Investors put money in Chinese start-ups despite regulatory crackdown

An aerial view of vehicles being driven on the road through the Central Business District on October 5, 2020 in Beijing, China.

Zhang Qiao | China Optical Group | Getty Images

BEIJING – Global investors invested more money in Chinese startups in the third quarter, despite Beijing’s regulatory crackdown that temporarily halted a rush of Chinese initial public offerings in the United States.

Multiple data sources showed that venture capital investment in China rose in July-September compared to the previous quarter, bringing year-to-date totals to more than all of 2020.

Investors’ interest came even as the quarter kicked off with a regulatory onslaught from Beijing. Just days after Chinese app Didi held its initial public transit order in New York on June 30, Beijing ordered the company to suspend new user registrations during a security review. Didi’s shares have fallen more than 35 percent since the IPO.

A few weeks later, the authorities suddenly ordered after-school tutoring companies to cut working hours and banned foreign capital investment in offshore lists. Shares of US-listed industry leaders such as Tal Education are down more than 90% since the start of the year.

“Global investors have certainly become very cautious,” Jason Hsu, chairman and chief information officer at Rayliant Global Advisors, told CNBC in late September. “I think it will take some time for this cautious feeling to reverse course.”

Since late July, China’s securities regulator has tried to placate foreign investors, while fund managers on the ground are tasked with explaining developments to those abroad.

“China still needs foreign capital. I don’t think China’s domestic capital will be enough to support this growth,” said Fan Bao, founder and CEO of China Renaissance, a Beijing-based fund manager and investment bank.

Bao said in an interview earlier this month that China has an agenda for how the economy and society should develop, as capitalism is a “very important tool.” “But if the outcome is not as intended throughout the process, and even worse, the outcome is undesirable, in China, strict action will be taken against it. This is the thing that people need to understand.”

More attention from Asia

Investors based in Asia remained the most interested in China, compared to those in Europe or North America, according to Precken data. For example, investors based in Asia actually increased the number of Chinese acquisitions and venture capital in the third quarter, the data showed.

“Asian investors and European investors are more calm in this environment,” Bao said, noting that his company has few North American investors.

However, his company is still bent on collecting US dollars to make it easier for many companies now wanting to list in Hong Kong, and Bao said it is difficult to raise the yuan because the Chinese economy is not as strong as it appears on the surface.

accumulate in some sectors

While Bao and others talk about the challenges in raising money for their mutual funds, analysis of the data reveals that at other levels, capital is accumulating in specific industries.

“Investing in China for foreign investors is now like a double-edged sword,” said Hongji Wang, partner at venture capital firm Antler, based in China. He noted that the state certainly offers financial returns, while there are concerns about increased regulation.

Read more about China from CNBC Pro

It can be difficult to get accurate numbers, especially with regard to financing in China. But KPMG’s analysis of Pitchbook data on venture capital financing in China puts the third-quarter figure at $23.7 billion, up from $22.5 billion in the second quarter. This quarterly increase is in line with industry trends reported by Preqin and CB Insights.

“Venture capital investors in China are being very cautious at the moment due to various regulatory changes taking place in the market, particularly in areas related to fintech, tutoring, and offshore public listings,” Allen Lu, Partner and Head of TMT Audit at KPMG China, said in a report.

“Caution is very focused on certain sectors,” Lu said. “Other solutions – such as healthtech, hardware and consumer market solutions – are still attracting very large levels of venture capital investment in China.”

Case in point: Sequoia Capital China was the busiest investor in the third quarter, with 1.5 deals per day, including some of the largest investments in chips, healthcare and industrial software, according to CB Insights.

In March, China launched its development plan for the next five years and beyond. Beijing is particularly focused on building its own semiconductors, as the United States has restricted China’s access to critical American technology.

This spurred a rush to invest in China’s semiconductor industry in ways similar to the Internet about two decades ago, Eric Shen, senior managing director at Citic Capital, said October 13 at the AVCJ Forum in Beijing. “If you have a war mentality, you will do things a lot faster than usual.”

The dotcom bubble saw investors pile into internet-based companies like, before stock prices crashed in 2000.

There are worrying signs other than regulations. Zhengdong Ni, founder of Chinese private equity and venture capital data firm Zero2IPO Group, said at a forum last week that an increasing number of funds are focusing solely on individual projects.

He added that about 60% of the funds raised by venture capital firms and other funds were in funds smaller than 100 million yuan. That’s a meager $15.6 million in an industry that raised 1.27 trillion yuan in the first three quarters of the year, according to Ni.

capital returns

A look at recent history states that China is an economy in which the sheer size of the market has attracted a lot of capital – which has not necessarily been used efficiently.

Bao said fund managers in China could have done a better job of allocating capital to their investors. “There is a lot of money that has been invested, and so little has come back.”

Siguler Guff analysts said in a report at the time that in the decade to 2014, the year SoftBank-backed Alibaba was announced, losses rose despite increased investment.

“Generally, the more private equity capital invested in a given year, the lower the returns,” they said. The update was not available until this article was posted.

This venture capital has come under further scrutiny. In this summer’s fallout for after-school tutoring firms and real estate developers, critics in China have blamed previously loose regulations for allowing these firms to attract more than they’re worth, especially abroad.

Reliant’s Hsu said investors in China “are constantly being bombarded with information by someone early on, bought into Alibaba, Tencent.” “The amount of bad information that dominates sharing the investor mindset specifically makes it difficult for managers to provide useful information. Because you’re not just trying to educate, you’re fighting other narratives.”

Alibaba, the poster child of China’s internet technology boom, set the world record for initial public offerings in 2014. Its shares are still trading 150% above the offering price. But the stock is down more than 40% in the past 12 months, with e-commerce giant Jack Ma the first of the internet tech giants to fall into Beijing’s crosshairs.


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