By John Lo, Partner, CorporateKing & Wood – Hong Kong

Angel investment in Hong Kong may be on the verge of an exciting transition from being an occasional engagement of a wealthy few to a more widespread, organized form of startup financing involving many more people with the wherewithal to invest.

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.