Lost in the current U.S. congressional debate over whether to grant China permanent normal trade relations is the fact that billions of investment dollars are flowing here every year as Western venture capitalists seek deals with local startups that rely on market savvy rather than government backing. Indeed, global venture capitalists, banks and members of the global stock exchanges complain that too much overseas venture capital is chasing too few Chinese technology startups.

The gap was an overriding theme at a recent international financial forum staged here as part of China's International High-Tech Week. The forum attracted venture capitalists from around the world, including H&Q Partners (Palo Alto, Calif.), Lehman Brothers, the Singapore Exchange, the Canadian CDNX/VSE Market, Japan's Softbank, C.G.-Capital (Tokyo) and Pacific Enterprise Capital (San Mateo, Calif.).

Foreign investment in China suffered as a result of the Asian financial crisis, but a rebound is under way. "We believe foreign investment will increase in 2000," said Jay Hu, managing director of the U.S. Information Technology Office here.

To boost the local high-tech industry, many Chinese provincial and municipal governments have created their own venture capital companies. Despite their lack of experience and relatively small coffers, the companies are a signal that the central government is ready to adopt capitalist-style financing structures.

According to a senior officer in China's Ministry of Finance, there are about 100 domestic venture funds in China with assets over $1 billion. That's a far cry from just a few years ago, when an official at a state-run telecom company asked reporters whether they could recommend any U.S. venture capital firms.

The foreign venture capitalists who first appeared here in the mid-1990s invested in software development and such other hot-button technologies as biotechnology and telecommunications. But they moved cautiously as they learned the ropes of technology development in communist China. For a time, the Nasdaq stock market was one of the few reliable vehicles for foreign investment in China as investors' missteps lead to early losses, such as a failed computer game software project in the city of Tianjin.

The strong performance of Chinese dot-coms on the Nasdaq exchange in recent years has altered the investment landscape, attracting more investors with deeper pockets. Despite language and cultural differences, Chinese Internet content providers have grown quickly and have become hot prospects for foreign investors in the past year. For example, the successful initial public offering of china.com on the Nasdaq last July stimulated both content providers and venture capitalists in China.

China's Nasdaq

Responding to the success of the dot-coms, the central government has moved to establish its own version of the high-tech-heavy Nasdaq exchange to create links between foreign investors and capital sources for emerging technology companies on the Shanghai and Shenzhen stock exchanges. The exchanges are modeled after the Growth Enterprise Market in Hong Kong. Venture capitalists, investment banks and stock listings have since flooded the high-tech industry here with billions of dollars in working funds.

Local startups naturally have embraced the eager overseas investors. Every venture capital event staged here attracts hordes of company executives and engineers from all over China. Some approach investors after their speeches with hat and business plan in hand. Most of the companies seeking investment understand that linking up with a foreign investor is a way to add value to their local business.

Overseas investors also see the growing value of Chinese investment. Michael Sacharski, chief executive of Pacific Enterprise Capital, said the company's "mission is to be the leading venture management firm focused on Internet and telecom ventures in China." Along with investment capital, he said, the company specializes in providing strategic management and technical, legal and other "incubator services" to "emerging Chinese companies who are promising candidates for an IPO or strategic acquisition."

Global electronics and information technology giants have emerged as some of the most important strategic investors in China. IBM Corp.'s software unit recently announced it would provide $200 million in venture capital to support local e-commerce startups. Intel Corp. also has made large investments in leading Chinese portals, e-commerce sites and some technology startups, such as UTStarcom and LinkAir. The latter is a wireless telecommunications company based here.

Happy returns

So far, the return on investment has been strong. UTStarcom, a wireless personal access phone supplier, has attained a market value of about $5 billion via a March 3 IPO on the Nasdaq. Softbank has a roughly 50 percent stake in UTStarcom, having invested $160 million in the company since 1995. Softbank's initial investment has thus grown about a hundredfold.

Softbank has so far invested in 10 projects in China, and executives there said all are thriving thus far. International Data Corp., another early investor in China, said the average rate of return on its investments here has been a thirtyfold increase. It plans to invest additional billions here in coming years.

Still, the sudden decline of the Nasdaq in recent weeks has dampened some investors' enthusiasm for Chinese high-tech startups. Trade barriers that hurt the return on investment have also prompted telecommunications investors to hold back funds as they await the outcome of the U.S. debate on China's entry into the World Trade Organization, said Jay Hu of the U.S. Information Technology Office.

Investors nevertheless continue to watch closely for dot-com startups, such as second-generation business-to-business e-commerce ventures. Indeed, e-commerce ventures appear to be the target of a new investment wave.

Meanwhile, the shine still isn't off promising startups in wireless and other telecommunications equipment sectors with new technologies geared for the emerging domestic market.

Gary Rieschel, executive managing director of Softbank Venture Capital, predicted that Internet growth in China will continue. He said content, special technology, market-tracking services and geographic expansion are becoming more important to venture capitalists here and to the companies they target.

While new technologies and a sound business model remain crucial, management has grown increasingly important as Wall Street analysts sift through revenue and profit reports. Investors may consider a solid management team more important than pure technology plays.

Information gap

Experts agree that the biggest challenge to foreign investors is gaining a better understanding of the Chinese market and improving communications with their Chinese partners. Few Wall Street analysts track Chinese technology companies, so there is less information about individual companies, their technologies and their true value.

H&Q Asia Pacific, one of the earliest venture capitalists in China, has gained hard-won experience here from joint ventures in biotechnology and pharmaceuticals with Peking University. "This is an excellent project with a bright future [since] China's biotechnology industry is four times closer to international standards than its electronics industry," said Tsu-Der Lee, co-managing director of H&Q. "But we probably have to list [the joint venture on the Hong Kong exchange since] few analysts and investors at Nasdaq know this fact."

Transparency is another challenge. Some Western investors said more openness is needed on how Chinese laws and regulations affect projects, particularly in different regions of the country. They said the risks are high because a lack of openness compounds conflicts between the old, state-run economy and the emerging, Internet-based one.

Finally, China lacks the international management teams needed to run new technology businesses. Local entrepreneurs are important revenue generators, but they often lack the experience to run an international business.

Consequently, foreign investors nearly always bring in their own management team to protect their investment. That often means that company founders lose control of their companies and earn far less.

Seeking to maintain a measure of control, such companies are searching for a balance between attracting investors and overcoming cultural and management differences, industry observers said.