Private Equity in China – Process, Opportunities and Challenges

China is now the second-largest PE market in the world and has expanded significantly in recent years

Author: Alisa Zhu
Alisa Zhu
Alisa Zhu
I am an undergraduate student at WFU, majoring in finance and philosophy. I have experience with investment banks both in the North America and APAC. I try to bring a unique blend of practical insights and theoretical understanding to the field.
Reviewed By: Patrick Curtis
Patrick Curtis
Patrick Curtis
Private Equity | Investment Banking

Prior to becoming our CEO & Founder at Wall Street Oasis, Patrick spent three years as a Private Equity Associate for Tailwind Capital in New York and two years as an Investment Banking Analyst at Rothschild.

Patrick has an MBA in Entrepreneurial Management from The Wharton School and a BA in Economics from Williams College.

Last Updated:October 7, 2023

What Is Private Equity In China?

When talking about private equity (PE) investments in Asia, the place people think of first is the People’s Republic of China. Currently, China is the most popular and active investing hotspot in Asia.

China is now the second-largest PE market in the world and has expanded significantly in recent years - and it is expected to continue to grow in the coming years.

China’s PE market is expanding for the following reasons:

1. Growing wealth and economic development

The increase in disposable income and the growth of the middle class in recent years have increased demand for investment opportunities, which means there are more opportunities in the PE market.

2. Government support

The Chinese government is supportive. It has shown support for developing the PE industry as part of its efforts to encourage innovation, entrepreneurship, and the expansion of the domestic capital market.

The Chinese government has loosened regulations and policies for PE investments, which makes it easier for PE firms to raise capital and make investments.

3. Globalization

China has been actively involved in globalization in recent decades through market liberalization, infrastructure development, and investments in technology and human capital.

Globalization has allowed Chinese PE firms to gain access to international capital, create cross-border deals easily, invest in and acquire international companies, and be more transparent, attracting investors into the market and working in an environment favorable to PE because of increased competition.

Like the United States, PE firms in China are privately owned and operated to generate profits for their investors and other relevant stakeholders. They raise capital from institutional investors, high-net-worth individuals, and other PE firms.

PE firms in China also target companies with the potential for growth and improvement and can provide those target companies with financial resources, strategic guidance, and operations support.

Key Takeaways

  • China is Asia's most popular and active investing hotspot, the second-largest PE market in the world, and has increased significantly in recent years.
  • China’s PE market is expanding because of growing wealth and economic development, government support, and globalization.
  • The advantages of investing in private equity in China have more investment opportunities, possibly enhanced returns, and exposure to high-growth companies and markets.
  • The disadvantages of investing in private equity in China are geopolitics risks, typical high valuations, and cultural clashes in business practice and culture.

Advantages of Investment Activities in the Chinese Private Equity Market

There are countless reasons why more and more investors are looking to China for investment opportunities.

Investing in the Chinese PE market allows for the following advantages to PE funds:

1. More investment opportunities

Private Equity in China is expected to grow further, helped by policy support as the Chinese government recognizes the importance of PE capital for early-stage, small-, and medium-sized as China’s development strategy moves from “made in China” to “invented in China.”

In addition, PE investment contributions are only 0.8% of the gross domestic product (GDP) compared to 1.7% in North America.

This means there is significant growth potential for the PE market as China’s share of global GDP is expected to grow to 30% by 2030, more than the US and Europe.

2. Possible enhanced returns

Investing in Chinese PE markets can add value to a global PE portfolio by diversifying away from developed markets. China has also shown exceeding performances across vintage years compared to the United States and Europe PE’s top quartile funds. 

Note

Vintage years in the context of PE refers to the year in which a fund began making investments - the date when the firm first deployed capital to a particular company and/or project.

3. Exposure to high-growth companies and markets

The Chinese PE market provides investors with high-growth companies at earlier stages of development. This means investors can potentially invest in successful companies before they get an initial public offering (IPO).

China has a quarter of all private companies with valuations above one billion dollars worldwide - only second to the United States. In addition, China now has more Fortune 500 companies than the United States.

Since most Chinese businesses perform business activities within China, investors must invest directly in onshore equities. 

Disadvantages of Investment Activities in the Chinese Private Equity Market

Despite having so many good opportunities and reasons why you should invest in the Chinese PE market as a foreigner, there are some disadvantages you should consider.

Investing in the Chinese PE market has risks, as listed below:

1. Geopolitical risk

If you've read any international news, you presumably already know that trade, competition for technological dominance, the COVID-19 origins, and disagreements over political, social, and religious matters have caused tensions between China and the US, the UK, Australia, and India.

Currently, the Biden administration's a less combative approach than the Trump administration. As a result, most foreign policy analysts do not anticipate seeing a dramatic change in China's relations with the US and most of its allies shortly.

Investors exposed to sensitive industries, such as those handling sensitive personal data or offering goods and services to the Chinese military, might see more negative effects due to the ongoing conflict.

2. High valuations

China has had a strong fundraising environment in recent years, which has caused an increase in “dry powder.”

Note

In the context of PE, dry powder is unspent cash that a firm has on hand but is yet to be allocated to a specific investment by managers.

Having dry powder is good sometimes because it is a cash reserve for companies to use and plan strategically. However, having a high dry powder means higher valuation, one of the top concerns a fund manager investing in the Chinese PE market will have.

Managers will have difficulty selecting and accessing the right funds because they don’t want to pick overvalued funds.

3. Business practice and cultural considerations

Investing in the Chinese PE market may be difficult because of a lack of information transparency and reliable data, weaker corporate governance, and legal enforcement.

A cultural challenge investors and fund managers will face is the reliance on guanxi, a system of powerful social networks that facilitate business. That means you have to follow the means of your networks and connections, which will help you open doors for new business and facilitate deals.

Guanxi is like networking for an internship or a job. However, in the United States, you can still get a job without networking, but it’s very difficult if you don’t network in China.

Private Equity in China and Investment Opportunities

With recent events and developments, investors can still benefit from investing in the Chinese PE market.

Although the Chinese PE market seems risky, those risks can be managed by skilled and experienced fund managers, which will reward through the many opportunities offered in the market.

1. Technology and innovation

In the early 2010s, many people did not think China had a strong innovation environment since China has few innovators and innovations compared to the West.

However, only two years later, eight of the ten businesses that had achieved a $1 billion value in the quickest period ever were Chinese.

China has reached a level of competitiveness with the United States during the past five years as a form of "innovation cold war" has emerged between global powers.

As a result, many PE firms are jumping on the trend and investing in early-stage tech companies with the potential to upend established sectors in China.

2. Consumer-focused industries

The demand for consumer products and services is rising as the middle class in China keeps expanding so much that, as per estimates using purchasing power parity (PPP) numbers, China has the world's largest consumer economy.

China is anticipated to provide more than a quarter of all global consumption growth over the next ten years, more than any other country.

Additionally, it is becoming an increasingly complex phenomenon as significant technical advancements, and demographic and societal shifts converge.

Private equity firms are capitalizing on this trend by investing in businesses that serve the requirements of the expanding consumer class.

3. Healthcare

China's healthcare market has grown to be the second largest in the world due to several variables, including a longer life expectancy, an aging population, and higher aspirations for quality of life.

This has created a rapidly growing market for healthcare investment in China. In addition, through the "Healthy China 2030" project, there has been a considerable investment in local healthcare infrastructure, market reforms, and assistance for innovation.

In addition, the pandemic has raised awareness of healthcare. Vaccines, antiviral medications, medical protection, and online medical analysis were the market's hottest commodities at the pandemic's beginning.

Experts have predicted long-term structural improvements that will open up opportunities for private equity investors in various industries, including biotech, medical devices and diagnostics, and hospital services.

PE firms invest in businesses offering drugs, medical equipment, and other healthcare services.

4. Infrastructure

China's infrastructure spending has always been a major factor in the country's economic expansion.

An urge to create jobs and enhance the quality of life for the populace sparked a construction boom that has persisted to this day, resulting in the laying of hundreds of thousands of kilometers of railway tracks and the construction of record-breaking buildings.

The Chinese government has prioritized infrastructure development to revive the economy and ensure long-term sustainability, such as investing in high-speed rail, water tunnels, and new energy projects to support the economy.

As China is undergoing a significant infrastructure build-out, PE firms realize this is a great investment opportunity in businesses that provide infrastructure services, like construction and engineering firms.

5. Energy and environmental industries

China has set goals to be carbon neutral by 2060. China is increasing its investment in green energy across various sectors to achieve these goals.

These sectors include renewable energy, electric vehicles, battery storage, and technology, which will lower factory carbon emissions and lessen China's dependency on imported energy.

Note

China is currently the world's largest investor in renewable energy infrastructure and made the largest single investment in clean energy in 2021, spending $380 billion across the governmental and commercial sectors.

In the past, PE fund managers paid little attention to this sector. However, with the increasing awareness of sustainability and opportunities in this sector in China, more fund managers are launching green funds or discussing including green tech as a significant investment sector.

Researched and authored by Alisa Zhu | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

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