Investments by private equity funds in China dropped in 2012 compared with 2011, in terms of both number of deals and investment proceeds. The state of affairs of the market in the past two years has spawned expectations that a window of opportunity could arise for secondary private equity funds. In anticipation of a growing secondary market, the Beijing Financial Commodities Exchange initiated the establishment of the first private equity secondary trading union in June 2012, in the hope that such a union could generate, within the network, synergies for the sourcing, financing, and closing of private equity secondary deals. Although a number of reported trading cases does not indicate an active market, the market appears to be shaping up, given a variety of factors:

• the position of Chinese state-owned funds (known as "guidance funds"), which are required by their constitutional documents to exit on a fixed schedule - in other words, policy-driven portfolio management;
• the mentality of the primary investors to exit the pre-IPO investees in view of the stalling IPO markets in China and the United States, which may indicate sell-offs to come;
• the relative lack of access to financing tools by primary investors in China, such as commercial loans; and
• an investor community that has started to shift strategies from fundraising and chasing pre-IPO deals to diversification of its assets and portfolios.

This article discusses the policy context in which investments by non-Chinese secondary investors are viable.  It also analyzes some regulation-driven structuring considerations.  Because the regulatory context for public stock acquisition is highly differentiated from that for private company stock acquisition, this article discusses only private company stock acquisition, with a focus on acquisitions of portfolio companies.  It also analyzes the regulations impacting the acquisition of venture capital and private equity fund interests.

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