Lunar Capital | 2016-09-30
During our most recent Annual General Meeting, Lunar Capital Partner Robin Song led a group of investors to meet with the Chinese Association of Small-Medium Sized Enterprises (CASME) in Beijing to learn how public and private financing is helping small-medium sized enterprises move up the value chain to become listed enterprises on China’s domestic stock exchanges. SMEs in China possess local products and services, innovation and new technologies, but require investment capital to monetize their competitive advantages, modernize management, gain capital markets expertise and – perhaps most importantly – deliver a solution to succession issues. More than 11 million of these enterprises lie within Lunar’s target revenue and EV scale.
As China's moves towards a “new normal”, it is evident that the capital markets and investment industry will also need to continue to evolve in parallel. Over years of engaging with local entrepreneurs and domestic financing channels, we have observed firsthand that needs are shifting - entrepreneurs are now eager to source capital from those capable of “driving the vehicle” and are reluctant to take on “pure speculative investors” who simply want to go along for the ride. Similarly, domestic investors are taking a much more professional and stringent approach towards allocating capital and are no longer chasing “miracles”. Local authorities have noted these trends, and understand that more robust capital structures will help relieve economic pressures on businesses and their communities.
From the visits with CASME and discussions with regulators, it is clear that this form of economic development can be divided into two overlapping “triangles”. The first encompasses industry, the market and resources. The type of industry is driven by the characteristics of a specific region, its marketplaces, and its native resources. The second triangle is made up of the enterprise or business, its city and the relevant government agencies. Business is the central theme of the second triangle, the city its carrier, and government supports and facilitates commerce. These two triangles can be summarized in a simple statement - “Government should follow market-oriented principles, leveraging the city to organize and mobilize resources, to cultivate leading enterprises in a specific region to develop comparative advantages”. Professional investment management firms or financial institutions can accelerate the development of these SMEs, through the combination of industry acumen and finance prowess.
In modern China, all levels of government are faced with the challenge of ensuring that their local SMEs’ balance sheets are strong, or well financed. Weaker enterprises should be left to fail or simply fade-out, with minimal intervention from the government, which should focus on supporting enterprises with the potential to create products and services demanded by consumers. These enterprises can in turn create jobs and generate stronger tax proceeds in the future. Additionally, government should no longer solely allocate capital to SOEs, but rather promote state-owned and private capital investing in privately run businesses with potential to become domestic champions. Government and policy should encourage state-owned capital to invest in private enterprises through investment fund vehicles such as fund of funds, to help develop these enterprises and to introduce operational best practices. Government can act as a leader in establishing links between urban and industrial development, and strengthen tax incentives and subsidies for private business and investors. Tax relief programs for professional investment managers (such as private equity firms like Lunar Capital) can encourage private investments and stimulate economic activity at China’s current stage of development.
Robin Song, Partner, Lunar Capital