China at “exponential” risk leaves venture capital funds short of cash

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Clicking through his pitch deck, the cash-strapped Chinese drone company founder began to wonder: Do the investors sitting across the table even have money to spend? ?

“We have to figure out if they are just coming because they have to do their job or if they really have the money at hand,” said the 28-year-old, who asked not to be named. fear of further harming his fundraising prospects.

“Before, raising funds was difficult but manageable, but since 2021 it has become difficult for us and for investors,” he said.

Private equity and venture capital managers in China say small and medium-sized groups face the biggest fundraising challenges to secure capital for five or 10 years and more. Global investors are being deterred by the country’s tech crackdown, the draconian zero-Covid regime and the possibility that Beijing could one day face the same barrage of Western sanctions as Vladimir Putin’s Russia. Instead, money is flowing to bigger names, such as Sequoia Capital China, which are seen as safer destinations.

Data from research group ITjuzi shows that start-up fundraising in the first half of the year fell 38%, with the number of transactions down 19% from a year ago. The amount of money they brought in during the second quarter, when the country locked down Shanghai due to rising Covid-19 cases, halved.

Genesis Capital and Xiang He Capital, led by former Tencent and Baidu executives respectively, have faced setbacks in closing new fundraising rounds, people briefed on the situation said. Last summer, Genesis opened its third fund, targeting more than $1 billion in commitments, but had to extend its fundraising schedule, the sources said.

Three years ago, newcomer Centurium Capital tapped 40 U.S. investment funds for $1.9 billion, according to public documents. But in April, Centurium announced that its second fund, which had been raising funds for a year, had recruited only six American investors for $250 million.

Coatue Management of Philippe Laffont, one of the biggest “Tiger cubs”, told potential investors last August that it was aiming to raise $1.5 billion to $2 billion for its first China-focused Asian fund. It has grossed less than $1 billion so far, according to a person familiar with the matter.

“China’s harsh regulatory crackdown on technology and the private sector, combined with a persistent zero Covid pandemic policy, has unnerved investors,” said Fred Hu of Primavera Capital.

“But China’s rise as a major global economic and technological power, although temporarily tempered by the pandemic and geopolitical forces, remains inexorable,” Hu said.

Xiang He, Centurium and Coatue did not respond to requests for comment. Genesis Capital said it could “not comment on any fundraising activities due to applicable laws and regulations.”

Foreign money is flowing to the biggest companies that have a long track record of performance. Since July 1, Sequoia Capital China and Qiming Venture Partners have closed $9 billion and $2.5 billion respectively for Chinese funds from overseas investors, more than double the total amount raised by all funds in the first semester.

Column chart of fundraising by China-focused private equity and venture capital ($ billions) showing investors soured on China-focused private funds

“It’s definitely a tougher environment, but China is hard to ignore, so LPs are still selectively looking,” said Qiming’s Duane Kuang, who noted that long-time investors such as foundations and University endowments had supported his new fund.

“During the Shanghai lockdown, 60 engineers from one of our semiconductor start-ups camped out in their office for two months,” he said. “They bought a bunch of disposable underwear – that’s the level of commitment from the teams here.”

In the 2000s, the prospect of investing in the world’s fastest growing economy attracted money from around the world, sparking the creation of hundreds of new Chinese funds. The number of active managers in China rose from 193 at the start of the decade to 3,149 last year, according to data from Preqin.

Now the thousands of funds are left chasing an ever-shrinking stack of dollars. In the first half of the year, just under $5 billion flowed into China-focused private equity and venture capital funds, down 94% from a year ago. year and the lowest half-year total since 2009, according to data from Preqin.

A myriad of new regulations from Beijing have added to the challenges facing start-ups. New rules on equity sales outside the continent have yet to be finalized, which contributed to slower investor outflows in the first half. Money earned by backers from Chinese IPOs in Hong Kong and New York fell 70% from a year earlier to around $15 billion, according to Preqin.

“The main question for LPs is why China right now, and that’s a very difficult question to answer,” said a Beijing-based investor, whose fund was unable to to raise new capital.

Discussions at Florida’s state board, which manages $245 billion primarily for state retirees, reveal how international investors have gradually reconsidered their strategy toward China.

“It is in our interest to invest globally, across multiple asset classes. . .[China is] a market that is hard to ignore. That’s 20% of global GDP,” Florida chief investment officer Lamar Taylor said at an investment advisory board meeting in December.

“In order to achieve the return and diversification goals of the total fund, we have to be there,” Taylor said in response to politicians and citizens who questioned the use of state pension funds in the country. Florida had 2.8% of its portfolio allocated to China.

But after Russia invaded Ukraine, Florida was forced to write down $300 million invested in Russian securities to “essentially zero.” Noting the unprecedented Russian sanctions, Taylor said in March that rising “downside risks” to China prompted the manager to suspend new investments.

In June, head of the Florida private equity team, John Bradley, told an advisory board meeting that “the risk part of the equation [for China] probably increased exponentially and so that caused us to step back.”

Another participant agreed, “I hate to be political when I make investments, but you have to recognize the politics going on. I think everything going on in China these days is a bit dangerous.

Venture capitalists say they hope apprehensions about the country will dissipate after the next meeting of China’s Communist Party this fall, when President Xi Jinping is expected to win his third term.

“Investors are waiting for signals from the party congress,” said Ming Liao of Prospect Avenue Capital. “Afterwards, things will be more stable,” he said.

For Chinese founders, the wait is long, but some predict the worst is over.

“Globally, everywhere there are risks right now, whether it’s inflation, politics or the energy crisis,” said Patrick Zhong of M31 Capital.

“No one will find it easy to raise capital as liquidity dries up, but great companies will emerge from this era.”

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