China’s year-old IPO closure ratchets pressure

The mainland’s IPO market has now been closed for one year, impacting the performance and fundraising of many GPs, according to speakers at PEI’s recent CFO & COO Seminar.

China’s IPO market has been shut for a year, with no official date set to re-open, increasing the pressure on GPs to demonstrate liquidity, the audience heard at PEI’s Private Fund CFO & COO Seminar 2013 in Hong Kong.

IPOs were frozen in late October last year to allow regulators time to work on reforming the listing process.

Filippo Huang, chief financial officer of Shanghai-based venture capital firm Gobi Investments, said venture firms in China are feeling the pressure to divest and some GPs will be hit on fund performance and fundraising.

If a firm’s past fund has a distribution to paid-in capital ratio below 50 percent, be prepared to answer questions from LPs, Huang said.

“When you go to raise a new fund with a DPI below 50 percent, LPs will ask where the money is that they invested in the previous fund.”

Huang added that the lack of exits makes it even more prudent to raise a fund to a properly determined size. “If you want, for example, a $100 million early-stage fund and get oversubscribed to $150 million, [as CFO] you should persuade the GP to resist the temptation to do a bigger fund.”

“If you stick to the original fund size, you have more bargaining power to get more favorable terms with potential LPs, and experienced LPs will respect you for limiting the amount to the target size,” he said.

On the upside, he sees domestic M&A trending up.

“We have seen a lot of trade sales and acquisition deals. Many CFOs in China are sensitive to the M&A that’s happening and are seeking ways to talk to potential acquirers.”

He mentioned the $420 million acquisition of video streaming company PPTV by appliance maker Suning and Hony Capital, which closed earlier this week. He believes it represents a broader M&A trend of Chinese companies moving sales from offline to online, opening opportunity for venture firms, which tend to invest in early stage companies in the internet sector.

The domestic markets respond favorably to strategic acquisitions, with the stock price of corporate acquirers often spiking on news of such a transaction, Huang said.

Melissa Obegi, Asia general counsel for Bain Capital Asia, added that the liquidity issue for LPs was “tremendously important” and GPs need to be able to demonstrate on-time exits during the lifecycle of a fund.

However, her firm identifies several types of exits – including sales to strategic buyers, listings on other exchanges and dividend recaps – when it initially assesses the deal.

“We tend to take control stakes, and we can underwrite the investment to have a variety of potential exits, so we don’t have portfolio companies solely dependent on an IPO exit in China. That’s how we’ve managed this particular issue,” Obegi said.