Legal framework for the development of venture capital in China: Policy recomendations for the establishment of a Growth Enterprise Market ('GEM')

Experimentation with Venture capital (VC) investment into high growth companies in China began in the 1990's. The past few years have seen rapid growth of foreign venture capital investment into Chinese-founded companies that are incorporated offshore (mostly in the Cayman Islands), operated in China, and listed in Hong Kong or on the NASDAQ. However, legal and institutional developments have lagged behind. This dissertation summarizes and evaluates the development of venture capital practice in China to date. It explains how China's recently developed "off-shore" system operates despite existing legal obstacles, compares China's VC system to China's banking system and government guaranteed loan program, and identifies ways to improve the relevant legal and institutional framework necessary for the growth of VC investment into China. By examining scholarly literature on the importance of a stock market as an exit mechanism for venture capital, this paper compares and analyzes Israel's experiences and China's current practice of piggybacking on institutions of the U.S. and other countries. This comparative analysis of the piggybacking or off-shore model reveals that this model does work to a certain extent but would not be scalable as a long term strategy for China, because China's vast domestic market demands home-grown or transplanted institutions. This dissertation concludes with a policy recommendation that China should consider opening a NASDAQ type Growth Enterprise Market (GEM). A GEM could contribute to the further development of China's venture capital financing via improved accounting standards, increased leveraging on imported professional services, and establishment of a specialized court to improve corporate governance and capital market regulations.