The private equity market in China continues to show signs of investor optimism and entrepreneurial zeal. However, behind the China firewall lies an industry that faces significant challenges and must adapt to generate the returns that investors expect.

As China's importance as a deal hub grows, so does the role of Chinese companies and private equity firms in the global marketplace. The growing amount of capital flowing into China will transform many domestic Chinese companies. The leading brands of 2020 will have a strong Chinese element, compared with the brands of 2012.

In order to best support the Chinese companies of the future, investors need to meet the demands of entrepreneurs and bring more than just capital. Chinese companies need to dominate domestically. One way is to look to developed markets for proven processes and procedures to incorporate back home. There is also a strong interest among entrepreneurs to pursue strategic partnerships and acquisitions outside of China. Leading PE firms will be able to help Chinese companies meet these goals.

This marks a significant shift in China's M&A evolution. Where in recent years the focus was often directed toward the Chinese IPO market, both through domestic offerings and Depositary Receipts listed on Hong Kong, U.S. and European exchanges, those transactions are now seen largely as financing vehicles for existing companies and are becoming difficult for many companies.

China deal counts rose at a compound annual growth rate of 20.2% between 2001 and 2011, according to data from Dealogic. Given the annual deal volume, the number of companies that the public markets can support and the tighter scrutiny faced by Chinese companies on foreign exchanges, strategic acquisitions are now showing greater promise as an exit mechanism. This will continue to increase as Chinese entrepreneurs seek to position themselves as global players.

There are a number of reasons why this trend is likely to continue. Cross-border partnerships offer opportunities to share technology, best practices, processes and procedures. They provide access to established companies in mature markets, and they allow growing Chinese companies to improve as they expand their market reach.

The mutual value is immediately obvious to all sides of these deals. When we have taken company representatives to the U.S. to meet with larger companies in their industry, we have found that U.S. executives are keen to get to know their Chinese counterparts. On a recent trip, the CEO of one of our Chinese portfolio companies spent several hours meeting each of his U.S. peers to discuss how their companies might work together.

We were surprised that these U.S. executives spent so much time with the smaller Chinese companies we advised, but it makes sense, considering U.S. and European companies are also looking for ways to build their businesses in China. As a market, China's potential remains enormous, and as its regulatory framework governing foreign direct investment loosens, the opportunity grows. Chinese companies have relationships, and expertise that international companies cannot compete with in the growing Chinese market. Thus there is a win-win proposition for large multinationals and smaller, domestic entrepreneurs.

Yet these partnerships are not easy, and building trust is essential. Trust comes from transparency in relationships and the ability of business leaders to feel that they can share their business processes, intellectual property and approach to client service with a true partner. PE firms can help guide Chinese entrepreneurs through this process.

Generally, partnering with a PE-backed company is viewed as a safer approach than going it alone. These partnerships can enhance value, but could also carry risks if either party proves to be less than fully committed. This is a time-intensive process, and in a rapidly growing market such as China, entrepreneurs cannot afford to be bogged down in structuring a partnership and then pouring resources into making it work.

For their part, U.S. and European companies must be careful in choosing a strategic partner in China. To be successful, these agreements require a long-term commitment, trust and transparency, and the latter is often elusive for foreign companies doing business in China. Foreign PE can act as an intermediary to help facilitate these transactions, increasing the comfort level and helping to maximize the value creation for both sides and, ultimately, for investors.

Aaron Rudberg is partner and director, investor relations and business development, at Chicago-based Baird Private Equity, the PE arm of Robert W. Baird & Co.