New Restrictions Choke Off Chinese Venture Capital Investment

by Mary Swire, Tax-News.com, Hong Kong

12 May 2005

Investment into China by global venture capital funds has slowed in the first quarter after Beijing introduced new restrictions strengthening its supervision of cross-border money flows in order to address fraud and tax evasion.

According to notices issued in January and April, Chinese residents must obtain approval from the State Administration of Foreign Exchange before starting or investing in an offshore firm. Foreign investors must now register and obtain foreign exchange approval before taking equity in a Chinese domestic enterprise prior to an offshore restructuring.

Coinciding with the new restrictions, the venture capital industry has noted a marked slowdown in investment into China during 2005: Investment into China by venture capital funds fell by 31% to $552.6 million in the first quarter from a year earlier as the number of announced private equity deals in China in the first quarter fell to 19, compared with 31 during the same period last year, according to the Asian Venture Capital Journal.

Chinese entrepreneurs and international venture capital funds have reorganized their businesses offshore because the local regulations do not recognize different classes of shares and restrict the sale and public trading of equity held by founding stockholders.

Under a typical offshore reorganization, Chinese entrepreneurs swap equity between a local business and an offshore holding company allowing them to issue additional shares in offshore jurisdictions to international investors.

The regulations will for the first time track cross-border capital flows and control the transfer of Chinese assets from domestic to offshore companies, including those in the Cayman Islands and British Virgin Islands, where many of the Chinese companies listed in Hong Kong and the United States have headquarters.

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