Can China Ski through the 'Capital Winter'? A Cutaway View of New-Economy Bubble
Is the current slowdown in venture capital investment a part of a bigger trend?
It is a commonplace that there are more tech startups in China than ever – the number grew almost exponentially over the last decade. In that time, companies in the sector attracted way more venture capital than any other industry. Yet recently a contraction in the flow of money has caused some to speak of an impending period of cooling-off. Here we assess the investment statistics and immediate prospects for the global tech prodigy that is China.
According to Bain&Company, the country’s Internet/tech pre-IPO firms have received around 83% of the total private equity funding volume since 2010. The management consultancy estimates that in 2018 Chinese startups grabbed a total of USD 81 billion from VC investors, consolidating their country's number two ranking in the global investment ladder.
Business information database Crunchbase has reported about 465 Series A-F 'supergiants' (venture funding rounds of USD 100 million and more) in the last five years (or just under 60 months since August 2, 2014). The total volume of capital collected through these commitments is as high as USD 154 billion.
In the United States, by comparison, local startups have been raising money with higher frequency: 512 rounds of financing have happened over the same period. Nevertheless, American investors seem to be stingier (or just less risk-prone) compared to their Chinese peers – the total volume of funding transactions in the States has slightly exceeded USD 103 billion since 2014.
Early-stage funding prevalence could be another wake-up call for overconfident investors in the “world’s factory”: while only 127 Series A and Series B rounds of financing have happened in the U.S. since mid-2014, this number hit 189, or almost 50% more, in China. The investing also tends to be concentrated; in general, pre-IPO investment portfolios in the emerging Chinese market are less diversified than those of the United States.
There have also been some cases of extreme 'ultragiant' funding events. Alibaba Group’s fintech affiliate Ant Financial carried out a USD 14 billion Series C round of financing in June 2018. It remains the largest-ever venture capital transaction to date.
Where is the exit?
As the booming private sector generates countless candidates for the hungry entities that always seek to gobble up promising startups, the question of “how many of the private firms eventually manage to exit?” is worth asking. A spoiler: not too many. EqualOcean found that less than 12% of companies with a total PE investment volume of over USD 10 million have exited in the last 10 years. Meanwhile, only 4% of the companies established in the past five years have made an exit.
Given the fact that, among 231 large enterprises, 80 were acquired within this period, the percentage of exits to the public market drops even more. It is somewhat ironic that, though the economy has been growing at a terrifying speed, local startups prefer to stay private in a socialist country. One reason is that the public equity markets, like socialism here, have some contradictory “Chinese characteristics”: they are surprisingly volatile and subject to either over- or under-regulation.
Over the last decade, Internet companies in China have been complaining about the strict listing requirements. Yet no thresholds for traders exist on the main boards of the Shanghai and Shenzhen bourses. This has led to a preponderance of inexperienced investors on the local trading scene, with the volatility issue becoming more exacerbated.
A new Nasdaq-style venue in Shanghai – the Star Market – is the second attempt by Chinese regulators to alleviate the problem described. The listing criteria for companies were eased, allowing yet-to-be-profitable technology firms to file for an IPO on the Shanghai Stock Exchange. At the same time, China's market watchdog has imposed requirements on individual investors to control speculative behavior.
The question is still open as to whether this radical measure will help to resolve the exit overhang problem in the short run. For now, it is obvious that the growing number of cautious VC investors has something to do with China's underdeveloped financial markets. Despite decades of growth, these simply weren't ready for an investment wave of such magnitude.