Funding issues

However, China's PE and VC industry is often confronted by many challenges. One of the biggest challenges for its development is fundraising.

Liang Xinjun, the CEO of Fosun Group, believes that though it is the right time to invest, limited partners are increasingly jittery in making commitments due to the market downturn.

"Some fund managers believe that investments should be conducted in a more discreet and conservative way. But from the angle of value investment, I think the current situation is an opportune time for investors to find good programs at relatively cheaper prices," Liang says.

Another challenge lies in the somewhat blocked exit channels for PE and VC investors. So far, China has 7,908 private equity investments totaling $104 billion, in which investors have to find exit options through other routes than the traditional public offerings, says a recent study conducted by China First Capital, an American-owned international investment bank focused in China.

A report released by Zero2IPO Research Center in December says that the number of Chinese companies that were listed was just 201 in 2012, while the funds raised by these companies declined 57.2 percent to $26.3 billion compared with $61.5 billion in 2011.

The number of Chinese companies that went public in overseas markets in 2012 was just 47, compared with 75 in 2011, while the funds raised by these companies fell to $9.8 billion from $17.8 billion in 2011, a drop of 44.9 percent year on year.

Apart from the weak global economic conditions that persisted for most of last year, the investment climate also took a severe hit following reports of financial and accounting irregularities at several US-listed Chinese companies.

The rampant short-selling that followed saw several companies defer listing plans. Only two Chinese companies launched IPOs in the US market in 2012, for a total financing of $153 million, a decline of 90 percent year-on-year, says a China Venture report released in December.

"There are 808 companies waiting to go public in China," says Liu from Fortune Capital. "Due to the grim stock market outlook, the return on investment ratio is not as high as before. And the way things are, it is likely that it will take at least another two to three years for all these companies to get listed. It is important that PE and VC investors should diversify their exit channels to mitigate potential losses and focus more on the M&A route as an alternative exit strategy."

Some companies have already made a start in this direction and more are expected to do so this year. Last year, PE and VC firms used the M&A route as an exit option in 144 deals, the highest since 2006, says a report released by China Venture Investment Consulting Ltd on Jan 5.

The report also says that the number and value of M&A deals completed by Chinese companies has been rising steadily in the past five years.

In number terms, only 3,555 M&A deals were completed last year, a 23 percent decline over 2011. However, the deal value increased by 37 percent to $307.8 billion during the same period, the highest in six years.

Among industries, manufacturing, energy (including mining) and finance had the greatest number of M&A deals.

"Many high-quality assets have become relatively cheaper in the US and Europe due to the economic slowdown. Chinese companies have been very active in the M&A market and have pursued many large deals since 2011," says Qiu Bochun, a lawyer at the US-based law firm Cooley.

When conducting M&A deals overseas, private companies often require funds but face obstacles in getting them through normal financial channels like banks. PE and VC companies are often the white knights that rescue these firms and help them through the troubled initial years, says the ChinaVenture report.

Qiu, who has lived in US for about eight years and once worked for three years at Innovation Works, a Beijing-based incubation service provider and venture capital fund for technology startups, points out that Chinese companies need to be more cautious when they go abroad.

"Because of the different cultural and investment environments in different nations, M&As in overseas markets are often complex. To make the M&A deals successful, the companies must know more about local markets, their laws and the business environment, and also seek advice from PE and VC companies," Qiu says.

Hugo Shong, founding general partner of IDG Capital Partners, says that foreign PE and VC companies like his, which have rich international connections, can provide more value-added services, such as guidance in terms of brand building, especially when the companies are planning overseas expansion.

"This is helpful since a lot of Chinese companies often face barriers in overseas expansion due to lack of contacts and knowledge," says Shong, one of the pioneers of the PE and VC industry in China.