China Law Insight : China Business and Intellectual Property Lawyers & Attorneys : King & Wood Law Firm : IP, Arbitration, Litigation, Securities, Foreign Investment

Angel Profiles

A recent article on Hong Kong’s VC industry has an interesting analysis of angel investors in Hong Kong. It put them into five categories :

• Sophisticated – the “true” and knowledgeable angel investment practitioners;
• Businessmen – knowledgeable but less intense investors in start-ups doing deals as an alternative investment form;
• Corporate – manufacturers seeking tech startups to extend their product lines or services;
• Incidental – highly wealthy individuals investing to prove themselves or kill time; and
• Traditional entrepreneurs – traditionally minded bosses who will invest only if they are in control, not the founders who came up with the original ideas.

Outside certain portions of the above circles, the concept of angel financing is only beginning to be understood or practiced widely.

Angel Networks

Angels acting in concert or in organized groups is a more effective way to invest. Accordingly, organized angel networks have begun to emerge in recent years. We cite a few better known examples below.

• British Chamber of Commerce Business Angel Programme (http://www.britcham.com/baker-tilly-business-angel-programme) was initiated by the British Chamber’s IT and SME committees and sponsored by a local audit and business service advisory firm. This program has been running two or three meetings a year, where a number of shortlisted investee companies are given the opportunity to make presentations.
• China Business Angel Network (CBAN) (http://chinabusinessangelnetwork.angelgroups.net/) Hong Kong Chapter is the local chapter of CBAN, an established network of more than 140 angels with chapters in Shenzhen, Shanghai and Beijing. CBAN members enjoy reciprocal membership with Business Angel Network South East Asia (BANSEA) in Singapore.
• Hong Kong Angel Capital Network (www.facebook.com/group.php?gid=4505959039) is created as a joint venture among its members and Dr. Samson Tam, founder of Group Sense Limited and currently a legislator in Hong Kong. Member admission is by invitation or referral only, requiring declaration of not less than HK$20,000,000 of investable fund and investment in at least one project of the Network in a 12-month period.
• Tolo Habour Business Angel Support Group (www.baf.cuhk.edu.hk/research/gem/_new/EN/education/thbasg/index_thbasg.html) is an initiative of the Chinese University of Hong Kong Centre for Entrepreneurship to match companies with good potential with prospective angel investors through the University’s alumni network.

Angel clubs, Angel funds or investment groups

Going beyond networks, angels might band together to invest collectively as angel clubs, angel funds or investment groups. So far, such efforts in Hong Kong seem far and few in between. A few of the budding ones may include:

• Black Horse (www.darkhorseinvest.com), a small angel investment group that typically invests US$50,000 to US$1,000,000 in each company and looks to co-invests with other venture funds in Asian companies with capital requirement of US$1,000,000 to US$5,000,000 and a valuation of US$2,000,000 to US$10,000,000. Its industry focus is IT, telecom, education and environmental protection.
• Catalyst Group (www.catalistgroup.com)
• Hong Kong Angel Investment Network (www.investmentnetwork.hk) is a London-based investment company. It provides a web-based matching service for angel investors seeking investment opportunities and entrepreneurs seeking capital. Entrepreneurs are charged upfront referral fees for the service

Amounts and Structure of Financing

Based on general observations, the deal size of angel investment in Hong Kong seem to largely fall under the norms elsewhere. Individual investors generally takes one or more units of roughly US$50,000 each, resulting in rounds of financing aggregating roughly between US$0.5 million to US$1.0 million per round.

The funding vehicle and the corporate structure in Hong Kong are often more complex and less uniform than those elsewhere, such as Silicon Valley. This is a reflection of the need to adapt to the varying requirements to operate multi-jurisdictionally. For instance, companies of Hong Kong based founders that operate in the mainland will need to set up a corporate structure not only in Hong Kong but also on the mainland. Typically, ordinary shares are used for the initial rounds. However, following the financing practice of the US, some investments are taking on more sophisticated structures, including the use of preferred shares and convertible notes.
 

In a broad sense, angel investment might have been a part of local economic life for decades. Most such activities, however, tend to be of an informal and spotty nature; well to do individuals would fund an occasional new venture of a favorite nephew or a close friend that has the potential to become a business success.

Better organized angel investment activities of the type prevalent in the West however, have been slow and hard to blossom. The causes are probably manifold. One factor may be the profusion of investment alternatives available in this business boomtown which distracts the attention of would-be angel investors. Another factor may be the traditional Chinese mindset to want majority control in any business one finances. The tendency to grow business within family circles also dampens efforts to support any outside business.

The tide may be changing though. During the last decade or two, thanks partly to the Internet led startup movement, angel investment are becoming familiar to Hong Kong. This coincides with two other significant trends that encourage entrepreneurial pursuits: the tremendous business opportunities unleashed by rapid economic development in mainland China and a change of attitude by the government on its policy toward technology and innovation.

These trends point to stepped-up entrepreneurial activities and an increased demand among the local startup community for more organized angel funding. We may now be reaching an inflection point, with angel financing poised to elevate to a much more active and visible level in the coming years.

Business Environment

Ranked as the world's freest economy by the Wall Street Journal and Heritage Foundation's Index of Economic Freedom for 15 consecutive years, Hong Kong has long been a favorable setting for entrepreneurialism and business formation. Many small companies grew into sizable operations and a considerable number became listed conglomerates. The most celebrated example is perhaps Cheung Kong (Holdings) Limited, empire of Hong Kong business legend Li Ka-shing, which started as a modest assembling operation of plastic products.

In face of the recent global economic turmoil, Hong Kong has been among the first few economies to show signs of recovery. Business formation continued to be on a rising trend. In 2008, a total of 97,985 private companies were incorporated, which shows a slight drop from 100,041 in 2007 but still exceeds 81,432 recorded in 2006.

Hong Kong's inherent business strength has received a further boost in recent decades by its close relationship with an opening mainland China. Hong Kong is an enclave with a population of merely seven million. Before mainland China opened up, most Hong Kong businesses had limited access to the mainland market and were only able to target the international markets. China's reform and open-door policies that began in the late 1970's and intensified throughout the ensuing years opened up an enormous new market to Hong Kong.

China joined the World Trade Organization (WTO) in 2001 and became an official member state in 2006. This made it possible for foreign, including Hong Kong, companies to crack open numerous market sectors in China. What is more, as a special favor to Hong Kong, the Chinese government and the Hong Kong government signed the Closer Economic Partnership Arrangement (CEPA) in 2003. As of this writing, Supplement VI of CEPA has already been signed, providing Hong Kong businesses with even more preferential treatments and policies in terms of duty free trade in goods, trade in services and sector access for investment in China.

The Arrangement for the Avoidance of Double Taxation on Income and Prevention of Fiscal Evasion (DTA) between China and Hong Kong, which came into effect on April 1, 2007, allows Hong Kong companies and individuals to enjoy reduced tax rates on such passive income as interest payments, dividends, royalties and capital gains. The reduction in tax rates under this Arrangement is favorable compared with other countries with double tax treaties with China. It has also further strengthened Hong Kong's position as the gateway for foreign investments into Mainland China.

Hong Kong and China also signed “The Arrangement on Reciprocal Recognition and Enforcement of Judgments in Civil and Commercial Matters by the Courts of the Mainland and of the Hong Kong Special Administrative Region Pursuant to Choice of Court Agreements between Parties Concerned” in July, 2006. The Arrangement became effective for Hong Kong on August 1, 2008. This made it possible for Hong Kong and Chinese parties to economic contractual disputes to have their disputes resolved by Hong Kong courts.

These developments have thrown open to the Hong Kong business community a huge market of 1.3 billion people. As the Chinese saying goes: “pavilions that are near the water first get the moon” (meaning the mere proximity to a source of wealth or influence gives a decided advantage), thanks to its proximity to China, Hong Kong is indeed running into a golden opportunity of a lifetime.