Shenzhen: China’s Silicon Valley
Since Alibaba’s U.S. listing in 2014, early-stage investing in China has attracted billions of dollars without much success. Only four U.S. dollar-denominated venture capital funds established between 2015 and 2020 have been able to return all the money invested, according to a report by alternative assets research firm Preqin. Preqin analyzed the distributed paid-in capital (DPI) metric to identify the top 10 funds in terms of returns. The remaining six funds have yet to provide investors with their initial capital, let alone any additional returns. The lack of successful IPOs, even before the recent market downturn, contributes to these funds’ struggles. Reuben Lai, Vice President of Private Capital at Preqin, stated that the investment cycle in China has shifted from fundraising to focusing on investments and generating returns.
In early-stage investing, limited partners provide funds to general partners (venture capital funds) to invest in startups. Once these startups go public or get acquired, the funds can exit and share the returns with the limited partners. The funds also earn asset management fees during the interim period. Only three U.S. dollar-denominated VC funds established between 2015 and 2020, including Fengshion Capital Investment Fund, LYFE Capital USD Fund II, and GGV Capital V, have returned all the capital to their investors and generated additional returns.
Similarly, only four U.S. dollar-denominated private equity funds established between 2015 and 2020 have surpassed the initial capital invested. These funds include Loyal Valley Capital Advantage Fund I, Hillhouse Fund II, Oceanpine USD Fund I, and HighLight Capital USD Fund II. While Sequoia Capital China Growth Fund V did not rank in the top 10 for highest distributed paid-in capital, it ranked 6th in terms of internal rate of return (IRR), an estimate of expected annual returns. Several funds performed well in both DPI and IRR, according to the Preqin report.
However, a significant amount of money is still waiting to be returned to investors. Private equity funds in China hold around $1.3 trillion in assets under management, with only $20 billion to $40 billion in exits every year. Alex Shum, Managing Director at TPG NewQuest, suggested diversifying away from IPOs to mergers and acquisitions or general partner-led deals to expedite exits. General partner-led deals involve the sale of an investment fund between different limited partners. Preqin’s Reuben Lai noted an uptick in these types of deals. Furthermore, selling companies to firms listed on China’s mainland stock market is another option.
With increased regulations in sectors such as education, gaming, and internet platforms, investor sentiment has been affected. However, recent developments, such as the U.S.-China audit agreement, have provided some relief. Several China-based companies have already listed in the U.S. this year. Jinjian Zhang, Founding Partner of venture capital firm Vitalbridge, emphasized the importance of looking beyond regulations and focusing on long-term opportunities. He highlighted the need for a 10-year VC fund and the potential it offers.
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