This book is, to my knowledge, the first major enquiry of a scholar in English language into the Chinese venture capital market, and is structured in five parts. Part 1 introduces the Chinese environment for venture capital investments, after which Parts 2 to 4 deal with the following three stages of venture capital investing: fundraising for a venture capital fund (pp. 44–143); investing, that is, identifying and analysing target investments (pp. 143–213); and exit, namely the legal environment under which stakes in target investments are sold (pp. 213–304). Finally, Part 5 briefly summarises and synthesises the main lessons learned from this substantial enquiry (pp. 305–22).
The book draws on Ronald Gilson's seminal thesis, which coined the “simultaneity problem”. According to Gilson, the development of a mature venture capital market simultaneously requires: investment capital; specialised financial intermediaries as the “nexus of a set of sophisticated contracts” that are willing to bear the risk arising from venture capital investments; and entrepreneurs willing to start venture businesses (Ronald J. Gilson, “Engineering a Venture Capital Market: Lessons from the American Experience” (2003) 55 Stanford LR 1068). Up until Lin Lin's book was published, some commentators had held that only the US economy had been truly successful in establishing these three pillars of a viable venture capital market, prompting provocative statements about the “singularity” of the US economy.
In meticulous detail, the book enlightens readers that China has created, in quite a short period of time, the world's second largest venture capital market, prompted by a government-led development programme initiated in 1985 (p. 8). Furthermore, the author lays out the regulatory and economic circumstances under which this extraordinary development took place and draws general conclusions as to how countries around the world could advance their own venture capital markets through state involvement and institutional reforms, based on the Chinese experience. In the context of the existing debate surrounding venture capital research, Lin Lin challenges, in a sophisticated manner and relying on an abundance of data, the singularity thesis.
The author is far from blind to the differences between the Chinese and US economies. The Chinese venture capital environment is less driven by truly institutional investors; instead, contributing some 40 per cent of the overall investment volume in various forms, the Chinese public sector assumes a highly active role as an investor. On top of that comes an emerging class of high-net-worth individuals (HNWIs) who, albeit inputting a small volume overall, are playing an increasing role in the venture capital market (p. 68). At the same time, the author takes great care in showing that legal institutions in China are mimicking US institutions and argues that this has facilitated the development of the Chinese venture capital markets; in particular, Lin Lin stresses the importance of the introduction of the limited partnership as the preferred legal form of US venture capital funds (pp. 47ff.) as well as the enhancement of minority rights, which is crucial to convincingly mimic US-style venture capital investment contracts (pp. 148ff.). The last aspect which the author sees as being among the most crucial legal and economic preconditions for the development of the Chinese venture capital markets is the country's booming stock markets that provide a liquid exit opportunity (pp. 218–81). The secondary market (discussed as exit via M&A, pp. 281–89), however, is less developed owing, according to the author, to restrictions on leveraged buy-outs (for which convertible preferred stocks are crucial), and bankruptcy laws are in their infancy, hence it is not guaranteed that unsuccessful entrepreneurs will have the opportunity of starting over afresh.
At first glance, the conclusions of this book are indeed puzzling. The author argues that the Chinese venture capital market developed under unlikely preconditions: underdeveloped legal institutions paired with underdeveloped financial markets (pp. 305–06). Both conditions together, from a traditional perspective, would render the provision of capital unlikely in the first place, thus removing one of the three preconditions of Gilson's simultaneity paradigm.
Lin Lin, a lawyer by profession, does not claim that existing law and finance literature is simply wrong. Rather, she states that the Chinese venture capital market's development was facilitated by constant reforms in the fields of company and financial law, resulting in improved conditions when compared to the pre-1985 period (pp. 307–08). In particular, minority rights were strengthened and state interference in financial markets has been gradually reduced, thus lowering the potential for rent-seeking and insider trading. At the same time, the Chinese Government, to spur economic activity, introduced a liberalisation agenda with the following consequences: (1) starting and doing business became less burdensome; (2) capital investments into businesses were encouraged through tax incentives and public co-investments; and (3) licensing as intermediaries became easier and more predictable, paired with the introduction of the limited partnership as the archetypal form of the US-style venture capital fund (pp. 309–10). These developments, together, signalled, according to Lin Lin, a shift from the interventionist communist model towards a more market-led venture capital market. In order to achieve a well-working venture capital market, the author implicitly argues that fully-developed, independent, Western-style court institutions are dispensable; and that the presence of some legal institutions and establishing legal certainty through other means is sufficient.
The book raises a number of questions which may be addressed in future research. The first question relates to the type of business being funded. The author understands venture capital in a broad sense, including for the most part all unlisted firms. The law and finance literature, however, usually focuses on new, highly innovative, high-risk businesses. On the contrary, some countries’ economy is driven by successful, more established entrepreneurs often held in a long-standing family tradition, as is characteristic, for instance, in the German Mittelstand; investments in these Mittelstand firms are, in relative terms, of a lower risk by their nature, and in turn yield a lesser return than what US venture capital investors are used to. While the author lists certain sectors in which funded businesses operate (p. 2), future research may benefit from looking into the age of the businesses funded by Chinese venture capital funds and delineating what is commonly referred to as mezzanine or bridge financing. Doing so would clarify whether the Chinese market is truly “risk-driven” and is a bona fide venture capital market or whether the book deals with sectors usually attributed to private equity.
The second question, which is linked to the first, relates to the returns of a venture capital investment in China. The core issue of venture capital investment is the prevalence of social returns over private returns; that is, society benefits to a greater extent from newly-established businesses than private investors do, as the latter often receive lower risk-adjusted returns than what they could have earned by investing in private equity or through liquid investments in stock markets. Future research should focus on the risk-return profile in the Chinese market. This could reveal one of two realities: either the risk-return profile is very advantageous for investors, which could signal overconfidence in the Chinese stock markets – this explanation is in line with the less developed secondary market as institutional capital may be less patient than Chinese public stock markets these days; or the risk-return profile is disadvantageous for investors, which could signal (overly) patient capital at the venture stage. Should the latter be true, this could be explained by the strong presence of the public sector in the Chinese venture capital market.
The third question relates to the institutional preconditions for a successful venture capital market. As such, the author posits, as a counter point to the market-driven US venture capital model, a government-led Chinese venture capital model. Naturally, the latter at least seems to be much easier to copy for other countries. But is it truly so easy to do so? The author argues that the reforms undertaken between 1985 and the present represented a step away from government intervention in the direction of free market operations. Refraining from government intervention is presented as an important building block for venture capital markets (p. 310). Lin argues this in the context of Stiglitz's thesis on the right balance between free market forces and government intervention, noting that at an early stage government intervention is necessary where legal and financial institutions are immature, but that once a certain degree of institutional maturity is reached, the tide shall tip towards free markets (p. 311). The author also argues that during the period observed, namely somewhere between 1985 and today, Chinese institutional maturity bypassed the point where government intervention was beneficial and entered the stage where free markets would yield greater benefits. Lin Lin identifies the tipping point being at around the year 2010, when after 20 years of beneficial state influence, China had achieved a state where legal and regulatory infrastructure allowed market forces to function effectively (p. 312). Whether these statements hold true will depend on the extent to which the Chinese economy is truly a “free market” in that sense – providing a definitive answer on that particular question is beyond the scope of this book review.
The fourth question relates to the type of government interference observable in China. The author presents as an example of excessive state interference some rules governing the distribution of fund units aiming at preventing the solicitation of funds from unaccredited investors, fraudulent fundraising more generally, as well as asset misappropriation. Lin Lin does not question the legislative intention as such, rather she is critical towards state interference at large: involvement of administrative agencies in structuring and allocating capital (p. 312) potentially raises corruption and insider trading. Finding the right balance between state involvement as effective anti-fraud measure and state involvement as barrier to market efficiency is a challenge many, if not all, emerging economies face.
The fifth question relates to the importance of clusters. The author highlights the development of different clusters with different focuses. While some clusters, such as Beijing's Zhongguancun Park, are science-based, the Hangzhou cluster is dominated by Alibaba's operations resulting in multiple spin-offs and service providers contributing to the Alibaba platform (pp. 310–11). While clusters have been identified as important for knowledge generation and sharing, and for the development of expertise in sophisticated technology and science sectors, ascertaining specifically what drives successful cluster development is key to understanding how to establish successful venture capital markets.
The unwritten thesis in Lin's book is a story of local optima: perhaps not every country in the world requires the same degree of institutional maturity? This connects the book to a much larger debate in institutional economics and law: to what extent can non-legal institutions supplement formal or legal ones? Of course, the book, which focuses on Chinese venture capital, cannot answer this broad question, yet it may be an aspect worthy of closer consideration in future debates.
Ultimately, the book offers substantial knowledge previously not available to a learned audience and is to be recommended to anyone interested in venture capital markets and their legal and economic preconditions.
