China’s VC playbook is undergoing a sea change as U.S. IPO exits get tougher

China’s VC playbook is undergoing a sea change as U.S. IPO exits get tougher


A financial institution worker depend China’s renminbi (RMB) or yuan notes subsequent to U.S. greenback notes at a Kasikornbank in Bangkok, Thailand, January 26, 2023.

Athit Perawongmetha | Reuters

BEIJING — Venture capitalists in China that when rose to fame with big U.S. IPOs of shopper firms are below stress to drastically change their technique.

The urgency to adapt their playbook to a newer surroundings has elevated in the previous couple of years with stricter rules in China as effectively as the U.S., tensions between the 2 nations and slowdown on this planet’s second-largest financial system.

Here are the three shifts which are underway:

1. From U.S. {dollars} to Chinese yuan

The enterprise mannequin for well-known enterprise capital funds in China such as Sequoia and Hillhouse sometimes concerned elevating {dollars} from college endowments, pension funds and different sources within the U.S. — identified within the business as restricted companions.

That cash then went into startups in China, which finally sought preliminary public choices within the U.S., generating returns for investors.

Now a lot of these restricted companions have paused investing in China, as Washington increases its scrutiny of U.S. money backing advanced Chinese tech and it will get tougher for Chinese firms to listing within the U.S. A slowdown within the Asian nation has additional dampened investor sentiment.

That means enterprise capitalists in China must look to various sources, such as the Middle East, or, more and more, funds tied to native authorities coffers. The shift towards home channels additionally means a change in foreign money.

In 2023, the full enterprise capital funds raised in China dropped to their lowest since 2015, with the share of U.S. {dollars} falling to five.3% from 8.4% within the prior yr, in keeping with Xiniu Data, an business analysis agency.

That’s far lower than within the earlier years — the share of U.S. {dollars} in complete VC funds raised was round 15% for the years 2018 to 2021, the info confirmed. The remaining share was in Chinese yuan.

Currently, many USD funds are shifting their focus to government-backed onerous tech firms, which generally intention for A share exits reasonably than U.S. listings

For overseas traders, excessive U.S. rates of interest and the relative attractiveness of markets such as India and Japan additionally issue into selections round whether or not to spend money on China.

“VCs have positively modified their view on Greater China from a couple years in the past,” Kyle Stanford, lead VC analyst at Pitchbook, mentioned in an e-mail.

“Greater China non-public markets nonetheless have a lot of capital out there, whether or not or not it’s from native funds, or from areas such as the Middle East, however basically the view on China development and VC returns has modified,” he mentioned.

2. China investments, China exits

Washington and Beijing in 2022 resolved a long-standing audit dispute that diminished the danger of Chinese firms having to delist from U.S. inventory exchanges.

But following the fallout over Chinese ride-hailing giant Didi’s U.S. listing in the summertime of 2021, the 2 nations have elevated scrutiny of China-based firms desirous to go public in New York.

Beijing now requires firms with giant quantities of consumer information — basically any internet-based consumer-facing enterprise in China — to obtain approval from the cybersecurity regulator, amongst different measures, earlier than they’ll listing in Hong Kong or the U.S.

Washington has additionally tightened restrictions on American cash going into high-tech Chinese firms. A number of giant VCs have separated their China operations from these within the U.S. below new names. Last yr, Sequoia most famously rebranded in China as HongShan.

“USD funds in China can nonetheless spend money on non-sensitive sectors for A share IPOs, however have the problem of native enterprise preferring capital from RMB [Chinese yuan] funds,” mentioned Liao Ming, founding companion of Beijing-based Prospect Avenue Capital, which has targeted on U.S. greenback funds.

Stocks listed within the mainland Chinese market are identified as A shares.

“The pattern is shifting in the direction of investing in parallel entity abroad belongings, marking a strategic transfer ‘from lengthy China to lengthy Chinese,” he mentioned.

“With U.S. IPOs now not being a viable exit technique for China belongings, traders ought to goal native exits of their respective capital markets—in different phrases, China exits for China belongings, and U.S. exits for abroad belongings,” Liao mentioned.

Read extra about China from CNBC Pro

Only a handful of China-based firms – and barely any giant ones – have listed within the U.S. since Didi’s IPO. The firm went public on the New York Stock Exchange in the summertime of 2021, despite reported regulatory concerns.

Beijing promptly ordered an investigation that pressured Didi to quickly droop new consumer registrations and app downloads. The firm delisted later that year.

The probe, which has since ended, got here alongside Beijing’s crackdown on alleged monopolistic practices by web tech firms such as Alibaba. The clampdown additionally lined after-school tutoring, minors’ entry to video video games and actual property builders’ excessive reliance on debt for development.

3. VC-government alignment, bigger offers

Instead of consumer-facing sectors, Chinese authorities have emphasised assist for industrial improvement, such as high-end manufacturing and renewable power.

“Currently, many USD funds are shifting their focus to government-backed onerous tech firms, which generally intention for A share exits reasonably than U.S. listings,” Liao mentioned, noting that it aligns with Beijing’s preferences as effectively.

These firms embrace builders of recent supplies for renewable power and manufacturing unit automation parts.

In 2023, the 20 largest VC offers for China-headquartered firms have been largely in manufacturing and included no e-commerce enterprise, in keeping with PitchBook information. In pre-pandemic 2019, the highest offers included a few on-line procuring or internet-based shopper product firms, and a few electrical automobile start-ups.

The change is much more stark when put next with the growth across the time on-line procuring big Alibaba went public in 2014. The 20 largest VC offers for China-headquartered firms in 2013 have been predominantly in e-commerce and software program companies, in keeping with PitchBook information.

… the enterprise capital scene has turn into much more state-concentrated and targeted on authorities priorities.

Camille Boullenois

Rhodium Group

The shift away from web apps in the direction of onerous tech requires extra capital.

The median deal measurement in 2013 amongst these 20 largest China VC transactions was $80 million, in keeping with CNBC calculations based mostly off PitchBook information.

That’s far smaller than the median deal measurement of $280 million in 2019, and a fraction of the median of $804 million per transaction in 2023 for a similar class of investments, the evaluation confirmed.

Many of these offers have been led by native government-backed funds or state-owned firms, in distinction to a decade earlier when VC names such as GGV Capital and web tech firms have been extra outstanding traders, in keeping with the info.

“In the previous 20 years, China and finance developed in a short time, and up to now ten years non-public [capital] funds grew in a short time, which means simply investing in any business would [generate] returns,” Yang Luxia, companion and normal supervisor at Heying Capital, mentioned in Mandarin, translated by CNBC. She has been targeted on yuan funds, whereas trying to elevate capital from abroad.

Yang would not count on the identical tempo of development going ahead, and mentioned she is even taking a “conservative” strategy to new power. The know-how adjustments shortly, making it onerous to pick out winners, she mentioned, whereas firms now want to contemplate buyouts and different alternate options to IPOs.

Then there’s the question of China’s growth itself, particularly as state-linked funds and insurance policies play a bigger function in tech funding.

“In 2022, [private equity and venture capital] funding in China was minimize in half, and it fell once more in 2023. Private and overseas actors have been the primary to withdraw, so the enterprise capital scene has turn into much more state-concentrated and targeted on authorities priorities,” mentioned Camille Boullenois, affiliate director, Rhodium Group.

The threat is that science and know-how turns into “extra state-directed and aligned with authorities’s priorities,” she mentioned. “That may very well be efficient within the quick time period, however is unlikely to encourage a thriving innovation surroundings in the long run.”



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