This is a guest post by Andy Mok, founder of Red Pagoda Resources, which finds and delivers exceptional talent toaudaciously visionary startups in China.

It’s said that a rising tide lifts all boats. In China today, a confluence of forces has created a tide of unprecedented proportions that will most likely lift entrepreneurs and those building companies now highest of all.

What are these forces?

First, while the notion of guo jin min tui (国进民退 – the state advances while the private sector retreats) has gotten a lot of recent attention, the private sector in China has quietly become the engine of economic growth and outpaces the state-owned sector in a few essential benchmarks.

For example, in a recent Economist article, a Communist Party official noted that there are 43 million companies in China of which 93% are private and employ 92% of China’s workers. According to China Macro Finance, a research firm in New York, the number of registered private businesses grew by more than 30% a year between 2000 and 2009. Given China’s continued strong economic growth and emphasis on domestic consumption, this trend is likely to continue, if not actually accelerate.

More importantly, a study by Qiao Liu, a professor at the University of Hong Kong, concludes that the average return on equity for state-owned companies was about 4% while the returns of unlisted private firms are at least ten percentage points higher.

Note that these heady growth rates and profitability indicators have been achieved with relatively limited access to capital. For example, some analysts estimate that the private sector accounts for up to 80% of enterprise profits in China yet loans to small and medium-sized enterprises (SMEs) comprise 4% or less of the total made by three of the country’s four largest banks.

Which leads to my second point, capital constraints are being vastly eased. Government policies to extend credit to SMEs have been emphasized and it looks like loan volumes are in fact increasing. Also, other lending institutions are starting to recognize the opportunity to serve this rapidly growing market. More interestingly, from both a business and investment perspective, the amount of risk capital available for high potential early stage companies has exploded with 2010 being a banner year.

For example, according to Zero2IPO, over US$10 billion was raised in 2010 for the China VC market and more than 150 new funds were launched. Also, more than 800 investments were made totaling more than $5 billion. This enthusiasm seems to be justified by recent exits including the highly successful IPOs for Dangdang and Youku, which were just two of almost 400 exits last year (versus about 120 in 2009). Also, within the TMT (technology, media and telecommunications) space, there are signs of a greater willingness by industry leaders to buy versus make (i.e. compete with) innovations launched by new companies.

Furthermore, the long-term “smart money” (i.e. institutional LPs such as sovereign wealth funds, pension funds, etc.) has made significant re-allocations to emerging markets with China being high on the list. This ensures continued availability of capital for at least the next few years.

As such, early stage businesses in China with credible leadership who can demonstrate a coherent strategy targeting sizable and high growth markets can expect to see greater access to capital at increasingly attractive valuations, which can fuel that virtuous cycle of expansion and profitability. Meanwhile, while competition for industry leadership will, of course, be fierce, strong domestic growth and continued economic integration with the rest of the world should result in a somewhat more benign and forgiving operating environment for many companies here.

Given all this, the risk-reward trade-off of joining a startup seems to be tilting very favorably toward doing so. If you’ve been thinking about taking the plunge, come on in, the water is just fine.

 

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