China startup frenzy seen cooling further in 2019

January 02, 2019 13:57
A worker rides a shared bicycle past a huge pile of unused bikes in a vacant lot in China. The market has seen several fast-growing Chinese bike-sharing startups going bust in 2018. Photo: Reuters

Chinese startups had been flooded with venture capital in the past few years, and the hype contributed to inflating the startup valuation, but it seems the trend has begun to reverse in recent months. In interviews with the Hong Kong Economic Journal, some mainland China-based venture capitalists have sounded the alarm over startups, with one expert saying “winter is coming”, as they believe there will be a wave of startup bankruptcies in 2019.

"[There are many venture capital funds] which don’t have knowledge in technology, or even financing,” said Nisa Leung, managing partner at mainland China-based investment firm Qiming Venture Partners.

She pointed out that numerous venture capital (VC) funds had set up shop in China in the past few years, riding a wave as the Chinese government started actively promoting entrepreneurship and innovation since 2015.

But things have begun to turn sour for some industry players, the venture capital veteran suggested.

There has been a huge flood of venture capital into startups, but the “quality of capital” is varying, said Leung.

She noted that the flood of venture capital has led to unreasonably high valuations of startups in mainland China. But as the Chinese authorities tightened financing in early 2018, the investment activities of VC funds started cooling down. Many newly established VC funds, in fact, have suspended operations or closed down entirely.

Besides less financial backing from VC funds, entrepreneurs of Chinese startups are also facing difficulty in the primary “exit strategy”, going public in the stock market. Leung said the public market is in general conservative, or even reluctant, to invest in highly valued startups' IPOs -- in particular, those with poor quality in their business models and products.

Edith Yeung, who heads the China unit of early-stage venture fund and seed accelerator 500 Startups, agreed there is a bubble in Chinese startups.

Yeung noted that Chinese startups have been taking on valuations that are two to three times larger than those of their US-based peers. "They think the higher valuation is justified as the China market has a larger population.”

According to Leung, in 2018, the valuations of startups focusing on internet and biotech have declined, while those focusing on artificial intelligence (AI) technology have seen valuations fall by as much as 20 percent. She expects the valuations of Chinese startups to continue to drop in 2019, with many of them seen ending up in bankruptcy.

While Chinese startups are used to burning through billions of dollars to tout subsidies and offer incentives to customers, muscling for market share, Yeung said they will be easily caught up in financial troubles if they can’t seek huge financial backing for the cash-burning operations.

To buttress his argument, the industry expert pointed to the woes of the cash-strapped Chinese bike-sharing startups as an example.

In mid-December, millions of users of Chinese bike-sharing giant ofo demanded a refund of their deposits, as the firm has been contending with disputes over unpaid debt and rumors of mass layoffs.

Amid escalating trade tensions between China and the United States, the US Justice Department’s antitrust division, the Federal Communications Commission and the Committee on Foreign Investment in the US, or CFIUS, has toughened scrutiny on acquisitions of American businesses by foreign buyers.

In addition, Yeung said that under the tightened review process, mainland China-based VC funds, as well as Chinese enterprises and startups, find it much more difficult to invest in high-tech startups in the US, especially in areas like AI, robotics, and autonomous driving, which makes it impossible for Chinese companies to acquire new technology through investment.

According to a survey released by accounting firm PricewaterhouseCoopers’s China unit in October,  41 percent of the Chinese startups see the problem in capital and financial backing as the biggest crisis they are facing.

This article appeared in the Hong Kong Economic Journal on Jan 2

Translation by Ben Ng 

[Chinese version 中文版]

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