Global venture capital insights and trends report 2011
Venture capital perspectives - China
"Given China's new fund-raising record and favorable exit environment, the investment pace will likely continue, but unrealistic valuations may dampen future returns." Lawrence Lau,
China VC Leader, Ernst & Young
Outlook: VCs on pace to reach all-time record in 2011
- China's VC industry set new heights in 2011 in both number of investments and investment amount. Due to its late-stage investment focus, China will likely surpass Europe as the second-largest venture hub globally by investment amount by the end of 2012.
Given China's new fund-raising record in 2011 and the favorable exit environment, the investment pace will likely continue. However, the median round size and valuations have risen to historical heights, more than doubling the value of 2006 - 09, which may dampen future returns.
- The Government supports VC by issuing policies in 2010 - 11 to stimulate the continued rapid growth of the VC industry, more investment in the middle and western regions of China and the emergence of high-value-added and environment-friendly products in seven ﬁelds for VC investors, namely energy conservation and environmental protection, next-generation IT, biotech, advanced manufacturing, alternative energy, innovative materials and new-energy powered vehicles. Thus, the IT and cleantech sectors are likely to dominate VC activity in the years to come.
- VC ﬁnancing of pre-IPO, late-stage investments dominates and continues to increase. Growth funds experienced a sharp rise in 2010 as domestic equity investors much preferred pre-IPO, revenue-generating or proﬁtable companies. Indeed, in 2011, revenue companies made up 94% of investment, while pre-revenue companies accounted for just 6% of investment.
The soaring corporate valuations of A-share listed companies and substantial ROIs of their IPOs attracted more and more funds into pre-IPO projects. In 2011, the median pre-revenue valuation jumped to US$60.5 million (up 30% from 2010, when the median was just US$46.4 million, and up 354% from 2006, when the median was US$13.3 million).
China's valuations will be driven largely by the P/E ratios on the new local stock exchanges and by the rise of new larger funds investing predominantly into late-stage deals. Unlike in Western markets, Chinese corporate venture groups are not willing to pay a premium when investing into companies for equity. They argue that their value-add warrants a discount, not a premium.
Early-stage opportunities are growing as rising levels of innovation within China assist the growth of early-stage ﬁ rms. Government-sponsored incubators, university R&D centers and formal business angel groups are also springing up. Furthermore, there is pressure to move investors into earlier stages, due to the very competitive late-stage environment.
China VC investment, 2005–11
Domestic VC industry expands rapidly
VC investment in China has expanded geographically, beyond ﬁercely competitive eastern China (including Beijing, Shanghai, Guangdong, Fujian, Zhejiang and Jiangsu) into new areas in central and western China, as investors seek better opportunities and local governments offer preferential policies, such as establishment of governmental guidance funds.
Currently, Beijing is the leading Chinese VC investment hotbed, raising the most capital — US$2.9 billion in 2011 — followed by Shanghai, which raised US$1.3 billion.
The Chinese VC industry has been led by global brand name investment funds that have established China-based funds (e.g., The Carlyle Group, Sequoia Capital), but domestic VC ﬁrms are emerging and growing much faster. In this period of transition, the market continues to mature, and new legal structures and commercial arrangements are emerging.
Consolidation of the VC industry is inevitable. The abundance of VC money available around China has enhanced the VC industry's boom and rapid development. However, as the competition has grown ﬁercer, some entrants may be eliminated and an industry reshufﬂe will be inevitable.
Only those VCs that have a strong, professional team for project selection, cost control and risk management can survive. The number of participants will increase severalfold, and so will the scale of the industry. Many VC funds in China started with reputable foreign limited partnerships. But limited partnership composition is in transition now that there are funds set up in local currency (renminbi, or RMB), which enjoy natural advantages.
- Many RMB funds operated by foreign institutions have been launched. Strong local preferential policies in tax and foreign currency exchange to foreign RMB funds from the Chinese Government contributed (e.g., Blackstone Group, IDG Capital, KPCB China, Sequoia Capital China, Qiming Venture Partners). For most foreign institutions operating in the Chinese capital markets, being subject to foreign-exchange capital account controls is now a small price to pay for the often exorbitant returns on investments.
- Private capital is becoming increasingly important. Although bank loans are difficult to obtain, start-ups still have a number of alternatives to VC, including ﬁnancial leasing, micro-funds, capital markets (e.g., IPO, bonds), private placement, angel investors and debt ﬁnancing. As elsewhere in the world, Chinese angel investors have become major investors in early-stage start-ups. The competition has nudged VCs toward later-stage, high-growth pre-IPO ventures.
Highly active exit environment
- The high-growth stock exchange ChiNext provides a much-needed domestic exit route. Launched in 2009, ChiNext enables China's portfolio companies to raise money, invest and exit within the country.
- IPOs make up more than 90% of all VC-backed exits in China, reaching a record high. In 2011, China saw 456 exits, including 356 IPOs (78% of all exits) and 41 trade sales.1 Of the IPOs, 171 (48%) were venture-backed companies. In 2011, the VC-backed IPOs saw US$15.3 billion in capital raised from these transactions.2 The median number of years from initial ﬁnancing to IPO is extremely short in China compared with the West — just 2.5 years in 2011.
- Domestic stock exchanges are playing a big role in supporting IPOs, accounting for 79% (281) of all VC-backed Chinese IPOs. SMEB and ChiNext garnered 115 and 128 listings each. Shanghai Stock Exchange had 38 IPOs. From a VC/PE-backed perspective, the 171 IPOs were backed by 2.61 firms on average.2 And 75 IPOs of VC-backed Chinese enterprises took place on foreign exchanges, namely NASDAQ, NYSE and the Frankfurt Börse.
- China's VC-backed M&A market rose sharply in 2010, both in the number of announced deals and the amount of capital raised, hitting an all-time high. There were 17 deals disclosed, up 31% from 2009, and worth a total of US$6.091 billion, up 392% from the prior year.3 In 2011, the pace quickened with 41 trade sales. For M&A exit, the median time from initial financing to M&A was just 4.1 years.
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