Guideline: Foreign Investment Financing In China
Foreign Investment
Financing in China
SME financing is a challenge globally, due to the nature of the SME’s as they often lack credibility with
banks, due to limited assets and weak financial systems. Financing a business in China is even more
challenging as an SME also needs to take China’s FX control into consideration as well as China’s
particularities, risks and regularly changing legislation.
China’s current currency control measures have been in place since the foundation of the People’s
Republic of China in order to trap Chinese savings and profits inside China, so they could be used to
sustain its economic development. China started out with very tight foreign currency control but these FX
controls are being loosened, both under international pressure as well as due to China’s desire to develop
its currency into a global currency, which can be used for intra trade settlements.
Over the last couple of years, China’s currency has appreciated reasonably fast; a trend which is expected
to continue in the longer run, although we can expect the appreciation to occur at a slower pace with
increased volatility.
The Central Government has launched a series of new regulations as well as bank products to facilitate
financing. Moreover, the RMB deposit savings rate in China has been quite high and this leads to a much
higher financing cost in RMB compared to other currencies. The continuously changing and challenging
situation requires SME owners to pay more attention to their financing and work closely with banks to find
the best solutions.
New recent regulations and economic experiments present foreign SMEs with more opportunities, such as
RMB Settlement in Cross-border Trade, non-residential accounts, completely marketed loan interests, etc.
Many of the experiments the PRC government is currently experimenting with are well received and are
expected to be implemented as new future national standards. For SME’s, these experiments can be useful
if they can take part in them, but you often need a strong local accountant or controller who is informing
head office of these opportunities and their implications so that the SME can judge the attractiveness and
decide to proceed or not.
Though China’s market is a challenging one, the Chinese government has expressed its commitment on
supporting SME’s through improved SME financing tools. At this stage, bank loans are still the largest
source for SME financing in China. With the government’s support, commercial banks in China have
launched various SME financing products/services, especially joint-stock commercial and city commercial
banks (the 5 large national commercial banks focus more on large companies and state-owned
enterprises).
SME financing products’ innovation aim to solve the problem of asymmetric information and high
transaction cost, which are the key obstacles for SME loan applications. Supply-chain financing provides
an SME with the opportunity to leverage on larger companies’ credibility. With various new financing
products and support from the government, banks are more open on the proof of SME credibility and bank
loan application is more case-based. To increase the success rate of loan application, SMEs need to think
like the bank and try to prove through credibility through various methods. Even though the PRC
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Guideline: Foreign Investment Financing In China
government is trying to increase SME financing, the banks don’t always want to follow suit as their large
SOE clients are more profitable to service. Whilst the situation is improving, the existence of the “shadow
banking industry” is the living proof that SME financing can still be very challenging for SME’s without a
strong profile that don’t fulfill the bank requirements. Due to government pressure, around ¼ of all loans
in China are now going to SME’s, a number, which is expected to increase whilst China continuous to
reform its economy.
This report focuses on funding options which are available in the Chinese market. However, it is vital that
European SMS’s first explore the opportunities which are available in their home countries as these “home
country” options will often be easier to consume than the financing opportunities sourced in China. The
first natural step to look for Chinese financing is to start with the China branch of your local home bank as
they can often assist and can build on your home country relationship.
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Guideline: Foreign Investment Financing In China
Table of Content
1
SME Financing In China ........................................................................................................................4
1.1
1.1.1
Internal Financing ...................................................................................................................5
1.1.2
Indirect external financing ......................................................................................................6
1.1.3
Direct external funding ...........................................................................................................6
1.2
1.2.1
2
3
4
5
Key Funding Types ........................................................................................................................5
Registered capital ...........................................................................................................................6
Minimum requiered registered capital ....................................................................................6
1.3
Challenges to SME bank loans.......................................................................................................7
1.4
Solutions for SME Financing .........................................................................................................8
1.4.1
Supply Chain Financing ..........................................................................................................9
1.4.2
Supply Chain bank products .................................................................................................10
China’s banking system ........................................................................................................................ 11
2.1
Policy banks ................................................................................................................................. 11
2.2
Rural Finance Institutes................................................................................................................12
2.3
Commercial Banks .......................................................................................................................12
2.4
SME Definitions ..........................................................................................................................13
Foreign Exchange control in China – an introduction ..........................................................................13
3.1
FX control mechanism .................................................................................................................14
3.2
RMB settlement in cross border trade ..........................................................................................14
3.3
Non-residential account (NRA) ...................................................................................................16
Private Equity .......................................................................................................................................17
4.1
Angel investment .........................................................................................................................18
4.2
Venture Capital .............................................................................................................................19
4.3
Growth Capital .............................................................................................................................20
Attachments ............................................................................................................................................1
5.1
External financing parties in China ................................................................................................1
5.2
External funding options in China .................................................................................................2
5.3
Case Study: Supply Chain Financing .............................................................................................1
5.4
Case Study: Private Equity investment ..........................................................................................3
5.5
Case Study: Attracting Angel Investor…………………………………………………………
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Guideline: Foreign Investment Financing In China
1
SME Financing In China
Starting from 2005, the Chinese government has been promoting SME financing, especially after
“Opinions on further promotion for SME development” from the State Council in 2009 (see Attachment
5.1 List of Main laws and regulations). The China Banking Regulatory Commission (CBRC) and other
key commercial bureaus have launched a series of regulations and policies to promote SME financing.
Whilst in theory, local and foreign SME’s should be treated at the same level, in practice, local SME’s are
favored, often because they have better relationships with their banks and they have a better understanding
of how a local bank works and how to build effective relationships with the relevant loan officer.
Key points of the regulations and policies include:

Encourage banks and other financial institutions to streamline and simplify SME financing
procedures, provide more financing products and provide more added value financial service
to SME’s.

Support SME’s with temporary financial difficulties but with promising long-term prospects.

Encourage collaboration among enterprises, banks and government to implement
governmental tax and fiscal preferences for SME financing as well as to build up risk sharing
and compensation systems for SME financing.

Encourage establishing a dedicated organization for SME financing.

Differentiate monitoring standards on financial institution and increase the bar for banks’
non-performing loan rate for SME financing.

Expand pledge categories and include Intellectual property and other assets into considerable
financing pledges.

Because the additional focus and support from the Central government on SME financing, the – mainly
short term - bank loans to SME’s have grown significantly. By the end of 2012, after 4 years of
sustained growth, the outstanding loans to micro-small enterprises has reached CNY 14.8 trillion,
representing 22% of total outstanding loans.
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Guideline: Foreign Investment Financing In China
1.1
Key Funding Types
Throughout an enterprise’s development, it has access to various internal and external sources of financing.
SME owners often use their personal assets to finance the company with their savings with external
financing often considered as an accelerator for company growth once the company reaches a certain stage.
Financing cost, Easiness to obtain, Entrance barriers and payback terms need to be considered when
choosing funding source.
The different funding options can be split into 3 groups and a more extensive overview of the different
external financing types can be found in Attachement IV: External Funding Options:
1.1.1
Internal Financing
Internal financing is normally provided by related parties such as shareholders, management and
employees, etc. When seeking money for an SME, entrepreneurs should consider the debt-to-equity ratio.
This is the relation between the money borrowed and the amount of money invested in the company. The
more money is invested in a company, the safer banks will consider an SME to be to lend to as the
liquidation value will cover the bank loans.
New or young companies with a limited track record and limited profits or cash flow will find it difficult to
obtain loans as they are often considered too risky for banks as they can’t show a stable track record yet.
In this very early stage of development for a company, an SME can turn to shareholder loans for its
financing. Shareholder loans can also be used in distressed situations when the shareholders are trying to
save the company.
Shareholder loans are a debt form used to finance a company. It’s normally the most junior debt in the
company, meaning these loans rank after all other debts in the case of a bankruptcy or liquidation. As this
loan belongs to the shareholders, it can be treated as equity in the company.
Once a company becomes a bit larger and starts having cash flow and profit, it can turn to other institutes
to receive loans or other forms of financing. At this stage, financial institutes will consider the amount of
money invested by the shareholders and other related parties to see how much risk an owner is willing to
carry himself before he turns to other sources.
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Guideline: Foreign Investment Financing In China
1.1.2
Indirect external financing
This normally happens via licensed institutes such as banks and financial institutes which provide bank
loans. These are still the most traditional and common way for SME financing, financing guarantees, etc.
The reason why this is considered “indirect” financing is because he who owns the money does not lend
the money directly to he who needs the money. China has many different types of financial institutions,
with different risk appetites and different economic focus areas and SME’s need to be aware which banks
focus on which areas so they can choose a financial partner which has the best chance to provide them the
long term financial support a growing SME requires. The different financial institutions in China and their
economic focus will be discussed later in this guideline and an overview of all financial institutes can be
found in Attachment III: Financial Institutions in China.
1.1.3
Direct external funding
Direct external funding involves attracting additional shareholders into the equity structure of the company
without the use a middle agency as the company who invest is also the one who owns the money. This can
happen through IPO’s, public debt issues, commercial credit financing, micro loans, private equity
investments etc. The Private Equity industry in China has taken off very quickly since the 2000’s and has
now become an important financing tool for SME’s in China. Frustratingly enough, Private Equity funds
are very risk aware and will often chase the same successful companies whilst ignoring other companies.
1.2
Registered capital
The concept of registered capital in a Chinese context used to be different from what an SME might
encounter in its home country as it’s determined by the PRC government and not by the actual financing
needs of the company.
Since March 1st, 2014, there are number of amendments to China’s company’s law in vogue. Whilst the
laws don’t explicitely state that these amendments are also valid for Foreign Invested Enterprises (FIE’s),
the expectations are that FIE’s can also benefit from these changes.
Whilst in the past, up to 70% of the registered capital could be paid by tangible and intangible assets, the
new law states that up 100% of the registered capital can be paid with non cash items as long as they can
be legally transferred to the newly established entity and they can be independently valued by a China
based appraisal company. Examples of tangible and intangible assest are patents, machinery, land use
rights, etc.
1.2.1
Minimum requiered capital
China no longer requires a mimimum registered capital as it has dropped these requirements with its
recent changes. The concept of registered capital was replaced by concept of subscribed capital, where
investor(s) decides amount of contribution. However, the amount of capital remains very important in
China as the higher the capital is, the easier the day to day activities for an SME in China will be as the
capital is taken into account to determine the credit worthiness of a Foreign Invested Company or to be
considered as a serious partner by some large Chinese companies.
The State Foreign Exchange Bureau (SAFE) allows Foreign Invested Companies (FIE) to borrow a certain
amount of FX loans from overseas. The maximum amount an FIE can borrow overseas is the total
investment – the registered capital. Any loans beyond the number will be rejected by SAFE. Because of
this, the “total investment” a company makes in its FIE in China is important.
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Guideline: Foreign Investment Financing In China
Due to the strict FX control rules and long approval procedures, it is recommended to consider and plan
well in advance capital needs in order to secure smooth financing of company operation. Of course the
higher capital the more space for FX loan (see the table below on the statutory minimum ratio between the
total investment and the registered capital).
Total Investment
Ratio of min.registered capital of total investment
USD 3,000,000 or below
70%
USD 3,000,001 to USD 10,000,000
50% or USD 2,100,000 whichever is the largest
USD 10,000,001 to USD 30,000,000
40% or USD 5,000,000 whichever is the largest
USD 30,000,001 or more
33.3% or USD 12,000,000 which is the largest
Challenges to SME bank loans
1.3
SME’s will be able to get local loans and normally it shouldn’t be an issue. Whilst there might be
preference to service local companies as mentioned above, according to law there shall be no difference
between providing bank loan to local SME or foreign invested SME as long as they prepare and
understand what the bank expects from them. Bank loans have been and are expected to remain a major
source for SME financing in China as it has the following advantages:
•
The terms and conditions are fixed by the bank, hence as long as the SME fits the
requirements, the procedure should be relatively simple and straight forward.
•
The negotiations are directly with the lender (banks) hence no need for promotion and
fund raising expenses.
•
Loan interest could be booked as finance expense which provides some tax benefits.
•
Compared to direct financing (IPO, public debt issuing), bank loans are faster to obtain
with lower financing cost.

However, a large amount of SME financing demand remains unsatisfied whilst banks are eagerly offering loans
to large enterprises at low interest rates. The main obstacles between SME’s and bank loans are asymmetric
information, i.e. banks do not have sufficient information on the SME to grant the loan as well as the relatively
high transaction costs versus the size of the loan.
Whilst the PRC government wants to expand SME financing, it is important to note that there is a large and
vibrant black market financing industry, indicating that the SME financing effort is not yet as efficient as the
government would want it to be and that SME’s – both foreign and domestic – often struggle to get financing if
they don’t fulfil the banks’ requirements.
Some issues facing SME’s resulting in difficulties for banks to assess their organization:
© 2014 EU SME Centre
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Guideline: Foreign Investment Financing In China

Weak Financials/Reporting compared to large companies. An SME’s financial system
often lacks credibility with banks.

Lack of pledges; many SME’s are light on fixed-assets, especially foreign SME’s in China
who mainly rent workshops and equipment.

Low recognizable value of pledges; as many SMEs are in niche markets, there can be
limited resell value to existing pledges resulting for a larger risk for the bank

Weak financial planning; SMEs often apply for loans urgently and unpredictably which
makes them less predictable for banks.

Lack of company credibility: hard for banks to find the good and sustainable SMEs

Some internal bank issues that have a negative impact on providing banks loans to SME’s:

High approval cost: a bank’s approval procedure is similar for large and small amounts.
Hence, it’s easier for a bank to focus on large loans as they can deploy more capital with
the same admin cost and research effort. The small loans for SME’s are not as effective
for banks as those to large multinationals.

More investment: compared to large enterprises, SMEs’ situation varies hence banks need
to invest more time and staff to understand an SME’s business, products, reputation, etc.
More risks: due to the nature of SMEs, the risks of default is higher compared to large
enterprises. This higher default risk translates itself in higher interest rates.
•
1.4
Solutions for SME Financing
As asymmetric information and high transaction costs are the key obstacles between SMEs and bank loans,
it is important that all parties involved in the loan process look at ways to deal with these issues.
Governments and banks throughout the world are also focused on dealing with these issues in order to
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© 2014
EU SME Centre
enterprises. This higher default
risk translates
itself in higher interest rates.
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Guideline: Foreign Investment Financing In China
Types of credit techniques used by banks
1.4.1
Supply Chain Financing
Supply-chain financing is a new innovation which breaks the traditional credit reviewing mode and
changes from valuing the single enterprise credit statically, to valuing the whole supply chain in which the
enterprise acts.
Under supply-chain financing, banks do not only focus on a company’s size, fixed-asset value, financial
statements or guarantees but more on the authenticity of the trade and the credibility of the key enterprises
in the supply chain.
Supply-chain financing pays attention on the sustainability of the whole supply-chain, the authenticity of
the business and the credibility of the trading partner which provides SMEs an alternative way to show
their “assets” and “value” as well as their credibility.
Supply-chain financing creates a win-win-win solution for the key company, their trading partners
(suppliers and retailers) as well as the banks.
In the past few years, supply-chain financing has grown rapidly and became the new driver for the
increasing SME loans for commercial banks. The process can be seen below.
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Guideline: Foreign Investment Financing In China
For the banks, this structure does not only enhance their relationship with key companies, but also gets
them into the SME financing market with lower risks. The SME’s can benefit from supply chain financing
as they can benefit from the financial credibility of their large suppliers and/or customers.
Many commercial banks believe that the growth of supply-chain financing will be much faster than
traditional financing in the foreseeable future. Retail, automotive, manufacturing, electronics, food,
beverage and pharmaceuticals are considered the most promising industries for supply-chain
financing due to the numerous upstream and downstream partners. So far, in China, supply-chain
financing products are available in many banks, especially the joint stock ones as they are more
commercially focused.
1.4.2
Supply Chain bank products
Based on the different stages of the supply-chain, Supply Chain products could be categorized into 3 types:
•
Inventory
•
Prepayments
•
Receivables
The inventory financing, as it is pledged by valuable and saleable products and with sales income as first
payment resource, could apply on both Supply Chain products as well as traditional financing, where the
credibility of loan applicants will be reviewed individually.
Prepayments and Receivables financing require more involvement of key companies as well as third
parties, such as warehousing companies, logistics, insurances etc. and are standard supply-chain financing
products.
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Guideline: Foreign Investment Financing In China
2
China’s banking system
When looking for financing in China, it’s important that European SME’s understand that China’s financial
system is designed by the Central government to support the Chinese economy and the different actors in
that economy.
China has 3 types of banks:
2.1
Policy banks
China has 3 key policy banks; China Development Bank, The Export –Import Bank of China and the
Agricultural Development Bank of China. These banks are used by the China government to finance large
(infrastructure) projects. These banks will not provide any day to day financing for SME’s.
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Guideline: Foreign Investment Financing In China
2.2
Rural Finance Institutes
This can be Rural credit cooperatives, bank cooperatives or rural commercial banks as well as village and
township banks. These organizations are founded to support the development of rural areas and activities.
SME’s who are active in the agricultural field can approach these organizations where their activities are
situated. They will have a much higher chance of success to finance agricultural activities than trying to
obtain financing through a “city bank” where the SME’s head office is located, as the city banks are set up
to develop and support city related activities.
2.3
Commercial Banks
China has a plethora of Commercial banks which are also organized by function.
An SME can
significantly improve its chances of getting local financing if it’s aware of which bank and bank
branch to approach. China has 5 different types of commercial banks.
1. Large Commercial Banks: These large institutes almost entirely cater to large multinationals and
China’s State Owned Enterprises. Their organizations are not geared to deal with SME’s.
2. Joint Stock Companies: These are often private for private companies not too dissimilar with
Western banks with good levels of service.
3. City Commercial Banks: These are set up to develop any type of commercial activity in urban
areas.
4. Rural Commercial Banks: These are used to develop commercial activities in rural areas.
5. Foreign Financial Institutes: These are the large global banks that SME’s might already have a
relationship with in their home country. In China, they are slow to develop as the government has
very restrictive regulations in place to protect their own financial industry.
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Guideline: Foreign Investment Financing In China
2.4
SME Definitions
It is important to note that banks and financial institutions use different definitions and requierments to
define what is a Small or Medium sized company. These definitions have an impact on how the banks and
other financial institutes deal with the company that is requesting financing. The below overview can be
used to see how China’s banking system judges an SME. This can again be important to decide which
financial institute to approach and which policy or regulation an SME can benefit from.
Industry Sector
Agriculture,Forestry, Fishery &
Animal husbandry
Industry
Construction
Wholesale
Retail
Transportation
Warehousing
Postal
Lodging
Catering
Information Transmission
Software & IT
Real Estate
Property Management
Leasing & Service
Others
3
Medium Size
Small Size
Micro Size
Micro - Medium
Enterprises
Revenue
Employees or
Total Assets
Revenue
Employees or
Total Assets
Revenue
Employees or
Total Assets
Revenue < 200m
5 ~ 200m
-
0.5m ~ 5m
-
< 0.5m
-
Employees < 1,000 or
Revenue < 400m
Revenue < 800m or
Total Assets < 800m
Revenue < 400m or
Employees < 200
Revenue < 200m or
Employees < 300
Revenue < 300m or
Employees < 1,000
Revenue < 300m or
Employees < 200
Revenue < 300m or
Employees < 1,000
Revenue < 100m or
Employees < 300
Revenue < 100m or
Employees < 300
Revenue < 1,000m or
Employees < 2,000
Revenue < 100m or
Employees < 300
Revenue < 2,000m or
Total Assets < 100m
Revenue < 50m or
Employees < 1,000
Employees < 300 or
Total Assets < 1,200m
Employees < 300
Employees
≥20m
≥ 300
Total Assets
≥60m
≥30m
Employees
≥ 50m
≥ 20
Employees
≥ 5m
≥ 50
Employees
≥ 30m
≥ 300
Employees
≥ 10m
≥ 100
Employees
≥ 20m
≥ 300
Employees
≥ 20m
≥ 100
Employees
≥ 20m
≥ 100
Employees
≥ 10m
≥ 100
Employees
≥ 10m
≥ 100
Total Assets
≥ 10m
≥ 50m
Employees
≥ 10m
≥ 300
Employees ≥ 100 &
Total Assets ≥ 80m
Employees
≥ 100
Employees
≥ 3m
≥20
Total Assets
≥3m
≥3m
Employees
≥ 10m
≥5
Employees
≥ 1m
≥10
Employees
≥ 2m
≥20
Employees
≥ 1m
≥20
Employees
≥ 1m
≥20
Employees
≥ 1m
≥10
Employees
≥ 1m
≥10
Employees
≥ 1m
≥10
Employees
≥ 0.5m
≥10
Total Assets
≥ 1m
≥20m
Employees
≥ 5m
≥100
Employees ≥ 10 &
Total Assets ≥ 1m
Employees
≥ 10
Revenue < 3m or
Employees < 20
Revenue < 3m or
Total Assets < 3m
Revenue < 10m or
Employees < 5
Revenue < 1m or
Employees < 10
Revenue < 2m or
Employees < 20
Revenue < 1m or
Employees < 20
Revenue < 1m or
Employees < 20
Revenue < 1m or
Employees < 10
Revenue < 1m or
Employees < 10
Revenue < 1m or
Employees < 10
Revenue < 0.5m or
Employees < 10
Revenue < 1m or
Total Assets < 20m
Revenue < 5m or
Employees < 100
Employees < 10 or
Total Assets < 1m
Employees
< 10
Foreign Exchange control in China – an introduction
Over the last years, China’s currency – the RMB – has appreciated significantly against all major global
currencies, creating currency exchange risks for companies active in China, especially those whose base
currency is not the RMB.
One of the first decisions a company needs to make when looking at how to finance their China operations
is the decision which currency to use. Dealing with the RMB versus other currencies has various pros and
cons as can be seen below.
Whilst the general expectation is for the RMB to continue to slowly appreciate, we can expect more
volatility due to the changing economic situation as well as other external factors that affect the RMB
exchange rate.
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Guideline: Foreign Investment Financing In China
3.1
FX control mechanism
In China, FX control is co-managed by two government organizations; The People’s Bank of China (PBC)
and the State Administration of Foreign Exchange (SAFE). Both organizations have offices in all major
cities and regularly share the same office space as well as occasionally some staff.
SAFE is the key point of contact for all daily operations and issues in regards to China’s FX control
policies. (See Attachment II: Daily FX operations)
As of July 31st 2013, there were 61 regulations in force related to the foreign currency current account and
140 regulations related to the foreign capital account, the latter the most strictly implemented. These rules
can change often and abruptly and they are known for their strictness and complexity. SAFE manages all
foreign currency activities in China including exchange, sales, purchases and payment covering
individuals, organizations and enterprises unless the amounts are “exceptionally” large.
This administration is based on the location of the activities not the nationality of the players as many other
government organizations are.
Local SAFE offices have some room to interpret currency control regulations themselves resulting in a set
of consistent national principles but inconsistent local regulations. It is therefore important to contact your
local bank and SAFE office to understand what rules your different operations in China have to follow and
to ensure strong local relationships as specific cases need specific solutions that need to be agreed on at a
local level. The general national principles are set by the Central Government whose ultimate goal it is to
achieve a freely traded RMB.
In the meantime, we can expect multiple waves of changes whilst the Central government is working out
its path to full convertibility. Whilst the path forward is unpredictable, we can expect it will lead towards
full convertibility of the RMB as a recognized global currency to settle international trade with China.
3.2
RMB settlement in cross border trade
As China is a very important trading nation, cross border trade and its settlement is an important issue with
a huge impact on the Chinese economy and domestic employment. In order to support trade with China,
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the Central government has embarked on a path of reform to ensure that foreign companies can more
easily trade with Chinese companies.
The below time line shows the different steps the current regulations went through. It’s also a good case
study to see how China develops its national regulations through a series of local pilot programs that are
modified through trial and error.
By settling cross border trade in RMB, SME’s can now significantly minimize their FX exposure through a
Non-Deliverable Forward and benefit from RMB appreciation. Below you can see an example of how this
would work.
Note: to avoid hot money, a
only allowed to have curre
interest rates (±0.35% pe
which makes interest
unavailable.
NOTE: A usance letter of credit (L/C) is a financial instrument that sets the terms and conditions for the payment of a debt at a specific date in the future. Typically, the
terms and conditions found within the letter of credit will cover details such as the mode of payment used to settle the debt, the total amount owed at the time of
settlement, and the name of the beneficiary. It is not unusual for the letter of credit to be accompanied by supporting documents, such as an invoice for the total amount
due for payment, and even a time draft that can be processed on the agreed-upon date.
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3.3
Non-residential account (NRA)
In Oct 2010, the Chinese government launched a new type of bank account, the Non-Residential Account
(NRA), which allows non-resident corporates (including Hong Kong and Macau registered corporates) to
open an RMB settlement account with an RMB Domestic Settlement Bank for settling valid RMB
payments and collections with their counterparties in China.
A Non-Residential Account is launched as a (potential) solution for RMB settlements for cross-border
trade. This has several similarities with an Off Shore Account. Both are for non-resident companies and
allow them to open foreign currency accounts without any limits on the amounts and types of currencies.
Both can be used for foreign currency deposits, currency exchange, international settlement etc. The NonResidential Account requires real name registration and both the payer and the payee are considered to be
cross border traders.
The differences between both the Non-Residential Account and an Offshore account can be seen in the
overview below:
Whilst this is considered to be a definite direction, the rules and policies are still expected to change.
All big commercial banks in China have started NRA pilot projects and it is to be expected that the NonResidential Account will be launched on a larger scale in the near future.
The key advantages for corporates and SME’s are as follows:
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Guideline: Foreign Investment Financing In China

Easier to receive and pay in RMB, regardless of the companies legal structure

Lower transaction costs

Increase in savings interests

Easier account management

The below overview shows how the combination of a non-residential account and a non-deliverable
forward can assist an SME in benefitting from interest arbitrage whilst limiting FX exposure.
4
Private Equity
Private Equity (PE) is an illiquid asset class consisting of equity securities in operating for profit
companies, that are normally not publicly traded on a stock exchange. It’s called illiquid as a private
equity fund, compared to listed shares, cannot easily sell this stake.
Investments are normally made for medium to long term periods (3 – 5 years) but some asset classes such
as infrastructure can hold their investments for many decades)
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The money is raised from the large pools of cash that exist in modern economies such as large MNC’s,
Insurance Companies, Pension funds, high net worth individuals, It’s a high risk/high yield asset class that
has developed in China for the last 20 years and which has a reasonably good regulatory framework in
China. The private equity fund is only a fund manager who manages its money on behalf of its Limited
Partners (investors).
PE comes in many different forms such as angel investment, venture capital, growth capital and
(leveraged) buyout. The last option – buyout – is normally only of interest to an SME whose owner(s) are
willing to sell a controlling stake to the new investor This often happens if no successor can be found. As
this guideline is focused on (growth) financing, only the first 3 categories will be discussed in more detail.
Working with a PE fund can have a positive effect on the company as they will put proper reporting into
the organisation focused on measuring cash flow, liquidity, product by product performance, expenses and
other industry specific measures. Whist this reporting gives the management a deeper insight into the
organisation, companies often underestimate the amount of time and effort required to produce the various
daily, weekly, monthly, quarterly and annual reports.
Whilst an angel investor could consider to invest in a subsidiary of a company, private equity funds will
normally invest in the highest legal structure of an SME. Local PE funds might be less open to invest in an
EU SME compared to Western fund managers based in China. However, more and more European PE
funds who are based in Europe, want to gain exposure to Chinese growth and invest in the European
legal structure of an SME to support the expansion of a subsidiary in China.
Due to the currency exchange limitations intrinsic to the Chinese market, it’s important to understand the
differences between RMB PE funds and USD PE funds. The former are normally much looser in their due
diligence requirements, reporting, etc. but have high expectations in regards to returns. RMB funds
normally provide very limited operational support. USD funds are more professional and strict in their
approach as they have to report to foreign LP’s.
Whilst having a private equity investor as a shareholder has many advantages, SME’s need to think
through the future of their company before they embark upon a path with a PE investor . One of the key
issues is that a PE fund will need to exit their investment after a number of years and hence their focus
from day one is on their exit which might mean they will have less interest in long term investments. They
can either exit through an IPO and make the company public or they can sell their stake to the highest
bidder, which can be another PE fund or an industry player. An SME often has limited control over who
will buy the stake of the PE investor in the case off a trade sales.
An overview of the 150 leading Venture Capital and Private Equity Funds in China can be found on
www.cvca.org.cn/membership/MembersList.asp
4.1
Angel investment
This is normally more suitable for the smaller SME’s who are still relatively young and small. An angel
investor is normally an individual who invests money in an SME in order to become a shareholder or
creditor.
As China has many high net worth individuals, angel investing is becoming more and more common and
more and more angel investment clubs are being founded (e.g. www.investmentnetwork.cn)
Investments can range from small amounts to € 1 million or above and are often used as seed or start
capital for particular projects such as setting up a wholly owned foreign enterprise in China. Whilst
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Private Equity funds are easy to find as they are operating businesses, Angel Investor’s are very hard to
find as they are individuals.
Whilst Angel investors are looking for returns, they don’t necessarily need to get their returns through an
exit. Also, as they are investing their own money, they have more flexibility with their investment horizon.
Angel investment is most suitable for very early stage companies. Whilst many people are keen to be an
Angel Investor, finding the right Angel Investor can make a huge difference for a company if this person
can provide money as well as operational and strategic advice, without interfering in the business.
4.2
Venture Capital
Venture Capital investments are made by a company, which manages money on behalf of investors.
Companies which receive venture money are normally relatively young but have high growth potential.
The funding happens through different financing rounds, which can be several millions per tranche based
on the funding needs of the company.
A typical venture capital investment is structured so that the venture capitalist gets convertible preferred
stock in your company. This stock gives the venture capitalist a preference over the common shareholders
in the event of a liquidation or merger. The preferred stock is convertible into common stock at the option
of the holder -- and may be automatically triggered by certain events. For example, the preferred stock
would convert to common stock in the event of an initial public offering (IPO) of the company to simplify
the capital structure of the company and to facilitate the IPO or trade sale.
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4.3
Growth Capital
Growth capital funds normally invest in mature and sizable companies that are about to embark on a
transformational phase in their history but which don’t produce enough cash flow to fund events such as
rapid expansion of a retail network, the construction of a new factory, significantly expanding the head
count, financing acquisitions, etc. Because of this, growth capital is often also referred to as expansion
capital.
As China now has a mature pool of medium sized companies that need access to large pools of money to
fund their growth, a successful growth capital industry, consisting of both local and international firms,
flourishes.
Whereas an angel investor and a venture fund might take a risk on the business model and the management
team and invest in the potential of the team and the company, the growth capital fund will require a proven
business model with a proven management team and track record.
A growth capital investment will normally be between € 10 – 50 million representing a significant minority
stake but always < 51%. Exit wise, both trade sales or IPO’s are considered.
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5.1
Attachments
External financing parties in China
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5.2
External funding options in China
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Foreign SMEs can do IPO only in Hong Kong. In Mainland China companies can be listed only if they are joint stock companies registered in PRC.
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5.3
Case Study: Supply Chain Financing
Background and Case Introduction:
In the automotive industry, the majority of upstream parts suppliers and downstream distributors are SMEs
who have difficulties in satisfying their financing needs. Generally, commercial banks require distributors
to provide assets of the company or personal assets of the company owner as loan pledge. For distributors,
this financing method results in slow procedures, small loan amounts and high financing cost, which could
not satisfy the company’s financial demand. Distributors’ financing difficulties have a direct effect on
automotive sales, which leads to a negative impact on the whole automotive industry. In the supply-chain
of the automotive industry, automotive manufacturers are the key enterprise which could help to solve the
asymmetric information between distributors and banks.
The automotive company is one of the largest automotive manufacturers in China (however the same
model would work with an EU car company). To help the distributors with financing so as to increase the
car sales, this company signed a supply-chain cooperation agreement with a domestic commercial bank. In
this agreement, the commercial bank agrees to finance the company’s distributors with Bank's Acceptance
Bill as key financing product. The bank will monitor and supervise the qualification certificate of the cars
and the company will be responsible for swap sales and buy-back. This agreement defined the cooperation
frame between the commercial bank and the company as well as the total financing size.
Crediting Subjective:
In the first round, the key company nominated 12 distributors to the bank. In the 12 distributors, there are
a few large size distributors with long-lasting relationship whilst also a few small size and newlyestablished distributors.
Traditional Financing Rating vs. Supply-Chain Financing Rating:
One newly-established distributor in Zhejiang province, has total assets of RMB 400 million with a Debt
Asset ratio of 56% and Cash Ratio of 0.31. By the end of 2010, this distributor is not break-even.
In traditional financing, for external ratings, this distributor is rated as 5.89 (equal to BBB level) which is
“the company’s pay-back ability for both long and short term debt is ordinary. Current operation seems
stable however, future operation might be affected by both internal and external issues and is uncertain.
The uncertainty could have significant impact on company’s pay-back ability. The agreed terms &
condition might not be enough for principal & interests protection.” When the distributor applied for a
bank loan, as a newly-established company, without any profit and without complete financial statements,
commercial banks could not have sufficient information on the company’s actual operation. As a result,
commercial banks rejected its loan application.
After the agreement of supply-chain financing between the key company and the bank, as this distributor is
nominated by the key company, with the key company’s commitment of swap sales and buy-back and car
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qualification certificate monitoring, the bank increased the credit rating of this distributor to the same
rating with the key company and provide the distributor with Bank's Acceptance Bill.
Financing Results:
With the bank’s financing support, this distributor increased its capital turnover ability and the company
size, car sales as well as profitability have improved significantly. The first 10 months after supply-chain
financing, the company’s sales reached RMB 450million with net profit of RMB 55 million. Financial
wise, the distributor’s Debt Asset ratio increased to 85% due to extra financing and Cash Ratio increased to
0.64. The ROE, Current Ratio and Quick Ratio all improved. New external rating reached 6.21 (equal to
BBB+). As a result, the distributor does not only improve the company operation and profitability but also
increase its credit rating for future financing.
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5.4
Case Study: Private Equity investment
Situation:
A German industrial machinery provider was founded in the 1960’s and grew organically in Europe and
the USA. By the late 2000’s the company had reached its maximum market revenue - approximately € 50
million - in its key markets. (Private Equity funds are interested in companies even with lower annual
turnover).
If the company wanted to continue growing, it had to enter new markets and the company decided –
amongst others - to enter China.
The Chinese market was consolidating and was technologically quite advanced. Because of this, the
German company could only enter the market as a technological niche player, focusing on the very top end
of the market.
After reviewing the market situation, it was decided that the company would enter the market with a dual
brand strategy. It would maintain its German brand as a premier brand, focusing on the very top of the
market and it would develop a local mid-tier brand focusing on the largest segment of the market.
As this segment was already populated by a number of efficient competitors, a greenfield startup would be
hard, hence, it was decided to acquire a local Chinese competitor.
As the company was planning to grow aggressively, it was already decided to pursue an IPO, part of the
proceeds of which could be used to finance acquisitions in China.
Challenges
It took the company slightly over 6 months to meet the key M&A targets and identify the preferred target
and another 6 months to finish the negotiations and due diligence.
By the time the company was in a position to go public in Europe, the global financial crisis arrived and
the IPO which was going to provide the crucial funds to finance the China acquisition became unattainable
due to the collapse of the markets and interest in new IPO’s.
The company then tried to obtain banks loans in Europe and China. The European banks rejected the loan
applications at that stage as they were too risk averse to finance an acquisition in China and the Chinese
banks rejected the loans as the company had hardly any bankable assets in China.
Solution and outcome
The company approached a large number of PE funds both in China/Hong Kong as well as in Europe to
see who could be a potential partner. This was a frustrating and time consuming process as few of the PE
funds wanted to back the company’s industry and the M&A target company had to be managed carefully.
The search was made even more challenging as the company was not only looking for somebody who
could provide the cash the company needed for its growth but also for somebody who could assist with
advising them how to grow the China business and how best to manage and integrate the China
acquisition.
In the end they decide to cooperate with a Hong Kong based growth capital fund which invested in a
minority stake in the European holding. The PE fund had a strong operational team which went over the
acquisition due diligence and identified some additional areas of concern which had not been covered yet
and which were looked into as they had an effect on the acquisition price.
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Post-acquisition, the PE fund provided guidance on the China specific issues the company was facing as
well as the company could use its new China operations to expand the Chinese second tier strategy to start
exporting the second tier brand to other emerging markets in Asia and South America. The PE fund will
stay for 3-5 years as an investor and is expected to exit the company through an IPO in Europe. The PE
fund and the shareholders have agreed that the PE fund will not sell it’s stake to another company as the
founding family wants the company to stay independent. The company has negotiated a pre agreed
purchase mechanism and price with the PE fund to buy its shares back with a guaranteed return for the PE
fund if it decides not to pursue an IPO.
The key reason why the PE fund could invest and was willing to take the investment risk was
because even though the company didn’t go public, it went through all the preparations
required to go public and had thus very strong and transparent accounting and reporting process
in place, providing a level of transparency which was reassuring for the PE fund. Whilst the
IPO preparations were expensive and intensive, 2/3 of the preparation work done created
significant value to how the company was managed. The company is currently still working
hard to build its presence in China but the acquisition has been a success and will remain the
basis for their China platform.
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5.5
Case Study: Attracting an Angel investor.
Situation:
A young entrepreneur obtained the China franchise for a European luxury service brand. The mother
company – who wasn’t really interested in the China market as such – only provided some modest
technical advice beyond which, the entrepreneur was left to his own devices.
Challenges
The entrepreneur identified a first location from which the company started to grow to. The entrepreneur
was faced with two key challenges; one operational as he was struggling to structure his company correctly
so it could grow in a sustainable way without being to reliant on him alone and the second financial that
the company – whilst cash flow positive – was not producing enough cash to satisfy the investment needs
to seize the opportunity (and the market). The company was too small and too risky for banks to consider
lending money too and the entrepreneur himself didn’t have any savings left so he started to look for an
external investor.
Solutions & Outcome
The entrepreneur embarked on a quest to find an investor or at least somebody who could give him advice
on the issues he was facing. He spend time going to PE and VC networking events and some related
conferences and got to know a range of professional investors. None of whom were interested in
considering investing in his company as it was too small and too risky. However, close to the point of
giving up on this way, he was introduced to an PE investor who was active as an Angel Investor and who
was keen to support small startups with his money and advice. Once both parties got to know each other,
the Angel investor decided to invest USD 250,000 in the company and in return expected a number of
monthly financial reports which allowed him to assess progress.
These monthly reports were discussed and the Angel Investor worked together with the entrepreneur to
improve the financial transparency so he had a clearer view of where the money was going, which allowed
the entrepreneur to run the company more efficiently. During each monthly meeting, the entrepreneur
could discuss his issues and challenges and could pick the brains of the Angel investor on how to improve
the operations.
Eighteen months after the first investment, the company needed some more investment and then the Angel
Investor – who had a wide network spanning the globe – introduced the entrepreneur to the family fund of
a European family owning a large luxury brand, who also invested in the company (USD 500,000). Whilst
the money was needed, what proved to be the game changer for the entrepreneur was network and business
support he got access to through the relationships of the family fund and their assets in China.
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Because of this, the entrepreneur got access to knowledge and distribution channels which allowed him to
add
consumables
to
his
service
only
business.
Three years after being founded, the entrepreneur received an offer to buy this business for
USD 5.3 million, which he rejected as there was so much more potential for him in China.
His key to success, apart from working hard, was that he was fortunate to have found smart
money to develop his business. Without the network of his Angel Investor, he would not have
been able to attract his second investment, which proved to be vital to his current success. In
his case, his networking proved to be his key to success. Relationships only harm those that
don’t have them.
Contact the Centre at:
Room 910, Sunflower Tower
37 Maizidian West Street
Chaoyang District
Beijing, 100125
T: +86 10 8527 5300
The EU SME Centre assists European SMEs to export to China by
providing a comprehensive range of free, hands-on support services
including the provision of information, confidential advice, networking
events and training. The Centre also acts as a platform facilitating
coordination amongst Member State and European public and private
sector service providers to SMEs.
The Centre’s range of free services cover:

Business Development – provision of market information, business
and marketing advice

Legal – legal information, ‘ask the expert’ initial consultations and
practical manuals

Standards – standards and conformity requirements when exporting
to China

HR and Training – industry and horizontal training programs

Access to a service providers directory and information databases

Hot-desking – free, temporary office space in the EU SME Centre to
explore local business opportunities

Any other practical support services to EU SMEs wishing to export
to or invest in China.
F: +86 10 8527 5093
www.eusmecentre.org.cn
[email protected]
Disclaimer
This document is provided for general
information purposes only and does
not constitute legal, investment or
other professional advice on any
subject matter. Whereas every effort
has been made to ensure that the
information given in this document is
accurate, the EU SME Centre accepts
no liability for any errors, omissions
or misleading statements, and no
warranty is given or responsibility
accepted as to the standing of any
individual, firm, company or other
organization mentioned. Publication
as well as commercial and noncommercial transmission to a third
party is prohibited unless prior
© 2014 EU SME Centre
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Guideline: Foreign Investment Financing In China
permission is obtained from the EU
SME Centre. The views expressed in
this publication do not necessarily
reflect the views of the European
Commission.
Date: April, 2014
The EU SME Centre is a project funded by the European Union.
© 2014 EU SME Centre
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