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How China has ‘throttled’ its private sector

其他 2024年09月13日 215 次阅读阅读原文

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核心导读中国风险投资行业正在遭受严重打击，许多初创企业纷纷倒闭或搬离。中国政府对科技公司进行了打压，使得私营企业的环境发生了巨大变化。此外，中国经济的放缓、美中关系的紧张以及外国投资者的撤资也对该行业造成了冲击。目前，国有基金在中国风险投资市场中占据了80%的份额。一些风险投资公司不得不解雇投资专业人员，并用律师或前法官来执行偿还条款。此外，许多公司已经削减了规模，而且外国投资者也在减少对中国的投资。这种行业的迅速萎缩将阻碍未来的创新。

For a place devoted to advancing knowledge of the human body, there are few
signs of actual life in BioBay, a science park in Suzhou west of Shanghai.

In a five-storey tower that houses biotech and pharmaceutical start-ups, the
only sound is a generator whirring away in the depths of the building.

Scores of its tenants have either moved out or closed down, and a funding
crunch that has hit the sector means many offices have been left vacant.
Opportunistic dealers emerged to snap up cheap computers and lab equipment to
sell on in Malaysia or Indonesia, leaving their business cards scattered
around. Many offices are caked in dust.

BioBay said it was “hoping to sublease” the empty spaces to new companies, but
the lifelessness of the state-run park, once celebrated as a shining example
of China’s strides in cutting-edge science and technology, speaks to a broader
trend in the country’s venture capital industry.

“China used to be the best VC destination in the world after the US,” says one
Beijing-based executive, referring to the business of private investment in
high-risk start-up companies.

Founders and investors harbour few hopes of a return to the glory years before
the Covid-19 pandemic, when the likes of Alibaba and Tencent took advantage of
rapid economic growth and the rise of the mobile internet to become globally
significant technology companies.

“The whole industry has just died before our eyes,” the executive continues.
“The entrepreneurial spirit is dead. It is very sad to see.”

The downbeat mood is reflected in the statistics. In 2018, at the height of VC
investment, 51,302 start-ups were founded in China, according to data provider
IT Juzi. By 2023, that figure had collapsed to 1,202 and is on track to be
even lower this year.

Keyu Jin, associate professor at the London School of Economics, says the
industry “has been critical to spur China’s entrepreneurial dynamism”.

“The outflow of global investment and the massive drop in the valuation of
Chinese companies will impinge on the nation’s innovation drive,” she warns.

The crisis in the sector partly reflects the [slowdown in the Chinese
economy](https://www.ft.com/china-economic-slowdown), which has been buffeted
by the protracted Covid-19 lockdowns, the bursting of its property bubble and
the stagnation of its equity markets. As bilateral tensions have risen, US-
based investors have also largely pulled out.

But it is also the direct result of political decisions taken by President Xi
Jinping that have dramatically changed the environment for private [business
in China](https://www.ft.com/chinese-business-finance) — including a crackdown
on technology companies regarded as monopolistic or not attuned to Communist
party values, and an anti-corruption crusade that continues to ripple through
the business community.

Desmond Shum, author of _Red Roulette_ and a former real estate mogul, says
the party “has throttled the private sector”.

“Successful entrepreneurs . . . can expect to be closely monitored, unable to
transfer money offshore and their transactions and public statements
scrutinised,” he adds. “Their money is the country’s money.”

The FT spoke to 11 executives at VC firms, including from state-run and
private funds, as well as industry experts, academics and entrepreneurs. Most
did not wish to be identified, as they are not authorised to speak on behalf
of their investors, but all painted a bleak picture of what, at its peak, was
the world’s most dynamic and cut-throat market for founders.

“Five years ago, the [venture capital](https://www.ft.com/venture-capital-
investment) and private equity guys were masters of the universe. They were
the most optimistic people in China,” says one industry insider.

“Now they’re depressed. You don’t see them any more.”

* * *

**Founders like Jack Ma** at Alibaba and Pony Ma at Tencent — the two are
unrelated — inspired a generation of Chinese entrepreneurs seeking to mint a
fortune by taking their companies public.

By the final quarter of 2020, the two companies were worth a combined $1.5tn.

That dream started to crumble in November 2020 after Beijing cancelled the IPO
of Ant Group, a fintech company carved out of Alibaba, just two days before
its shares were due to begin trading.

[Jack Ma was hauled in by the
authorities](https://www.ft.com/content/fa9ed13c-25a8-4aae-900d-58333e4cea12)
for what were termed “supervisory interviews”, kicking off a wider crackdown
on the technology sector that underscored the unpredictability of investing in
China.

Since then, the optimism that fuelled a generation of risk-taking
entrepreneurs has been systematically eroded. “There is no good reason to
start a company,” says one serial founder in Shanghai. “Why should we take the
risk? We have had five years of lost start-ups.”

Many start-up companies sold equity to investors on the basis that they would
buy back those shares if they did not list on the stock market or get acquired
by a certain date. But a wave of failures has led VC firms to try to claw back
assets from their insolvent investee companies through the courts.

> Today, VC firms have to explain to the state why their companies failed and
> why they have lost the country’s money

Chinese business publication Caixin reported in August that the country’s
leading state-owned VC, Shenzhen Capital Group, has filed 41 lawsuits since
2023, of which 35 were against companies that had largely failed to go public
by a set date and had not repurchased shares.

Executives in the sector say that while such redemption clauses have been
commonplace for years, especially in renminbi-denominated funds, few of them
were enforced because there were always enough lucrative successes to more
than cancel out the failures.

That calculus has changed, say several sector executives, who now find
themselves under pressure from external investors — known in the industry as
limited partners or LPs — to return capital. As a result, one Beijing-based
investor says the sector has “turned into a debt-chasing monster”.

In most cases, firms know there is little hope of reclaiming their investment.
“We know that few of the founders have the means to pay us back, but we need
to show our government LPs that we have made an effort to get their money
back,” adds another Beijing-based executive at a renminbi-denominated fund.

“You do not want to be accused of losing the government’s money,” says a third
executive.

VC firms have laid off investment professionals and in some cases replaced
them with lawyers or former judges to enforce the repayment terms. At law
firms such as DeHeng and Zhonglun W&D, teams that previously worked on IPOs
and buyouts have pivoted to advising on redemption clauses.

New start-ups face even more onerous terms. Two executives at renminbi-
denominated funds, whose LPs are primarily local governments, say that it is
no longer enough that the company is on the hook for repurchasing shares;
founders must take personal liability for the debt.

“We require our founders to put their house and car on the line. In this
market it is mandatory,” says one. These strict requirements mean the fund has
had to reject good investments — including one profitable company with strong
growth and customers — because the founder refused to be personally liable for
the loan, the person adds.

Another executive at a state-run fund that invests in early-stage start-ups,
says they have started checking founders’ assets, including bank deposits and
property, to ensure they have the means to buy back shares.

Several firms have complained about their inability to track down founders who
closed their companies and left China. To mitigate this, the executive at the
state-run firm says founders with US citizenship now have to hand over the
company chop — a rubber stamp widely used in China to authenticate documents —
when a funding deal is signed, meaning the investor can take over if the boss
flees.

Plaintiffs can ask the courts to impose restrictions on founders whose
companies have reneged on their obligations, making it difficult for them to
travel or find new jobs in China.

* * *

**The pool of capital** that VCs can tap into is also shrinking.

Foreign investors, wealthy Chinese, and corporate investors have been
divesting or reducing their exposure to China, leaving state-backed players
with an outsized role.

“In the past, US limited partners looking at Asia only wanted to meet China
funds. Other markets like India struggled to get their attention,” says one
investor. “Today, we are like lepers. They don’t want to touch us with a
10-foot pole.”

![Column chart of Share of total market capitalisation of top 100 listed
firms, by ownership $%$ showing China’s private sector has been losing
ground to state-owned enterprises in recent
years](/Media/editor/other2024-09-136866777479896878/2024-09-138585756767657680.png)

Three separate venture capital executives estimated that state-run funds now
accounted for around 80 per cent of capital in the market. “The state is
taking over the industry in an age of anti-corruption,” says one Chinese
expert on innovation, who declined to be named. “It is contradictory to the VC
spirit of engaging in high-risk and high-potential ventures.”

“In a portfolio of 10 companies, you would expect one or two to be a mega
success and the rest to die. But now VC firms have to explain to the state why
their companies failed and why they have lost the country’s money,” the expert
adds.

Limited partners are also increasingly requiring fund managers to guarantee
returns, creating a bias towards lower-risk investments. Two executives at
renminbi-denominated funds say state LPs had over the past couple of years
asked fund managers to guarantee annualised returns of between 6 and 8 per
cent.

> In the past, US limited partners looking at Asia only wanted to meet China
> funds. Now they don’t want to touch us with a 10-foot pole

Several firms say they are now mostly looking at companies in manufacturing,
regarding them as less risky. In 2023, advanced manufacturing companies
working on new energy, integrated circuits and new materials accounted for
over 30 per cent of start-ups founded, according to IT Juzi — a marked change
from previous years, when biotech, consumer technology and education topped
the charts.

Beijing’s efforts to cut what it views as excessive salaries in finance have
also reduced the incentive for high-risk but potentially high-reward
investments. State limited partners have either mandated that fund managers
either cap their salaries at the Rmb2.9mn (around $407,000) annual limit that
has been more rigorously enforced this year at state-backed financial
institutions, or slash management fees by half, according to several people
with knowledge of the matter.

Many funds are downsizing. Source Code Capital, an investor in ByteDance, let
go of 50 of its 150 staff last year, while the big-name funds HongShan
(formerly Sequoia Capital China) and Hillhouse have also cut back their China
offices, according to people familiar with the matter.

Source Code, HongShan and Hillhouse declined to comment.

The person at the renminbi-denominated Beijing firm says that bosses are
either laying off staff, reducing pay or creating working conditions that are
so unpleasant that people leave voluntarily, thus avoiding the need for
expensive severance payments.

“This industry used to be a 10,000lb gorilla. Now we’re slimming down to the
size of a chimpanzee,” says another executive based in Shanghai.

* * *

**The rapid contraction of** an industry that helped make China a
technological superpower will hamper future innovation, experts say.

Sebastian Mallaby, a senior fellow at the Council on Foreign Relations and the
author of a book on venture capital, says “the debt mindset” that has taken
hold means “fewer experiments in cutting edge science and technology that
could push China to the technological frontier”.

Jin, at the LSE, says it is not just the amount of capital “but the strategic
expertise of investors, their global connectivity and managerial knowhow that
benefit these companies”.

Even sectors outlined by Beijing as critical to national security are now
struggling to attract investment. Financing for biotech and pharma start-ups
fell by 60 per cent in 2023 from its 2021 peak of Rmb133bn, according to IT
Juzi.

Entrepreneurs are increasingly building companies without raising outside
capital, rather than agree to onerous terms. “There are still founders doing
start-ups. But they are literally bootstrapping the company, borrowing money
from friends and family or taking out loans,” says the Shanghai-based venture
capitalist.

He added that a lot of these entrepreneurs are catching the wave of cross-
border ecommerce, using Chinese manufacturing prowess to build cheap consumer
electronic products that then sell on Amazon, Shein or Temu.

![Pedestrians on an elevated walkway silhouetted at
dusk](/Media/editor/other2024-09-136866777479896878/2024-09-137568687065767474.jpg)Pedestrians
in Shanghai’s Lujiazui financial district. Investors have been divesting or
reducing their exposure to China, leaving state-backed players with an
outsized role  © Qilai Shen/Bloomberg

While a funding chill has hit most areas of tech, several venture capitalists
mention humanoid robots and electric flying vehicles as two areas gaining
traction, after Beijing singled them out for support in recent policy
documents.

But several say the path to monetisation remains elusive. The robots are still
far from replicating human dexterity and speed, while the Chinese military’s
strict control of domestic airspace precludes the widespread commercial
adoption of flying taxis.

Many of the funds that emerged during the rapid growth of the 2010s are now
looking overseas and trying to convince their investors that they have the
skills to make money outside their original market.

HongShan, Hillhouse Investment, 5Y Capital, ZhenFund, DCM Ventures, Linear
Capital, Shunwei Capital, Genesis Capital and Qiming Venture Partners have
either increased investments overseas or are more actively scouring markets
like the US and Europe for deals, according to public filings and multiple
people familiar with the matter.

Linear Capital founder Harry Wang acknowledges there are still VCs “trying to
piece together the best offerings from different countries” for collaborative
innovations. The other firms did not respond to requests for comment.

Another executive in Shanghai says “people are voting with their feet” and
questions whether China venture capital will ever come back.

He adds that he has little option but to remain given his team and investments
are all in China. “I am like the Titanic, flying the flag as the ship goes
down.”

_Additional reporting by Ryan McMorrow in Beijing_

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