In the early 1980s, after decades with a tightly managed planned economy, China’s state leadership began introducing capitalist market principles into the Chinese economy. In the following decades, the Chinese economy grew dramatically; from 1990 to 2005, China’s gross domestic product (GDP) grew at an average annual rate of more than 10 percent. During the same period, in comparison, U.S. GDP grew at approximately 3 percent per year.3
In addition, China had a large and growing entrepreneurial population. According to a 2009 Global Entrepreneurship Monitor (GEM) report, China had even more entrepreneurs than the United States, both in terms of the number of small business owners and high-growth-expectation ventures.4
Despite the growth of entrepreneurship in China, the financing landscape for start-ups in China was far less developed than the situation in the United States. China had limited sources of domestic funding, and Chinese banking regulations restricted the ability of financial institutions to support Chinese companies. It was especially challenging for banks to finance small and medium enterprises (SMEs) as well as companies with intangible assets (e.g., technology companies). However, given the need to sustain entrepreneurial growth, the Chinese government began to loosen the banking sector in the mid-2000s. The ability to finance China’s budding entrepreneurs presented a huge opportunity to financial firms, and foreign banks were eager to participate.
Although China’s growing economy was a great opportunity, it also posed many challenges, especially for western companies. In addition to language and cultural differences, foreign companies faced distinct customer preferences as well as stringent government policy hurdles. Navigating this new landscape was a challenge even for successful U.S. companies; eBay, Google, and Walmart, among many others, had struggled to gain traction in China.
An additional challenge for foreign financial firms was the inability to conduct business in renminbi, the Chinese local currency. International investors, including banks, could access the Chinese market and Chinese companies through the “offshore” market. However, the offshore process was complicated and cumbersome. If a foreign company wanted to invest in a Chinese company, the transaction would require the creation of new holding companies, navigation of complex Chinese M&A laws, updated company articles, the exchange of foreign currencies, and then months spent waiting for government approval of the foreign investment deal. To avoid such complexities, Chinese companies often preferred to work with domestic investors and banks who could invest directly in the company in renminbi. This was especially true for Chinese technology companies, the majority of which did not want to wait months to receive financing in a foreign currency. Yet in the mid-2000s, it was uncertain whether foreign companies could access the onshore renminbi market; and even if they could, making these deals would undoubtedly be time-consuming, expensive, and risky.