Venture Capital in China
Recent Activity and Trends in the Industry
It’s time to believe in fairy tales. 2018 was the best year record with 47 new unicorns — global private companies valued at more than US $1 billion. By January 2019, CB Insights recorded 310 unicorns globally with a collective worth of $1,052 billion, which raised a combined total of nearly $257 billion. 172 of these unicorns are from the United States with China following in second place with 82 unicorns. Interestingly, two of the top three highest valued unicorns on this list, Bytedance and Didi Chuxing, are from China.
China has been successful in its efforts to transform itself from a factory floor based economy into a technologically innovative leader and has earned its leading place on the map in the VC and financing scene. This has been occurring together with the Government’s support in order to position the country as a leader in technological innovation.
In this regard, Venture Capital has been playing a key role in this transformation and growth of the Chinese economy.
Globally, 2018 saw an incredible number of large-sized deals, most notably the US $14 billion raised by Ant Financial as well as the US $12.8 billion raised by Juul, a US-based developer of e-cigarettes. The US led the market in terms of overall VC investment with an increase in mega-deals above $100 million, with China coming in at second place however, Asia has been leading the space with large-size over $1 billion+ deals.
Venture Capital in China
In recent years, China has experienced significant economic growth and technological development and is now the world’s second largest VC market including over 3,500 firms. Corporate Venture Capital is also growing- whereby more companies have VC arms that are looking for disruptive technologies that can enhance their core business.
There has been a large amount of private equity and Venture capital flowing into China’s new economy. These investment amounts have prompted investors to structure larger deal sizes and the average deal size rose 7 times to $213 million in 2018 from $30 million in 2013. PE funds, LP’s, Sovereign Wealth Funds, as well as the country’s Tech Giants have been investing in larger size deals (greater than $200 million) while their VC counterparts usually remained focused on the smaller deals.
China VC Market Trends:
China’s new economy has grown rapidly over the past few years and its’ entrepreneurs are creating a new model for growth, which has in turn has sparked a dynamic capital financing activity.
China’s New Economy
In 2018, PE funds were very active in China -especially in the Internet and technology sector. Investors have been very active in supporting the technology behind the new economy and have been focused on the growth of its Internet and tech start-ups in order to try and generate strong returns. The Internet and technology sectors, which make up the new economy, have accounted for almost 85% of the growth in Greater China private equity since 2010.
Technology Companies and Corporate Venture Capital are behind much of the Financing
China’s technology companies have also led to expansion and are fuelled by consumers’ rapid adoption of new technologies including applications in financial services, gaming, education, healthcare and artificial intelligence.
Some of these technology companies that are now investing in startups were recently a startup themselves and are now actively investing. Similarly, corporate VC Funds in China are actively looking to fund technologies that can enhance their core business models. An example of such activity is Baidu Ventures, the VC arm of the Chinese search giant, which was among one of the world’s most active Corporate Venture investors in AI in 2018. The firm invested $1.2 billion in 53 companies last year with 13 of those deals in AI companies.
Less Capital for Early Stage Technology & Innovation
China is the 2nd largest economy in the world and expected to become the largest by 2030. However, according to a recent SCMP article, China has been experiencing a fundraising “winter” in which China bound VC investments have decreased by 13 percent in 2018. There have been fewer deals since last year for early stage startups and deals are taking longer to close. This has resulted in more capital going into growth stage startups and later-stage tech companies, while the earlier-stage start-ups or below series-B capital investments have been struggling to receive funding. There has been a “flight to quality” investment trend whereby PE and VC funds have been accepting lower exit returns by allocating less funds towards riskier investments and preferring later stage and closer to IPO options. This is polarising the market and also threatens the vibrant entrepreneurial spirit that has characterised the innovation sector in China as of recent.
It may not be the best time for Chinese early stage startups as technology giants are drawing in the funds, leaving less in the capital pool for startups who require early stage rounds in order to grow and scale. While China dominated VC investment in Asia during 2018, deals in the last quarter of this year reflect a preference for investors in the region funding less prospective deals number at higher amounts.
In a recent SCMP article, Cheng Yu, a partner at early-stage Morningside Venture Capital, who was speaking at a panel of the Hong Kong Venture Capital and Private Equity Association conference in January was quoted as saying:
“On both the capital-raising and investing sides, the Chinese market is getting more polarised. You see a lot of capital going into billion-dollar mega funds, leaving behind a lot of smaller funds that could not raise sizeable US dollar funds”
It can also be seen that over the past year, in 2018, VC firms have been focusing on fewer but bigger deals, which has left a funding gap for companies seeking earlier stage deals. Funding platforms such as AngelHub, Hong Kong’s first SFC licensed startup investment platform is aiming to bridge the funding gap for such companies with operations in Asia.
Valuations are Lower and it is Harder to Raise Capital
Since the end of 2018, the valuation correction that everyone was predicting would happen in China- appears to be happening. One such case is Zhong-An Online P&C Insurance, which is backed by Ant Financial, Tencent Holding and Ping An Insurance. Zhong-An Online, the online insurance start-up raised about US$1.5 billion via its Hong Kong listing in September 2017, two years after receiving close to US $730 million of pre-IPO investment. Furthermore, for PE and VC funds that choose to exit through IPOs, the valuations of their portfolio companies could be sold at a reduced value as they are impacted by the overall market. In a recent SCMP article, Nisa Leung, managing partner at Qiming Ventures Partners mentions “Valuations have also declined. Even for ‘hot’ segments like artificial intelligence applications, valuations have fallen by 20–30 per cent.”
The Greater Bay Area Promotes Growth
There has been extensive activity taking place in the GBA in order to promote innovation and cooperation in the region. The Chinese Government aims to create a multi-hub region whereby, Shenzhen assumes the role of technological innovation hub and Hong Kong will continue to lead as the region’s financial hub. Many Hong Kong based startups including Qupital, Bowtie, Lalamove, WeLabs and others have been able to leverage the GBA as a stepping-stone for both financing and scaling their operations in the region.
Qupital:
Qupital, is a Hong Kong based trade finance platform for SMEs across the Greater China Region. Qupital closed a US $15 million Series A round led by China’s CreditEase FinTech Investment Fund (CEFIF), with participation from returning investors Alibaba Hong Kong Entrepreneurs Fund and MindWorks Ventures. Qupital plans to use the funding to launch into mainland Chinese cities and is setting up a new technology centre in the GBA.
Bowtie:
HK based Insurtech startup, Bowtie, secured Hong Kong’s largest series A funding of 2018 with US$30 million from investors including global insurer and Sequoia-backed HK X-Technology fund — chaired by Tencent’s Pony Ma and Canadian insurer Sun Life. Bowtie has been granted the first “virtual” insurer license issued by Hong Kong’s Insurance Authority (IA).
Lalamove:
Lalamove a Hong Kong-based logistics startup, closed a $300 million Series D round for its expansion plans in Asia. The recent round was led by Hillhouse Capital and Sequoia China. The Lalamove business is anchored in China, where it covers more than 130 cities with a network of over two million drivers covering vans, cars and motorbikes.
WeLab:
WeLab is an online money lender in Hong Kong and since then has extended into the GBA, offering financial services to over 30 million customers in Hong Kong and China. WeLab closed US $400 million in over 3 rounds and investors in the series B+ included Alibaba Hong Kong Entrepreneurs Fund.
Additional Factors affecting investment activity
Several trends have also affected fundraising activities in China including the US-China trade tensions, which have increased the risk of macroeconomic disruption in China and across the region.
Additionally, the private equity market in China has become sharply polarised between large funds with strong track records and smaller funds that are having difficulty raising funds and exiting, resulting in a winner-take-all dynamic.
Furthermore, as the Chinese economic downturn is strengthening, the Government has tightened financial regulations towards curbing debt and financial risks, which have led to a series of regulatory measures affecting PE investments and have led to a decline in 2018 renminbi fund-raising. On a brighter note however, the regulations against Chinese companies having a dual listing in Shanghai and Hong Kong are lightening up and some of the huge tech China Giants are now listed on the HK stock exchange or considering an IPO in Hong Kong.
Although technology and innovation in China have seen exponential transformation and growth, the validity of Chinese core technology is often questioned in light of having a potential US-equivalent that already exists in the market.
China is also waiting patiently while the wave of mobile Internet is slowly diminishing and the great opportunities of artificial intelligence lie ahead. One such AI opportunity that was actualised is Hong Kong’s SenseTime, which is the highest valued AI company in the world and has extensive operations in China.
The Hong Kong Venture capital market is not included in the current analysis and the fund-raising scene for startups in Hong Kong is vibrant and flourishing. Hong Kong currently boasts eight homegrown unicorns and has one of the highest density per capita of unicorns in the world.
