The legal infrastructure for creativity in China: a perspective of venture capital

• Author: Zhang Lin, AN Jingjing
• Position: (??) Ph.D. in commercial law, Faculty of Law, The University of Hong Kong, Hong Kong, China; Professor, School of Law, Fujian Normal University, Fuzhou 350117, China; Distinguished Professor, School of Law and Economics, Shandong University of Technology, Zibo 255000, China. Contact: linzhang@sdut.edu.cn - (???) Corresponding Author, Ph.D....
• Pages: 452-480

FRONTIERS OF LAW IN CHINA

VOL. 15 DECEMBER 2020 NO. 4

DOI 10.3868/s050-009-020-0026-0

ARTICLE

THE LEGAL INFRASTRUCTURE FOR CREATIVITY IN CHINA: A PERSPECTIVE OF

VENTURE CAPITAL

ZHANG Lin *, AN Jingjing **

Abstract A new concept of “legal infrastructure” has recently been emerging and

becoming increasingly popular in China. The concept offers a novel analytical

framework to explore China’s existing legal organism for creativity. For this academic

mission, the perspective of venture capital is developed by this article in that it has been

already been convincingly demonstrated by extant studies that venture capital is an

indispensable catalyst for the output level of a country’s creativity. The findings of this

article are that the current legal infrastructure in China impedes the life cycle of venture

capital, to some degree, and in turn impairs the capability of creativity in China’s

economy.

Keywords legal infrastructure, creativity, venture capital (VC), China

INTRODUCTION .................................................................................................................... 453

I. GROWTH OF THE CHINESE VENTURE CAPITAL MARKET......................................... 455

II. SUCCESS OF THE AMERICAN VENTURE CAPITAL MARKET .................................... 458

A. Fundraising of American VC............................................................................. 458

B. Incentive Mechanisms of American VC............................................................. 462

C. Exit Channels of American VC .........................................................................464

III. LEGAL HAMPERS FOR CHINESE VENTURE CAPITAL ............................................. 467

A. The Absence of Institutional Investors from Their Real Involvement in the

Chinese VC Market........................................................................................... 467

B. The Underdevelopment of Incentive Mechanisms in the Operation of Domestic

* (张琳) Ph.D. in commercial law, Faculty of Law, The University of Hong Kong, Hong Kong, China;

Professor, School of Law, Fujian Normal University, Fuzhou 350117, China; Distinguished Professor, School

of Law and Economics, Shandong University of Technology, Zibo 255000, China. Contact:

linzhang@sdut.edu.cn

** (安婧婧) Corresponding Author, Ph.D. candidate in international law, School of Law, Korea University,

Seoul, Korea; Lecturer, School of Law, Shandong University of Technology, Zibo 255000, China. Contact:

anjingjing@sdut.edu.cn

The authors would like to thank Fujian Philosophy and the Social Science Fund (Grant No.

FJ2018MGCA005), Korea University Law Review, Springer, and Elsevier for their financial and intellectual

support for the completion of this research.

2020] THE LEGAL INFRASTRUCTURE FOR CREATIVITY IN CHINA 453

Chinese VC ....................................................................................................... 469

1. Limited Partnership...................................................................................... 469

2. Convertible Preferred Stocks........................................................................ 470

3. Stock Options............................................................................................... 472

C. The Exit of Domestic Chinese VC through Domestic Chinese Stock Markets: An

Uneven Road..................................................................................................... 473

1. Main Boards................................................................................................. 473

2. The SME Board............................................................................................ 476

3. The GEM...................................................................................................... 479

4. Reform of the Securities Regulation in China..............................................480

CONCLUSION........................................................................................................................ 480

INTRODUCTION

In 1946, with generous support from Ralph Flanders and MIT President Karl

Compton, General Georges Doriot, a professor of Industrial Management at Harvard

Business School, established the first modern venture capital (VC) firm, American

Research Development Corporation (ARDC), in America.1 The mission of the new firm

was simple but far-reaching: “… aid in the development of new or existing businesses

into companies of stature and importance.”2 During its 26-year existence, ARDC’s most

attractive success resulted from its decision to put up $70,000 to support Kenneth Olsen

and Harlan Anderson’s plan to start up the Digital Equipment Corporation (DEC). In its

first year, DEC made a small profit by producing Digital Laboratory Modules, but the real

harvest occurred dozens of years later. In 1968, in the wake of DEC’s successful initial

public offering, the value of ARDC’s stake quickly grew to $355 million.3

ARDC was just the beginning of the success story of American VC. In 1978, the U.S.

Department of Labor unbound part of the restrictions of the Employee Retirement Income

Security Act (ERISA) under the “prudent man rule,” thus allowing pension funds to inject

a tremendous amount of money into American VC firms.4 After that, and until the year

2000, the American VC industry came into its “golden age.” During its booming period,

American VC incubated many current big names including Microsoft, Apple and Lotus,

and paved the path for America being the currently unparallel leader in the global

high-technology market. Even though the bursting of the Internet bubble tainted its image

in 2000, American VC as the “crown jewel” has always been the engine that pushes the

1 Ralph E. Flanders, Senator from Vermont, Little, Brown and Company (Boston), at 188–189 (1961).

2 Id.

3 Id.

4 Paul Gompers & Josh Lerner, Venture Capitalists and the Decision to Go Public, 35(3) Journal of

Financial Economics, 293–295 (1994).