Pictured here is Shenzhen in southern China. The city is sometimes referred to as China’s Silicon Valley.

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BEIJING – In the years since Alibaba’s U.S. listing in 2014, early-stage investments have attracted tens of billions of dollars to China with relatively little to show for it.

Among China-focused investment firms, only four U.S. dollar-denominated venture capital funds founded between 2015 and 2020 have returned at least all of the money invested to investors.

That’s according to a new report, “China’s Private Capital Landscape,” from Preqin, an alternative asset research firm. Alternative assets include venture capital, but exclude listed stocks and bonds.

Preqin examined an industry metric called Distributed Paid-In Capital (DPI) and listed the 10 funds in the category with the highest DPI.

The other six have not yet returned all of their money to investors, let alone any excess returns, the report shows. Preqin does not track every single Chinese VC fund and only considers those with data from the end of last year or more recently.

While these funds may still need a few more years to truly perform, their struggles so far reflect a lack of IPOs – even before the recent market downturn.

“The most important trend is the change in the investment cycle,” Reuben Lai, vice president of Greater China private equity at Preqin, told CNBC in a telephone interview earlier this month.

From about 2015 to 2018, fundraising in China “flourished,” he said. Now “people are more focused on the investment itself and the exit, the return.”

In the world of early-stage investing, “limited partners” (typically institutions) give money to “general partners” (venture capital funds) to invest in startups. As soon as the startups go public or are acquired, the funds can “exit” – and generate a return that they can share with the limited partners. Meanwhile, the funds also receive asset management fees.

Fengshion Capital Investment Fund, LYFE Capital USD Fund II and GGV Capital V were the only US dollar-denominated VC funds founded between 2015 and 2020 that returned all their money to their investors – and then some, according to Preqin data showed.

The market is tough. Not many companies manage to reach the IPO stage.

The 10th-best performing fund, BioTrack Capital Fund I, returned just 8.1% of capital to its investors in March, about five years after the $186 million fund was launched.

The same trend held true for U.S. dollar-denominated private equity funds founded during the same period from 2015 to 2020 – only four returned more money to investors than they invested, Preqin said.

The outperforming funds were: Loyal Valley Capital Advantage Fund I, Hillhouse Fund II, Oceanpine USD Fund I and HighLight Capital USD Fund II.

According to Preqin’s data, Sequoia did not make the top 10 lists for highest DPI. Sequoia Capital China Growth Fund V ranked 6th in another metric, internal rate of return (IRR), among U.S. dollar-denominated private equity funds founded between 2015 and 2020.

The IRR is an estimate of expected annual returns based on cash flows and the valuation of unrealized assets.

Several of the high DPI funds also performed well on an IRR basis, the Preqin report showed.

IPO alternatives

However, there is still a lot more money waiting to be returned to investors.

Private equity funds in China manage about $1.3 trillion in assets, with at least $20 billion to $40 billion in exits made each year, Alex Shum, managing director at TPG NewQuest, said at the AVCJ in early September Conference in Beijing, a major annual gathering of China-focused venture capital firms.

That means existing assets take about 20 to 30 years to separate, he said, citing the need to diversify away from initial public offerings and into mergers and acquisitions or general partner-led deals – or deals that involve the sale of an investment fund between include various limited partners.

Preqin’s Lai said there has been an increase in such deals led by general partners.

“The market is tough. Not many companies manage to reach the IPO stage. Because of the extended fundraising period … people have to hold on to the portfolio a little longer,” Lai said. “So they have to change ownership through a secondary fund and transfer it to someone else.”

Lai said it was difficult to know what the return on such transactions would be.

“It’s a pretty mysterious thing. “People don’t want people to know that they’re making secondary returns because that means they’re doing poorly,” he said. “We’ll see [sellers] offers a more generous discount compared to previous years. People are, you could say, more desperate.”

Another option is to sell the company to a company listed in mainland China.

Jinjian Zhang, founding partner of venture capital firm Vitalbridge, said at the AVCJ conference last week that his firm sold an investment to a listed company in March, about three months after the initial deal.

This deal was one of ten projects the fund invested in in the second half of 2022, once the lockdown in Shanghai was lifted.

For a long term investor today part of [the situation] is regulation, but part of it is the emotions evoked by regulation.

Jinjian Zhang

Founding partner, Vitalbridge

In 2021, Zhang said Vitalbridge raised more money than planned, but the company generally held off on new investments because the market was overvalued. Zhang said the people providing investment term sheets had not actually seen the projects in question and that startups were charging excessive prices.

In the two years since then, the mood has changed dramatically with a series of regulations targeting education, gaming and internet platform companies.

This year, Beijing has signaled a softer stance.

The U.S. and China also reached an audit agreement last year that reduces the risk that Chinese companies will have to be delisted from U.S. stock exchanges.

Several China-based companies, mostly small, have listed in the US so far this year.

“For a long-term investor, today is part of it [the situation] is regulation, but part of it is the emotions caused by regulation,” Zhang said in Mandarin, translated by CNBC.

“So at this point, [if you] “If we look beyond regulation when starting a 10-year VC fund, there are many opportunities,” he said. “We’re focused on those opportunities and not what the sentiment is around regulation.”

Source : www.cnbc.com

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