Legend Capital, founded in 2001, is the independent venture capital investment subsidiary of Legend Holdings. It is therefore a sister company of Banque Internationale à Luxembourg, with which it develops joint projects. Like the Bil Private Equity fund, which launched in 2019 and has so far achieved an internal rate of return of 14% net per annum, "despite the covid crisis", as Florent Saint-Quentin, head of alternative & innovative solutions at Bil, explains.
The European investor who wants to invest in private equity in China has some benchmarks. "Basically, this asset class is similar in its foundations to what exists in the West: it is about investing in private companies before they are listed on the stock exchange. Private equity was imported from the US in the mid-1990s," says Wang, who does however point out "certain local peculiarities". Such as the fact that most investments are minority stakes, "which is different from what happens in Europe, where the activity is mainly about buyouts and takeovers".
Growth financing
Another notable difference is that private companies in China are in the hands of "first generation" entrepreneurs. Venture capital and private equity professionals are therefore more involved in growth deals than in restructuring deals. “In China, these restructuring deals are mainly in the public sector, a sector in which we have little or no involvement.”
Having said that, Wang believes that the culture and practices of the sector are strongly inspired by what happens in Europe and the United States. The same players and the same best practices can be found there as elsewhere in the world. And the same risks.
First and foremost, Wang points to the illiquidity of the asset class, unless one accepts a discount on the secondary market. That illiquidity provides a premium of between 350 and 500 basis points over the public markets.
In China, "a market that still has the characteristics of a developing market and where the predominant asset class in private equity is venture capital", the risk of loss is between 10% and 20%. Legend Capital dilutes this risk by diversifying the holdings in its portfolio for an average net internal rate of return of 20% per annum.
Appreciating the regulatory risk
When it comes to risk in China, the one that is in the news is regulatory risk.
It is a risk that Wang contextualises. “I think that each region, each country has its own regulatory particularities. As a foreign investor, it is important to use local partners who are rooted in the system. Coming back to the situation in China, when I see the reactions of the outside world to the various regulations and their evolution, criticising a lack of transparency, I say to myself that we have not done a good job of explaining and communicating to foreign investors the meaning of these regulations.
“For me, regulatory risk is everywhere. We have invested in the US in the past and for us the regulatory risk there was very high, mainly because we don't understand all the issues there and the government and political structures are different. In China, regulations are predictable, announced in advance in five-year plans and implemented. Everything after that is a matter of interpretation and analysis. It seems clear to me that in China, as anywhere else, if you want to be on the right side of the law and do things according to the regulations in place, you won't take risks.”
Financing innovation is fascinating.
The choice of investment sectors is also important to Wang, who favours innovation, whether technological or disruptive, and the IT and healthcare sectors. These are young and innovative sectors in the Chinese economy where traditional sources of finance such as banks are less available. "That's where we can have a role and that's also why we can secure higher returns."
"Financing innovation is fascinating. The state has aid and subsidy programmes in place, but they come in at a very early stage. We come in later, usually at the time of the first fundraising."
What about the return? "It varies according to the time of entry and the sector of activity. For an early investment with a high risk, as is the case for innovation and technology, you can expect a return of up to five times your investment. For a more mature company, and therefore the visibility until the IPO is clearer, the multiple will be three compared to two in general in Europe for similar cases."
Appetising ranges.
Originally published in French by and translated for Delano