Venture capital market

‘Winter is coming’ for China’s private market investors as economy slows, forcing many to adjust strategies

PUBLISHED : Monday, 17 September, 2018, 7:01am
UPDATED : Monday, 17 September, 2018, 1:00pm

In 2017, Chinese investors would regularly call Zhao Xiuwen, founder and CEO of Beijing-based ZingFront, to pitch their interest in investing in his artificial intelligence-driven video production start-up, but since the beginning of this year, he’s had to reach out himself – often with little success.

“Fundraising has become harder than ever for us recently,” said Zhao. “There is less money in the capital market and competition has become more fierce.”

The pain Zhao is feeling has been dubbed “the winter of capital” by Chinese investors and entrepreneurs. In response to a domestic economic slowdown, Chinese financial regulators have stepped up financial deleveraging measures to reduce bad debt risks. As a result, the number of Limited Partners (LPs) that invest in venture capital deals and private equity funds has decreased, along with financing from banks, shrinking the pool of cash to fund start-ups.

An investor working for an RMB venture capital firm told the Post that one of its LPs recently failed to transfer the second instalment of an investment it had promised. The representative requested anonymity due to the private nature of the information.

“This is the coldest winter for capital in 10 years,” said Zhao Tian, founding partner of Beijing-based 36Kr Fund, at a conference organised by the firm last Tuesday. 36Kr, originally an online platform offering news about technology and start-ups, was expanded into a crowdfunding investment platform for start-ups in China.

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The number of new private equity funds in the first half of 2018 was 3,111, down 59.5 per cent from the same period a year earlier, according to a report by Jingdata, a start-up database from 36Kr. Also during the first half, 579.5 billion yuan (US$84.3 billion) of equity investments were made, down 10.7 per cent year-on-year, according to Zero2IPO.

Capital raised by investment firms for seed funding was only 3.82 billion yuan (US$559 million) during the first six months of 2018, a 53 per cent drop year-on-year, according to research firm Zero2IPO.

Venture capital investors have had to adapt to the colder climate, either by putting on a brave face or adjusting their strategies.

“As a VC, when the market is good, you have to work hard, but when the market goes bad, you have to work even harder,” said Gao Xiang, founding partner of Beijing-based Banyan Capital, which manages a fund worth more than 11 billion yuan (US$1.6 billion) and has e-commerce disrupter Pinduoduo and on-demand service giant Meituan Dianping in its portfolio.

“The temporary difficulties won’t affect long-term opportunities,” said Gao.

Chinese investors are a hardy bunch after all, having weathered several storms over the past five years, including the stock market crash in 2015 and the circuit breaker crisis of 2016. However, some veteran Chinese investors sound more like the character Jon Snow from the TV series Game of Thrones - “winter is coming” they say, with an edge of caution.

“The market has its own cycle and is all about investor confidence,” said Roger Liu, managing director of Shanghai-based private equity firm V-Capital. This time, investors might not re-gain their confidence so quickly as the uncertainties are mounting – including a domestic economic slowdown and brewing US-China trade war, said Liu.

Liu’s team, the M&A fund of V-Capital, has felt the colder weather effects. It just raised a new round of funding this year after an effort of nearly ten-months, taking a lot longer that what was needed over the previous three years. “During the good times, we’d often see an injection of money after just a casual discussion with investors,” Liu said.

Liu says he’s now switched his focus from placing new investments to taking good care of the companies he’s already invested in, because in the current environment ensuring healthy growth at invested companies is likely to yield better returns than planting new seeds in hard ground.

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During the good times in 2016 and 2017, Chinese investors chased investment hotspots one after another, from bike sharing to virtual reality (VR), from augmented reality (AR) to autonomous vending shops [convenience stores with no human employees designed around facial and object recognition technology], raising valuations in the primary market to sky-high levels. Bike sharing firm Mobike was valued as high as US$3.5 billion, according to Chinese magazine Caijing, but was eventually bought by Meituan in April for US$2.7 billion, down 23 per cent from its peak valuation.

Fallout could also be seen when investor darlings such as video-streamer iQiyi and smartphone maker Xiaomi went public – sliding on their market debuts. And there is no current “investment hotspot” in China after the autonomous vending shop concept came along at the end of 2017, which is a sign that the era of easy money may have ended for now.

“It’s a good time for everyone to rethink the essence of investment, which is based on solid market research instead of blindly chasing the trend,” Liu said.

Zhang Ye, founding manager of Beijing-based venture capital firm Cyanhill Capital, feels market conditions have normalised to some extent as valuations for seed round start-ups seeking funding have already fallen from around 60 million yuan in 2016-17 to around 30-40 million yuan this year - with some even below 10 million yuan. Zhang says that although market conditions will be tough during the second half, he thinks there could be a thaw after next year’s Spring Festival.

As such, he’s divided the year into two halves – with less investment in the first half and more in the second. He invested very little in the first half – less than 10 deals – in order to keep more firepower for later in the year, when invested start-ups are likely to require new capital injections.

Some investors have looked for opportunities in the education sector to keep them in the game, betting on the Chinese mindset that “education is the last thing to sacrifice during hard times”. Education, a bright spot amid the encroaching dark of winter, attracted 14.7 billion yuan (US$2.1 billion) of funding during the first half, almost equal to the total for 2017.

Beijing-based Matrix Partners is one of the investors focused on education, running funds worth 30 billion yuan (US$4.4 billion). It has invested in 20 education firms so far – including unicorn VIPKid, which connects global English-speaking teachers with Chinese kids.

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Although RMB investors will have to stick with the current “capital winter”, no matter how cold it is, Chinese start-ups will do everything they can to survive.

Jason Sun, founder and CEO of the Beijing-based blockchain gaming platform Krypton, said he is actively looking to raise more capital from the US. “The Chinese gaming industry is seeing very tepid interest from Chinese investors,” said Sun.

That’s not much of a surprise given the smaller pool of money available, fewer exit opportunities and the fact that hardly any new gaming companies have secured approval to list in the domestic market. The approval rate for IPOs in the domestic stock market was only 49 per cent in the first half, compared with 79 per cent last year.

Krypton’s last fundraising round of 7 million yuan (US$1 million) was half a year ago.

“For us, getting out to talk with overseas investors is the only way out,” said Sun.