 In addition, the slow recovery of the global economy, the strong performance of the U.S. stock market during the first quarter, the maturing of Chinas entrepreneurial talent, the large pool of venture capital ready for investment, and the enthusiasm of local entrepreneurs and venture capitalists all contribute to increasing venture capitalists confidence in the future entrepreneurial environment in China.

Table 1

Participating China-based Venture Capitalists in the 2012 1st Quarter Confidence Index Survey

Alan Song Alicia Eastman Johannes Schoeter Lucas Wang Marvin Lai Max Burger Michael Scown Tony Luh Anonymous

Soft Bank China Venture Capital Asia Pacific Capital Victoria Capital Limited WI Harper Group iTM Ventures Limited Golien Ltd Intel Capital, Asia Pacific DFJ Dragon Fund China Anonymous

Mark V. Cannice, Ph.D. is Professor of Entrepreneurship and Innovation with the University of San Francisco School of Management (Cannice@usfca.edu). He has also been a Visiting Associate Professor with Peking Universitys Beijing International MBA Program and the Hong Kong University of Science and Technology Business School. an MBA from the University of San Francisco. Ling Ding holds The authors wish to thank the participating venture capitalists who

generously provided their expert analysis and commentary. Thanks also to Jack Cannice for his copy-edit assistance. When citing the Index, please refer to it as: The China Venture Capitalist Confidence Index, and include the associated Quarter/Year, and the full names of the authors. Copyright 2005 2012: Mark V. Cannice, Ph.D. All rights reserved.

11

GDP 8.1%, Source: Sohu.com; April 13, 2012, http://money.sohu.com/20120413/n340445737.shtml