If there were a perfect set of criteria for setting up a venture capital group then Legend Capital, the early and growth-stage investment divisionof China-based computer company Legend, would perhaps meet them all.
A checklist of ideal criteria for limited partners when deciding on a VC firm would include access to proprietary dealflow of top-performing companies that want capital and advice, strong economic growth, and talented and experienced investment managers with sector knowledge, connected to a major research group.
Formed in 2001, Legend Capital is an independent venture capital firm under Legend’s holding company and has ticked all these boxes. As a result, it has grown in less than a decade to be China’s biggest and most successful domestic technology-focused venture capital group.
With four dollar-denominated funds – all double the previous fund’s commitments – and a local currency fund, Legend Capital now manages more than $700m (€566m) and has inspired a wave of other corporations, such as electrical retailer Gome and food group Bright Food, to set up venturing units.
Legend Capital’s last dollar- denominated fund closed at $350m in 2008, just more than double the size of its 2006-vintage vehicle. Chen Hao, co-founder of Legend Capital and chief investment officer, said there were three reasons it had been successful: "First, Legend Capital can leverage parts of Legend Holdings, especially IT, as the founder, Liu Chuanzhi is a brand name. The success of the Legend family of businesses [formed as a spin out from China’s Academy of Sciences research institute] gives easy access to private enterprises. When entrepreneurs have Legend as a shareholder, they think of it as an honour, and the name can also help as an aspect of an initial public offering."
Legend Capital said it saw 500 entrepreneurs each year looking for investment, out of which it agreed 10 to 12 proposals. Its focus areas are companies in mainland China in outsourcing and professional services, IT applications and services, infrastructure, consumer goods, clean-tech, healthcare and advanced manufacturing.
Since 2001, Legend Capital has invested in about 90 companies with average investments of between $5m and $20m but as its funds grow in size it has looked towards later-stage deals, peers said.
Chen added: "Second, we have a very solid team. The four original partners from the Legend family know how to run businesses in a growth stage, especially start-ups. We have a systematic approach to finding deals and reviewing them. Though each deal is tailored to the company, there is a common theory that looks at whether the management or team is compatible with the company’s business development. Business first, team foremost is our motto.
"It is like a building, at the top might be products, business process and marketing but the foundation of the building is the basics of management and a scientific decision-making process. For example, if a portfolio company misses a revenue or profits target we look at where the management team are heading rather than just the product price or inventory."
In January, Legend Capital promoted Wang Junfeng and Huang Xiohong (Emily) as managing directors and now has eight staff with this title.
Chen added: "Third, when we started there were no good local VCs so the management studied foreign VCs within our long-term teamwork and very good incentives system."
This homework paid off as in 2005, three years after first contact had been made, DCM, a top-tier US-based VC formerly known as Doll Capital Management, became a limited partner in Legend Capital’s second, $100m fund in order to tap these advantages as part of its own international expansion.
DCM, formerly known as Doll Capital Management, has subsequently committed to Legend Capital’s third and fourth funds but within an informal relationship between the two top-tier VCs. David Chao, co-founder and general partner at DCM, said: "Chinese relationships are people based. We have no hard-wired contract with Legend Capital but vibrate off each other well as we are like-minded about working with entrepreneurs in early-stage technology deals.
"About half of the seven to eight companies we have invested in together have come from introductions from the other party and we would think of Legend first when it came to a Chinese deal coinvestment opportunity.
"Legend Capital is a rising star with a great track record as it moves to later-stage businesses, a strong brand even in tier three cities outside of Beijing and Shanghai and it helps that other parts of the firm are doing well, such as Lenovo and Hony."
Chen said Legend Capital preferred to work with financial rather than other corporate VCs but that being connected to Legend’s computer division, Lenovo, "helps us learn its research plans and about new IT sectors".
He added: "Lenovo helps us make good judgements and portfolio companies are helped by Lenovo because they can be a client at arm’s length. Legend Capital has not yet sold a portfolio company to Lenovo but we hope to do so."
Through Lenovo, Legend has also formed strong links with US-based private equity firms TPG Capital and General Atlantic. Both subscribed to a $350m convertible bond to help fund Legend’s acquisition of Lenovo from US computer group IBM in 2005 for $1.25bn.
This deal transformed Legend’s international reputation and the group is preparing to invest RMB15bn ($2.2bn) in its technology businesses and list in Hong Kong over the next five to seven years.
Since the beginning of last year, Chinese government control of Legend has eased after the Chinese Academy of Sciences sold nearly half its 65% stake for RMB2.8bn to mainland property developer and financing company China Oceanwide Group.
Legend is preparing to fund its expansion in asset management, which already includes Hony Capital, a separate $2.8bn mid-market private equity division, as well as Legend Capital, which in September raised RMB700m for its first local-currency fund.
Chen said over the next three to five years US dollar and renminbi funds could co-exist but within five years
"if the Chinese government is open-minded, it may allow mergers of these different currency funds so investors can make commitments to the same fund".
However, its financial structure of earning a 20% performance fee from its profitable investments and thengiving 30% of this so-called "carried interest" to Legend would continue.
Legend Capital has been cashflow positive to Legend, which now commits 30% of each dollar fund raised, down from 100% in its first fund. However, Legend has committed half of the RMB700m raised. Chen said the returns from Legend Capital’s first three funds had exceeded commitments to all four dollar funds. These profitable exits include early international successes, such as selling a minority stake in Joyo to Amazon in 2004 for a $75m enterprise value and listing Solarfun Power, Spreadtrum Communications and VanceInfo Technologies on US stock exchanges.
Fact box – Legend Capital
Key people:
Zhu Linan, chief executive;
Chen Hao, head of investment;
Wang Nengguang, chief financial officer;
Li Jiaqing (Richard), head of Shanghai;
Ouyang Xiangyu, managing director;
Liu Erhai, managing director;
Wang Junfeng, managing director;
Huang Xiohong (Emily), managing director.
Funds raised
Date Size Legend’s commitment (%)
2009 RMB700m 50
2008 $350m 30
2006 $170m 50
2003 $100m 65
2001 $35m 100