As China's venture capital (VC) landscape grapples with significant fundraising and investment challenges, a new trend is emerging among VC and private equity (PE) firms in mainland China: an increasing interest in seeking funding in Hong KongThis emerging wave reflects a strategic pivot towards markets that offer more favorable conditions for investment.

However, mainland Chinese institutions face several challenges when attempting to navigate the Hong Kong market, from understanding qualification criteria to the intricacies of the licensing application process

What does the future hold for these institutions as they embark on this venture? And how can they effectively adapt to a “local” dynamic in the business?

Investors are turning to Hong Kong for funding

Recently, one investor named Wu Shuang (alias) has been preoccupied with the possibility of setting up a private equity fund in Hong KongWu is the fundraising director at a major VC firm in South China managing billions in assetsHe told our reporter, “I’ve heard that Hong Kong is heavily investing in tech innovation and has set up various guiding fundsWe want to explore these opportunities.”

Similarly, the head of another VC firm mentioned to our reporter, “We have been contemplating this for most of 2023, consulting with intermediaries about the feasibility of fundraising and establishing a fund in Hong Kong.” Meanwhile, the founder of a VC focused on biomedicine disclosed that they have already initiated a small fund in Hong Kong aimed primarily at local and overseas projects.

Indeed, 2023 witnessed a notable rise in the number of mainland VC/PE institutions exploring overseas fundraising options

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“This past couple of years, we've seen an uptick in VC firms consulting about building cross-border structures and overseas fundraisingThis includes not only big players but also mid-tier institutions,” said Chen Wenfeng, who has been facilitating VC firms in establishing USD frameworks and connecting with overseas capital.

Whether it was the previous “Singapore boom” or the recent Middle Eastern investment enthusiasm, the common denominator remains the same: fundraising and investment in mainland China are both cooling off significantly“It’s incredibly challenging to raise funds domestically now, and locating suitable investment targets has become a persistent difficultyWe thought about exploring overseas options,” Wu expressed.

However, our findings reveal that most institutions contemplating overseas fundraising are still in the consideration and preliminary research phases, with very few having successfully established funds and begun actual investments.

Hong Kong's funding climate is becoming more invigorated

Over the last couple of years, Hong Kong's accelerating focus on technological innovation has unlocked latent opportunities for mainland VC/PE firms

“Hong Kong is home to many prestigious universities with robust research capabilities, suggesting there are numerous technological breakthroughs ready for investmentFunds like ours, which focus on early-stage investments, find this especially appealing,” Wu elaboratedIncreasingly, early-stage investment firms are “investing earlier,” forging collaborations with universities to co-incubate projects, while also monitoring high-quality technological achievements and assisting in their commercial deployment.

In light of the prevailing trend of “early and smaller investments,” many university projects have become highly sought afterFor Hong Kong projects, standout factors include exceptional research capabilities and seamless pathways for capital exit

“Projects in Hong Kong can expand into mainland markets and eventually aim for listings either back in Hong Kong or overseas, which is a captivating prospect for capital providers,” Wu remarked.

It’s noteworthy that several prestigious universities in Hong Kong are exploring various avenues for engaging in venture investments, thereby enriching local tech projects and funding sourcesFor instance, on December 18, 2024, the University of Hong Kong publicly announced a milestone partnership with its initial cohort of Entrepreneurial Engine Fund (EEF) investors, committing alongside China Science and Technology Innovation Venture Capital (CSTVC) and InnoAngel Fund to inject 370 million HKD to support startup development from the university.

Previously, funds established by Hong Kong universities have tended to be relatively small, mainly supporting entrepreneurial ventures undertaken by their students or alumni

However, these institutions are now “testing the waters” with larger fund structures, designed to leverage social capital in collaborative investments in either their universities or local tech projectsAs noted by InnoAngel’s Hong Kong partner, Tan Weijiao, having universities set up funds allows social capital to team up with them, balancing risk while complementing each other’s strengthsThis localization can also benefit out-of-town institutions looking to penetrate the market.

Moreover, the establishment of Hong Kong Investment Management Company and its 30 billion HKD co-investment fund has garnered significant attention from mainland investment entitiesThis fund serves as a counterpart to the government-guided funds on the mainland, offering greater flexibility compared to the investment prerequisites of such funds back home

We have learned that several leading VC firms in Shenzhen are currently engaging with this fund.

During the Chief Executive's Policy Address in October last year, Hong Kong’s Chief Executive John Lee proposed numerous substantive support measures for fostering innovation and technology in Hong Kong, including the establishment of a 10 billion HKD “Innovation and Technology Industry Guide Fund” and the allocation of 1.5 billion HKD to establish collaborative funds with the industryThis indicates a burgeoning pool of innovation funds in Hong Kong is poised to create numerous avenues for institutions eager to invest in the region.

Current data shows that by the end of 2023, the total assets under management for private equity and venture capital funds in Hong Kong reached approximately 1.3 trillion HKD

In terms of innovation funds, the number of newly established such funds surged by around 30% compared to the previous year, while the amount of newly raised funds increased by nearly 40%.

How can foreign investors effectively navigate the local market?

Despite the eagerness to enter this new market, mainland VC firms are encountering numerous queries during the practical implementation phase“We remain unsure if we meet the qualifications required, how long the licensing application process will take, the potential costs involved, and whether funding in the local context will be flexible—all of which necessitates thorough preliminary research,” Wu articulated her concerns.

Interestingly, the vexing issue of tax in the domestic venture space might see alleviation in Hong Kong

Hong Kong’s Secretary for Financial Services and the Treasury, Xu Zhengyu, previously stated that eligible private funds could benefit from profits tax and salary tax exemptions based on their investment performance and returns.

As mainland VC institutions consider establishing a foothold in Hong Kong, understanding the local nuance in fundraising is crucialChen Wenfeng noted that the differences between the two markets are already evident at the fundraising stageWhen facilitating offshore fundraising for various domestic VC institutions, he observed that they tend to first showcase overarching aspects such as the firm’s brand, investment philosophy, targeted sectors, and historical internal rates of return (IRR), often neglecting to highlight specific project investment narratives.

“International investors delve into the details of investment specifics—like which projects have been funded, the process of sourcing projects, decision-making logic, how investments succeeded or failed, and what actions were taken post-failure,” Chen explained

International investors prioritize whether the firm’s investment philosophy and logic hold up when backtracking from tangible projects, especially during China's previous phase of rapid economic growth when there was heightened interest in whether investments generated “alpha” returns, enhancing the chances of successful fundraising.

For VC and PE institutions eyeing overseas fundraising, Chen provided three essential recommendations: first, conduct in-depth research and feasibility assessments of the overseas market; second, familiarize themselves with international investors’ investment logic and habits to seize the limited opportunities for fundraising roadshows; and third, prepare relevant materials in advance, aiming to enhance fundraising efficiencyTo put it simply, embracing a local mindset is imperative—understanding the “local” and the “customs” is vital for achieving success.