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Sep 27, 2021
One Measure Shows How China’s VC Market Is Tightening Under Regulatory, Market Pressure
When it comes to VCs’ reaction to new regulation, anyone can venture a guess about what happens next.
Venture capital is on the risky end of the global pool of investable capital, and private market investors tend to get skittish when faced with public stock market volatility, macroeconomic shifts (such as changes in interest rates), and new regulations. Although VCs are ostensibly tasked with backing the businesses of the future, their investing patterns are very much affected by what’s happening right now.
China’s VC market, second largest in the world, still sees billions of dollars go to work across hundreds of deals every month. But it’s not like the “good old days.” It wasn’t so long ago that, if only for a brief moment around Q2 2018, Chinese startups raised more than their US counterparts.
The period around 2016-2019 was a wild time. Ride-hailing company DiDi raised USD 9.5 billion across two growth equity rounds in 2017. And in June 2018, Alibaba’s fintech spinout Ant Group raised USD 14 billion in a Series C round—still the single largest venture capital deal in history. Companies like ByteDance, Full Truck Alliance, JD.com, Ke.com, Meituan, Pinduoduo, and others each took down billions of dollars in new financing—often from investors outside of China—to accelerate their already explosive growth.
Today, many of these same companies face pressure from Chinese government regulators and other market forces. And since several of them are now publicly traded, the effects of government intervention on China’s tech sector can be observed in real time with publicly listed Chinese technology companies losing USD 1.5 trillion in market capitalization since February 2021
New Regulations Tighten China’s Tech Market
Although China’s economy is ostensibly centrally-planned, over the past decade its technology sector has received limited regulatory oversight as the likes Alibaba, Tencent, and ByteDance became global tech giants and a second new wave of tech firms including Pinduoduo, Meituan, and Didi embraced global public markets. But with massive scale and economic prosperity come social influence and potential threats to establishment power.
Over the past twelve months the Chinese government, led by President Xi Jinping, has tightened control over both the financial and business aspects of the country’s technology sector, as well as the ways in which people use and experience these products and services.
China’s approach to controlling its tech ecosystem is three-pronged:
- Antitrust. China’s antitrust watchdog, the State Administration of Market Regulation (SAMR), is beginning to apply pressure to some of the country’s largest technology companies. For example, on April 10th the regulator fined ecommerce giant Alibaba a record CNY 18 billion (USD 2.75 billion) to close out an anti-monopoly probe which found the company had “abused its market dominance.” Ramped up scrutiny of Alibaba coincided with a response to statements made in October 2020 by the company’s founder, Jack Ma, which critiqued China’s approach to financial regulation. SAMR has since levied fines against Tencent, Meituan, ByteDance (which owns TikTok), and others, on similar grounds.
- Gating access to public markets. In November 2020, a week after Jack Ma’s public remonstrations, government securities regulators put the kibosh on Ant Group’s initial public offering on Shanghai and Hong Kong exchanges. The suspension of the AliPay operator, spun out of Alibaba as an independent company, was reportedly ordered by no higher authority than Xi Jinping himself. The decision cost the fintech giant the opportunity to raise up to USD 34.5 billion at a valuation of USD 313 billion. In December 2020, Chinese regulators launched an effort to “contain disorderly expansion of capital” in the economy.
- Data governance. The Cyberspace Administration of China (CAC) is the government body tasked with maintaining China’s access to its citizens’ data and control over online speech. In early July 2021, days after Didi—the Chinese analog to Uber and Lyft—began trading on the New York Stock Exchange, the CAC initiated an investigation into the company. Full Truck Alliance and Kanzhun, two other Chinese companies which went public on US exchanges over the summer, were also targeted by the regulator. Outwardly concerned that transportation data was being exposed to foreign investors, the CAC initiated “reviews” of cybersecurity practices at these companies, and at least in the case of DiDi, police and state security officials were sent to investigate in person. Shares in DiDi are currently trading at around half their July IPO price levels.
Add to this the summer crackdown on the online tutoring sector and the even more recent restrictions on video games, and a comprehensive re-evaluation of the current tech sector by the Chinese Communist Party begins to emerge.
China’s VC Market: Fewer Bigger Bets On The Future
Venture capital is a game of making bets on the future based on the best information available today. And if that’s the case, it looks like VCs are less willing to bet heavily on the future of tech in China.
It used to be that USD 100 million was a lot of money for a private company to raise. Now it seems like there are multiple nine-figure raises by private tech companies every week/month. And fewer of those rounds are being raised by Chinese startups, at least relative to those in the U.S. and elsewhere.
Sometimes called “mega-rounds” or “supergiant rounds,” the latter referencing the largest stars in the universe, the rise of these nine-figure deals bent the shape of VC investing forever. Now they serve as a barometer of investor sentiment, capital availability, and expectations of future growth.
Over 1,000 such deals have been struck so far in 2021, according to Crunchbase data, and given the pace of deal-making by the likes of SoftBank Vision Fund, Tiger Global, Insight Partners, and other deep-pocketed investors it’s likely that dozens more are in the works or haven’t yet been publicly announced.
The chart below shows the number of venture capital rounds of at least USD 100 million raised globally over the past decade.
Although the number of these supergiant VC deals struck by Chinese companies is on pace to exceed the 2020 count by a decent margin, China’s prominence in the global venture capital market may be waning as investors seek emerging growth opportunities in other parts of the world.
As of late September 2021, Chinese startups have raised a little less than 12% of the supergiant venture capital rounds indexed so far this year. In the chart below, we plot the last decade of supergiant VC deals on a quarterly basis, which highlights the speed of China’s rise and fall in the global market for huge venture rounds.
To be clear, the 118 supergiant rounds raised in China are still more than twice the third and fourth-ranked markets—the UK with 50 deals and India with 48, respectively—combined. China’s VC market is likely to be the second largest in the world (at least among individual countries) for the foreseeable future, but the rest of the world is maturing rapidly and the pace of growth in the US VC market far outpaced China over the past few years.
As the Chinese government imposes more restrictions on its tech sector, investors—especially those outside of China—are likely to seek markets with more permissive regulatory regimes and pro-growth postures.
Looking at the investors behind the largest number of supergiant deals in China shows that many of them are themselves China-based. The table below lists the investors who led two or more supergiant deals between 2019 and the end of Q3 2021.
Perspectives Differ On Outcomes And Motivations
Interpretations of these measures cover a spectrum. Some have praised aspects of China’s market interventions. Writing in the blog of the Brookings Institution back in April 2021, former US Federal Communications Commission chairperson Tom Wheeler said that
“The Chinese government has moved forcefully to do what American tech companies have long fought in their home country: pro-market, anti-monopoly intervention and pro-innovation opening of big company chokeholds on digital information.”
Others are more critical, if not of the purported principles of such policies than of their outcomes. Many investors have concluded that these policies limit business opportunities for Chinese technology companies, resulting in a trillion dollar haircut for the industry.. “Any so-called data-security review conducted by a secretive party agency with little technical expertise, no legal accountability, and a responsibility only to its political masters will erect another unpredictable regulatory hurdle deterring most, if not all, foreign investors,” commented Minxin Pei, a professor of government at Claremont McKenna College, in Project Syndicate. “Since foreign backers of Chinese tech start-ups usually plan to exit their investment through an overseas listing – preferably in New York – the prospect of a CPC agency wielding a veto over future listings may make them extremely reluctant to invest,” he continued.
Reconciling such opposing viewpoints is a challenge. Wheeler, the former regulator who had taken steps to break up monopolistic control of the U.S. telecommunications industry, appears to take the Chinese government’s stated objectives at face value. Pei, however, implies that Chinese Communist Party assertions of data security and market fairness is a palatable pretext for petty, politically-motivated applications of authoritarian control.
“Only time will tell” is a pretty trite conclusion most of the time, but given the sweeping nature and rapid pace of new policy pronouncements from China’s government, it’s still unclear if these policies—specifically those tied to anti-monopoly ambitions—will manifest the positive effects some hope for, or if the effort to split the market pie more equitably only serves to shrink the Chinese tech sector.
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