Capital is not a problem in China. Capital allocation is. 

Expansionary credit policies by the government has created a boom in bank lending. This rising tide of bank credit is also lifting Chinese SMEs. Through the first half of this year, loans to SME have increased by 24.1% , or 2.7 trillion yuan ($400bn).  All that new lending, though, has not substantially altered the fact that bank lending in China is still directed overwhelmingly  towards state-owned companies.  So, while lending to SME rose by nearly a quarter, that equates to only a tiny 1.5% increase in the share of all bank loans going to SME. 

State-owned banks and state-owned companies are locked in a mutual embrace. It’s not very good for either of them, or for the Chinese economy as a whole. Faster-growing, credit-worthy private companies find it much harder and more costly to borrow.  Over-collateralization is common. An SME owner must often put up all this company’s assets for collateral, then throw in his personal bank accounts and property, and finally make a cash deposit equal to 30% to 50% of the loan value. 

China isn’t the only country, of course, with inefficient credit policies. Japan’s banking system still puts too much cheap credit in the hands of favored borrowers.  But, the problem is more damaging in China that elsewhere, for two reasons: first, many of China’s best companies are small and private. They are starved of capital and so can’t grow to meet consumer demand. Second, the continuing deluge of credit for state-owned companies distorts the competitive landscape, keeping tired, often loss-making incumbents in business at the expense of better, nimbler and more efficient competitors. 

In other words, China’s credit allocation policies are actually stifling overall economic growth and inhibiting choice for Chinese consumers and businesses. 

State-owned banks everywhere, not just in China, have the same fatal flaw. They like an easy life, which means lending to companies favored by their controlling shareholder, not those that will earn the greatest return.  They can turn a deaf ear to profit signals because, ultimately, profit isn’t the only purpose of their labors. They allocate credit as part of some larger scheme, in China’s case, maintaining output and employment in the country’s less competitive,  clapped-out industries.  

There’s a regional dimension to this too. China’s richest, most developed areas are in South,  particularly the powerhouse provinces of Guangdong, Zhejiang and Fujian.  The economy here is driven by private, entrepreneurial companies, not the state-owned leviathans of the North. As a result, a credit policy that discriminate against private SME also ends up discriminating against the parts of China with the highest levels of private ownership and per capital wealth. 

That’s not sound banking, or sound policy. The good news is that the situation is changing. SME are gradually taking a larger share of all lending. The change is still too slow, too incremental, as the latest figures show. But, with each cautious step, the private sector, led by entrepreneurial SME, gains potency, gains scale and gains more of the resources it needs to provide the products and services Chinese most want to buy.  

I’m flying back from China as I write this, and bringing with me something of great value to me personally — even if I can’t claim to recognize every character. It’s the Chinese-language report prepared by my China First Capital colleagues on how a Chinese SME can avoid the quicksand and plan a successful IPO. Built on a first draft in English of mine, it’s written specifically for Chinese SME bosses. The report is called “如何选择上市的时机和地点”. 

Download Here: 如何选择上市的时机和地点 “When & Where to IPO for Chinese SME”

We prepared the report with the explicit goal to help SME bosses make more informed decisions in capital-raising and IPO. There’s been an acute lack of reliable, well-researched information in Chinese on this topic. We hope the report will improve this “information deficit”. 

For me personally, this is the most important report we’ve prepared thus far for SME bosses. As this blog has discussed at length recently,  Chinese SMEs have been victimized disproportionately by every form of IPO indignity, from US OTCBB listings, to reverse mergers, Malaysian IPOs, SPACs and other schemes promoted by the predatory bankers, lawyers and advisors that swarm around China. 

Indeed, there are few bigger risks to a successful Chinese SME than making the wrong decision and heeding the wrong advice on where and when to IPO. 

I’d welcome feedback on the report. You can email me at ceo@chinafirstcapital.com

For those who can’t read the report in Chinese, it provides a comprehensive summary of pluses and minuses for Chinese SME of listing on the US, Hong Kong and Chinese stock markets. It also discusses at length, with several case studies,  the damage done to good Chinese SME by OTCBB listings and reverse mergers in the US. The bad examples abound. 

Even if you can’t read the Chinese, I hope you’ll consider sending it on to those active in China’s capital markets, as well as to any Chinese businessmen contemplating a public offering.  Better Chinese-language information is the strongest antiseptic to kill off the bad deals and bad dealmakers in China. So, I hope all those with a genuine interest in promoting entrepreneurship in China will help spread the word.

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In recent years, a large percentage of all OTCBB IPOs have been for Chinese SME companies. This is largely because too many Chinese SME fall too easily into the pit of investment vipers – the lawyers, accountants and self-described “investment bankers” and “private equity investors” that promote these OTCBB listings, reverse mergers and other schemes concocted by advisors generally for their own self-enrichment.

Once caught in the trap, the prospects for the SME are generally pretty bleak. They’ll be bled of badly-needed cash to pay the advisors, bankers and lawyers their fees, and later, by the costs of remaining a listed company. The bosses come to learn that a “US IPO” isn’t at all what it’s cracked up to be when it takes place on OTCBB: there are no celebratory news reports, no huge sums flowing into their personal or corporate bank accounts, no boost in company prestige or brand awareness. At best, it turns out to be a very expensive lesson. At worst, it’s the transaction that leads to the company’s premature demise.

Of course, by the time the SME realizes the scale of the mistake it made by agreeing to IPO on OTCBB, the advisors, lawyers and bankers are all long gone. I’ve heard from a Chinese lawyer friend that these advisors will change their mobile phone numbers after the IPO so the SME boss can no longer contact them.

Indeed, the distinguishing characteristic of these advisors and bankers is their disregard for the future condition of the Chinese SMEs once they’ve done the OTCBB transaction. They have no stake in the long-term success of the company, because they cash out at IPO, and move onto their next victim, er client.

It is not unusual that advisors earn millions of dollars from these OTCBB deals. It may be the most successful and durable investment banking racket of all time. Hundreds of Chinese companies have been ensnared over the last seven years.

How has it gone on for so long? For one thing, the OTCBB is not regulated in any real sense of the word. So, the SEC has little or no power to crack-down. The larger factor, though, is the complete lack of adequate scrutiny by the Chinese SME bosses. They put their business’s future in the hands of a bunch of guys with a proven talent (and mile-long rap sheets) for destroying companies, not building them.

I’m constantly amazed that great Chinese SME bosses I’ve met will do no independent due diligence on financial advisors. They don’t ask for a full track record of past deals, or partner bios, or a list of satisfied past customers to consult. Everything is taken at face value, and appropriately enough, the common result is a very large loss of face for the Chinese boss, after these bad deals have closed, and the damage is calculated.

Even if a Chinese boss wanted to do some proper due diligence, it’s by no means simple. There’s a notable lack of good, current information about the OTCBB in Chinese. Chinese journalists don’t ever seem to write about it, perhaps because these IPOs take place outside China. I did a search of OTCBB on China’s main search engine, Baidu.com, and the top results included information that’s three to four years old, and a site called OTCBB.com.cn that offers very little information, and seems to be owned and run by the kind of advisory firm that specializes in (you guessed it) doing OTCBB listings of Chinese companies. You won’t find anything too useful here.

It doesn’t take a lot of digging, assuming one can speak some English and knows where to look, to discover information that should start alarm bells ringing loud enough to wake the dead. For example, the Chinese government doesn’t recognize the OTCBB as a legitimate stock market for many transactions. Here’s a kernel of disclosure language from the SEC filing of a Chinese company that listed on OTCBB. (Underlined for emphasis:)

“The stock portion of the purchase price of Weihe to Weihe’s stockholders because the delivery of shares of the Company’s common stock in connection with the acquisition of Weihe is not permitted pursuant to applicable PRC law, so long as the Company is listed and traded on the OTCBB, rather than an exchange recognized by the applicable PRC governmental authorities, such as Nasdaq, AMEX and the NYSE.”

Imagine for a second you’re a lawyer, working with a Chinese SME on a proposed OTCBB listing. You must know this fact, that the Chinese government doesn’t recognize that stock market as legitimate. What do you do? Do you exercise your duty-of-care, and tell the client of the danger of an OTCBB listing? Or, do you just gloss over it, so that the deal will go through and you’ll earn big legal fees?

No prizes for guessing which course many of the lawyers take who advise Chinese SME on OTCBB listing. This is why it’s not, in my mind, exaggerating to say that these advisors are often a disgrace to their professions.

What can be done about all of this? It’s already too late for hundreds of Chinese companies that went down this road. For the other thousands of good SME bosses, however, access to better information in Chinese is obviously going to be important, to give them a solid basis to decide which kind of capital markets transaction to pursue.

I’ve done my share lately of cursing the darkness in this blog, remonstrating against the advisors, lawyers and bankers who’ve grown rich off promoting OTCBB and Pink Sheet listings, reverse mergers and SPAC deals. It’s time I also lit a candle.

Together with my colleagues at China First Capital, we’ve been working on a Chinese-language publication called “如何选择上市的时机和地点” or “When and Where to IPO”. It discusses at some length the problems with listing on OTCBB, or doing other kinds of rushed IPOs.

We’ll be completing it this week, and once done, we’ll do our utmost to make it as widely available as possible, in print and online.

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The timing of IPO is the most important question for all Chinese SME preparing for a public listing. Unfortunately, the correct answer is often the one most rarely heard. Instead, many investment bankers and advisors in China tell the SME boss that an IPO should be scheduled “as soon as possible”.

This is often music to the bosses untrained ears, since they’re wrongly assuming that the proceeds of an IPO will go directly into their pockets – a misconception these same investment bankers and advisors can literally cash in on. They’ll tell the SME boss the “bad” news — that the IPO proceeds must go to the company not to his personal bank account, and that the boss won’t be able to sell any of his own shares for a year or more after the IPO – towards the end of the expensive pre-IPO planning process, when it’s usually too late to pull out, without losing a huge amount of money.

This is if they bother to mention it at all. I’ve heard of instances where the Chinese boss is never told directly by his investment bankers, lawyers and advisors, but only finds out if his staff prepares a Chinese translation of the SB-2 prospectus used in OTCBB listings.

So, if not “right away”, what is the correct answer to the question: “when should a Chinese SME IPO”? Of course, circumstances will differ for each company. But, as a general principle, an IPO should come at the apex of an SME’s growth curve, when the company is achieving its historical highest return on equity and return on investment. This way, the SME will get a fuller value for its shares when it does list them publicly.

This also explains why pre-IPO private equity can have such a key role to play in the process. The purpose: put more capital to work than the company can generate internally, or can borrow from banks. This equity capital is then invested where it will earn the highest return over a two to three year period – for example, increasing production and improving economies of scale, or accelerating the pace of opening new distribution outlets.

The PE firm will also help improve efficiencies – in their role as risk-sharing partner with the SME boss – that can lead to significant improvement in net margins. In most cases, the pre-IPO PE capital can result in a doubling of profits. Done right, the pre-IPO capital will result in only modest level of dilution for existing owners – usually no more than 25%. It’s like switching on the after-burners: the SME can speed up its growth, improve its margins, seize large available market opportunities, and so position itself for a far more successful IPO in two to three years’ time.

An IPO has one great value above everything else: it will be the cheapest and most efficient way for an SME to raise the capital it needs to expand its business. The shares will likely be valued at multiples two times higher than a pre-IPO PE investor will pay. Since the amount of capital raised will be a multiple of profits, the higher the profits at IPO the better.

To illustrate this, let’s imagine a company with profits last year of RMB75 million. It has its IPO now, at a PE of 15 and its market capitalization at IPO is RMB 1,125,000,000. The company sells 25% of its shares in the IPO, and so it raises RMB 281,250,000. If instead the company waits another year, it raises a RMB50 million of pre-IPO private equity to help push its profit growth. A year later, profits have reached RMB120 million. If the company now has its IPO, at the same PE of 15, and sells 25% of the shares, it will raise RMB450,000,000 or 60% more.

Let’s  assume  the company continues to maintain a high return-on-investment, after IPO. If so, the more money raised at IPO, the higher profits should be able grow in the future. This is perhaps the most important predictor of overall share performance after IPO. By waiting to IPO, so that its size and profits would be larger, this company will be able to raise much more at IPO and so continue generate higher profits for many years into the future.

A company can IPO only once. So, it is important to raise the optimal amount during this one IPO. If a company IPOs too early, it will sacrifice its ability to finance its growth in the future. Many of the most successful IPOs in China were for private SME companies that had pre-IPO investment from private equity companies: Baidu, Alibaba, Suntech, Belle. That isn’t a coincidence. It’s the result of the sort of smart IPO-planning that is too rare in China.

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At ground level here in China, it’s easy to see some of the more obvious signs of the financial distortion this chart portrays. In August last year, in the face of gathering worldwide economic slowdown, the Chinese government relaxed earlier controls on bank lending, basically instructing the state-owned banks to keep the economy and employment growing by expanding credit to businesses. Later in the year, the government lowered interest rates to further spur lending. 

My worry at the time was that most of this increase in bank lending would be channeled to the least deserving customers: the many clapped-out large state-owned enterprises, rather than the far more numerous thriving private sector companies short of cash. This would more or less defeat the purpose of the government pump-priming, since the lending would only allow some of the country’s least competitive most loss-making manufacturers to stay in business that much longer, at the expense of their better private-sector competitors. As a job-saving mechanism, it would likely be equally flawed, since most of the new lending would sustain for a little while longer bad jobs in bad businesses that should be allowed to wither. Failure is rewarded and success penalized. 

Well, the worries appear to have been very well-founded. The most deserving borrowers, China’s dynamic entrepreneurial Small & Medium Enterprises (SME), mainly came away empty-handed when all this new lending was being handed out. As the chart shows, overall bank lending to SMEs didn’t even crack 10% of total lending at four of the largest state-owned banks. With the exception of the more entrepreneur-friendly China Merchants Bank, which also happens to be the only bank on the list not owned by the central government, the large Chinese banks continued their past (bad) habits of stuffing bank loans into the tottering state-owned giants. 

The eventual outcome, of course, will be a lot more write-offs and non-performing loans inside these state-owned banks. For an abject lesson in bank lending policy, it’s hard to outdo this: the government-owned banks make loans to other government-owned bodies, which then default, causing losses at the government-owned banks that then need to be recapitalized by – you guessed it – more money from the government. 

There’s an even more malign effect: it’s actually getting harder – not easier – for China’s best-performing SMEs to obtain credit. These are the companies that are producing products consumers want, expanding employment, servicing their loans, making profits and paying taxes. The private sector now accounts for over two-thirds of China’s total economic output, and private SMEs represent the bulk of this. 

The Macquarie chart suggests the credit system of China state-owned banks is largely broken: borrowers least able to repay are those granted most of the lending. There are lots of losers in this, but no one is affected more adversely by this than the owners of China’s best SMEs. They are being locked out of the market for bank lending by Chinese banks. 

That leaves one possibility: SMEs finance their expansion through equity, rather than debt. This investment capital will come from outside the realm of China’s state-owned banks. Instead, it will largely be provided by the 100 or so private equity and venture capital firms now active in China. They have raised over $30 billion to invest in China, and the SMEs are a favorite target. 

Of course, not all SMEs will be able to raise equity. It’s generally an option only for the higher-performing SMEs with significant scale and significant presence in China’s domestic market. My company is an international investment bank working exclusively with Chinese SMEs, to help them raise equity finance from the best sources active in China, mainly the top private equity and venture capital firms.  The challenge for us, as for the private equity firms, is that too few of China’s best SME bosses know that they can access private equity investment and so escape from the perils of undercapitalization. 

For the SMEs that can raise money from international investors, this is not just the best option – but also often the only option – to finance growth. An injection of equity will deliver both the resources to grow more quickly and sizable competitive advantage against under-capitalized competitors. 

An additional advantage: by raising equity, an SME will strengthen its balance sheet and so be more likely to succeed in borrowing from one of the very good international banks with operations in China and a focused expertise on lending to Chinese SMEs: Citibank, Standard Chartered, ABN-AMRO foremost among these. I know the management in Shenzhen of all three banks. They are very well-run and very well-connected among SMEs across China. The three international banks bridge the huge gap created by Chinese state-owned banks failures to make adequate lending available to SME customers. 

For Citibank and ABN-AMRO, their current performance in China, founded on their strong presence in SME lending, is one of the only bright spots for two organizations that could do few things right elsewhere recently. Together, they lost over $30 billion last year, and Citibank is now a ward of the US government. 

Everything ABN-AMRO and Citibank did so spectacularly wrong in other countries, they do spectacularly right in China – they focus on the right clients, the right kind of products (loans to growth companies) and having steady bankers, not deal-makers, at the top.  If Citibank and ABN-AMRO are ever to recover their lost luster globally, they should learn from the example of their China operations. The banks represent two of the brightest hopes for the future financing of China’s SME entrepreneur class. 

In China today, there is no larger financial need – and no larger financial opportunity for investors – than to put additional finance into strong fast-growing private SMEs. This will allow them to grow most immediately into the leaders in China’s domestic market, and eventually, for some, into publicly-traded global businesses. 

China’s state-owned banks, meanwhile, will likely continue on their wayward path of lending to companies with more political clout than business ability. It’s a losing strategy for them. But, it’s one that creates ideal conditions for well-managed international banks in China, with the skills, market knowledge and focus to lend to SMEs (take another bow Citibank, Standard Chartered, and ABN-AMRO), to prosper alongside their SME clients.  

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Not quite “a staircase to hell”, but the graphic below shows the steep fall in IPO activity in China in 2008. It looks pretty scary, doesn’t it? Chinese IPO activity in 2008 was at its lowest level since 2004. IPO activity basically came to a halt towards the end of last year. 

No one looking at the table will see much room for optimism. But, it’s worth remembering that though down by almost 80% from the year earlier, IPOs of Chinese companies in 2008 still did manage to raise $20 billion of new capital. The key thing now is that this money is used well and wisely, to build profits and market share at these now-publicly-traded Chinese companies. By doing so, these companies will provide an impetus for companies and investors to get back into the IPO market. 

In other words, the IPO market in China is most attractive vibrant not when a company sees a big price jump in its first days of trading. This does little for company, and benefits mainly those who claimed an allocation of shares ahead of the IPO. The key driver for the IPO market should be that the capital raised in an IPO is used wisely, to put companies on a higher growth path. 

Higher profits will boost company valuation, and also allow newly-listed companies to more easily raise additional equity capital in the future. As I sometimes remind the Chinese laoban we work with, “an IPO should not be just a goal in itself, but also the cheapest way to raise additional capital to build your business even faster.” 

Take the money from a public listing to make more money: that’s the quickest way in which Chinese companies can do their part for reviving the IPO market and start building again the “staircase to heaven”, with annual gains every year in the amount of money raised through IPOs. 

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Looking purely at the economic news from China of late, this has not been the happiest of Chinese New Years. The Chinese government is estimating that 16% of the huge migrant labor force of 200 million will have no job to return to after the New Year.  Factories are continuing to close, or cut employment, across the country. Guangdong province, where China First Capital has its base in China, is particularly hard hit, because it’s still the primary production base for much of China’s better private factories. While factories are being moved out of Guangdong to less expensive, inland locations like Jiangxi, overall industrial employment in factories in Guangdong is still huge, and hugely reliant on migrant labor. There’s no solid date, but ten million or more workers may have lost their jobs in Guangdong over the last six months. 

The picture is no less bleak in terms of projections for corporate profits in China in 2009. Larger companies are reporting profit falls of over 50% in 2008, and forecasting even worse results this year. This matters crucially in China. Over 40% of total economic output is generated by business investment. This, in turn,  is intimately tied to corporate profits, since most of that business investment is financed out of retained profits. According to a recent report in the Wall Street Journal, “official statistics show that 63% of investment in China last year was financed by what are called “internally generated” funds, which include retained profits. That’s up from just below 50% a decade ago.” 

In other words, as corporate profits decline, they take Chinese GDP growth with them. This falling economic output, in turn, influences consumer sentiment, and so takes personal spending down with it. 

Good economic news is a scarce commodity this Chinese New Year. But, I see one bright glimmer of hope here. Chinese companies have been excessively reliant on retained earnings and expensive bank debt to finance their growth, rather than equity capital. The difficult economic environment, in China and indeed worldwide, provides a good opportunity for better Chinese companies to reorient their method of financing capital investment and growth. It’s the right time to take on equity capital, and use it as a platform to continue to invest and grow, even if corporate profits are in cyclical decline. 

The Chinese companies that can raise equity finance will enjoy a significant financial advantage over competitors, and so be able to gain market share. Adding equity finance lets a company both lower its overall cost of capital, and also increase the amount of capital it can put to work in its business. Both of these factors equate to a very real competitive advantage. 

Equity investors, principally PE firms, will need to change their orientation as well. The opportunities to do shorter-term “pre-IPO” financing are far fewer than they were, because stock market valuations are way down and IPO activity has slowed to a crawl. So, the simple arbitrage of a PE firm buying into a Chinese company at a valuation, say, of 10x and selling out 18 months later in an IPO at 20x are gone. 

Instead, PE investors in China need to think more like value investors, and less like arbitrageurs. This means looking for opportunities to deploy capital into good businesses offering high rates of return on that invested capital. Equity investment is then used to expand output, lower unit costs, gain market share, and so expand both profits and profit margins. Build profits and valuation will take care of itself. If a Chinese company can put equity capital to work well, and accelerate profits in 2009 and beyond, that business will be worth a lot more money when the IPO market revives than if it simply cut back on investing to ride out the bad times. 

This year is going to be difficult, challenging, but also potentially highly rewarding for all of us participating in the financing of private companies in China. It’s a year when good companies should be able to get even better. And smart-money PE firms will make far more, over the medium-term, than fast-money valuation arbitrageurs ever did. 

I’m just back in Shenzhen from a visit to a client in Kunshan, near Shanghai. For me personally, it was a particularly poignant trip. 

It’s the first time I’ve been back to Jiangsu since 1982, when I left Nanjing University. Thinking as much with my stomach as my head, I immediately on arriving at 9:30pm on Wednesday night cajoled Nina, my partner, to go on a late-night search of great Jiangsu food. I eventually lost count, but by the time I left, I must have had enough xiaolongbao to feed a nursery school.

 As thoroughly enjoyable as this “Jiangsu homecoming” was, it was not even close to being the highpoint of the trip. We spent two full-days with our client, in meetings with a very select number of Private Equity firms. The meetings, from my standpoint, were truly outstanding – a text-book example of how great businesses and a great institutional investors should interact.

In fact, our client and the PE investors were, to my eye, as well-matched as this pair of Tang Dynasty horses. 

As I told one of the PE partners afterward, I’ve been in a lot of initial meetings between companies and PE or VC firms. But, never was I involved in a investment meeting that was conducted at such a uniformly high level, with both company and investor executing at the highest level of accomplishment and professionalism. 

For the PEs, this was the second-round of meetings, following earlier ones in Shenzhen, with our client’s CFO, that focused primarily on the company’s financial performance. Our client’s core leadership and ownership, however, are both based in Kunshan. So, there was even more to discuss in this second round meeting. 

For our client, this was on-the-job training. They’ve built an enormously successful business, with sales this year in excess of $120 million, and a strong likelihood of becoming, within five years, a multi-billion dollar enterprise. But, the client has done all this without equity finance, using only retained earnings and bank debt. So,  they’d never before presented themselves to sophisticated and experienced equity investors.  They don’t come any more sophisticated and experienced that these particular PE investors, with track records, both as individuals and as firms, that put them at the top of their profession. 

Our client more than exceeded our highest expectations, preparing exhaustively and answering comprehensively. 

China First Capital works to find the right investor for its clients. Not the investor offering the highest valuation, or the quickest path to IPO. We give this a lot of thought, matching the strengths of our client to the strengths of a particular PE firm. Done right, it’s transformational for both company and investor: a case of the total value created not being just larger than the sum of the parts, but exponentially so. 

It’s early yet in the process. We’re planning on several more meetings with PE firms. But, I left Kunshan even more optimistic about our client’s future, building a great partnership with a PE investor. 

It may not sound like it, but it’s meant to be my highest compliment to both our client and the PE firms we met with this week:  the xiaolongbao were good. The meetings were better. 

One of the supreme satisfactions of my work – and I’m fortunate that my job offers quite a few – is the time spent advising laoban (“business owner” in Chinese) on the value of private equity investment. These owners are entrepreneurs, not financial engineers. So, the world of private equity deal-making and finance is often entirely unfamiliar. As I tell these laoban, in my less-than-fluent Chinese, “you have already done the hardest thing possible in business, by taking an idea, adding little or no capital, and created in China, the most competitive market in the world, a successful business of significant size and fantastic prospects.” Compared to this, anything will appear easy, including closing a round of equity capital from one of the leading private equity or venture capital firms. 

Now, of course, closing a PE investment round is anything but easy. It involves, at a minimum,  a sizable amount of time, stamina, senior-level attention, perseverance, transparency, thoroughness and commitment to building a fully-aligned partnership with an outside investor.  I’ve seen it from both sides, both as a CEO and as a venture capitalist. The process can seem like breaking rocks with a spoon. 

But, it’s always rewarding and inspiring for me to see how quickly our laoban start mastering the intricacies of raising capital. They climb the steep learning curve fast. But, it is still a learning curve, and I’ve often made the process harder by doing an inadequate job preparing them for their first meetings. In fact, there ought to be a typically wise four-character Chinese proverb, or chengyu, to describe it: “Good students. Poor instructor.” 

I’ll admit to being a poor instructor. But, an improvable one? I’d like to think so. 

Together with my colleagues at China First Capital, I’ve put together a list of ten questions laoban should expect to hear in a first meeting with a PE firm. The purpose: to give the laoban a quick sense of the scope and rigor of the PE investment process.   

Of course, in any first meeting with a professional PE firm, there will be many more than ten questions. It’s unlikely any PE would ask all – or even the majority – of the ten on the list. 

But, these owner-entrepreneurs are all outstanding problem-solvers. If they weren’t, they wouldn’t be running and owning the sort of businesses of interest to good PE investors. 

So, the questions are really just a catalyst, to get the laoban to think about how a sophisticated investor will evaluate his business. In other words, to see his business from the outside looking in. This is like refraction, where shifting the angle changes the quality of the light. 

Here are the ten questions.  There are no right answers, of course. Only a right mindset.      

1.  How much of your equity are you selling?
   
2. What will you use this equity investment for?
   
3. When do you hope to complete this fund‐raising?
   
4. When will you IPO?
   
5. What are you looking for besides capital from an investor?
   
6. How do you think you can double or triple your profits?
   
7. How much is your valuation?
   
8. Who are your competitors and what are your competitive edges?
   
9. Can you please explain your strategy for growing faster than your competitors?
   
10. Please give me brief summary of the jobs and the past experience of the most important members of your management team?