China’s VC Market is Dwindling, but Is It a Bad Thing?

In 2019 China’s venture capital market plummeted to its lowest level in almost 5 years. After a record-setting 2018 that saw Chinese VCs ladle out cash to startups at mind-boggling valuations, current numbers spooked global investors, some of whom regard the diminished numbers as a sign of an imminent industry debacle. However, as proponents of a more moderate and well-balanced approach to market analysis, we set out to examine the situation from a systematic perspective and unpack some of the causes that forced Chinese VCs to tighten their belts and the effects this might have on the local tech industry.

IPO underperformance and unicorn flops

Despite the Chinese tech ecosystem being fairly self-sufficient, it is not cut off from the rest of the world. The processes that shape the global tech industry do have an influence on the Chinese market, albeit not as resounding as in some other markets. For one, it is clear that the poor performance of highly anticipated Uber and Lyft IPOs, as well as WeWork’s laughable failure to go public, have made VCs more cautious, including those in China.

Throughout 2018 and 2019, China’s VC market had plenty of its own WeWork moments. One of the most promising local startups ofo went from a multibillion-dollar valuation to barely making ends meet within a span of two years. Most fintech companies in the P2P sector were labeled as fraudulent by the government and pushed to the margins of the playing board. The EV company Faraday Future, founded by billionaire Jia Yueting, had to go through a massive restructuring followed by Jia’s personal bankruptcy. 

China’s VC Financing 2014-2019 (Source: ChinaVenture Investment Consulting)

Time and time again Chinese VCs were reminded that having a visionary idea is hardly enough to build a successful company. Efficient management, profitability and scalability were among the biggest buzz words in China this year heard pretty much at any tech event and investor dinner. As China’s economy matures, days of frivolous nouveau riche money squandering are fading from view. 

No wonder some of the biggest news of 2019 in China was centered around rumors of the possible VIPkid bankruptcy as well as Luckin Coffee’s money-losing business model. After a chain of failures, pundits are on tenterhooks waiting for another pitfall. 

M&A uptick

In his comment for Forbes, Brian Hirsch, the co-founder and managing partner at Tribeca Venture Partners, made an interesting prediction on what 2020 could bring to the table.

“The IPO market will slow down considerably but will be replaced by a surge in M&As as strategics find pricing to be more reasonable. As public equity investors have begun to shun startups without a clear path to profitability, those startups will turn to strategics for exits,” he said. “When this occurs, price expectations will decline and come more in line with expectations of strategics that have struggled over the last few years to match public market tech multiples. The record amounts of cash sitting on corporate balance sheets will finally be put to work.”

Despite the deceleration in the VC sector, the first half of 2019 saw China’s domestic M&As rise by 8% from the second half of 2018 to $142.3 billion dispersed over 2,236 deals, including 28 mega deals valued at more than $1 billion compared to just 18 deals in 2018, according to PwC. Most of the action came from industrials, real estate, consumer and financials, but tech is also likely to crawl up the ranks in the near future. 

Part of it is the decline in outbound M&As due to increased scrutiny. “Governments are getting more involved in M&A approvals, as anything that is sizeable and cross-border is politically challenging. Countries are becoming cautious on selling assets that have security, technology and military implications,” says David Brown, PwC deals leader for Asia-Pacific.

At the same time, Chinese tech giants have taken a liking to acquiring promising start-ups and nurturing them as part of their ecosystems instead of merely investing in them. Strategic investments are largely a gamble as proved by ofo, which received vast cash injections from Alibaba and flopped anyway. On the other hand, Meituan’s acquisition of Mobike and Didi’s acquisition of Bluegogo have virtually turned the companies into bike-sharing monopolists. 

Expansion to Southeast Asia

Amid a slowdown at home, China’s venture capitalists increased their investment in Southeast Asian tech more than fourfold this year, according to the Financial Times. The region that is going through a similar but belated process of mobile digitalization that took the Middle Kingdom by storm just a decade ago is a natural target for VCs who see fewer opportunities in China’s maturing tech sector.

Out of a total of $3.4 billion invested by VCs in Southeast Asian tech start-ups in the first half of the year – which is 300% higher than in the same period of 2018 –, $667 million came from China, up from $148 million in 2018, according to Refinitiv data. All this is followed by some of the most prominent Chinese VC firms, including Qiming Ventures and GGV Capital, opening offices in Singapore to get a direct access to the region. 

“Southeast Asia has a high mobile internet penetration and a lot of people coming online,” Helen Wong, a partner at Qiming, told the Financial Times. “China’s mobile internet growth is slowing down — it has reached maturity. A lot of Chinese firms that we are close to, such as the Alibabas and Tencents of the world, are also looking at the region as the next market.”