A prominent investor and financial expert in China has warned of “disaster” from a desperate gold rush into tech startup funding.
The dire prediction comes as the number of venture capital funds in China has more than doubled to 1,216 at the end of October, up from 552 at the beginning of 2015. The data is from the Asset Management Association of China (AMAC).
“We are concerned about the consequence of massive flooding of capital from some institutions, including local government-backed policy guidance funds and fund-of-funds,” said Jia Hongbo, general secretary at AMAC, a self-regulatory body supervised by China’s securities regulator. He was speaking at an industry conference on Thursday, reports China Money Network.
You have inexperienced fund managers backing companies that don’t deserve it.
“The volatility and the size of the incoming funds could be a disaster to early-stage investing,” Jia added.
Despite the boom in venture capital in the country, startup funding is down significantly this year as sky-high valuations make it tough for VCs to find decent deals.
The number of China investments by venture capital firms is down 34 percent from the same period last year, according to Beijing-based Zero2IPO Research. The total value of all those deals dropped 12.5 percent.
“The rule of thumb is that 80 percent of the returns that VCs make come from 20 percent of the funds, and the majority of funds don’t break even,” says William Bao Bean, partner at Shanghai-based SOSV, a particularly active investment firm among early-stage startups.
One major impact of the cash flood in the nation is that “second-tier fund managers are able to raise funds – and these managers fund lower quality startups,” explains William to Tech in Asia. “While they might have a lesser product, these tier two startups’ ability to burn cash make it harder for tier one players to shine. Bottom line: you have inexperienced fund managers backing companies that don’t deserve it and as a result the entire market suffers.”
It’s cold out there
“During my 21 years in investment, the first half of this year is the first time that I’ve felt the winter chill,” said Xu Xin, founder and managing partner at Capital Today, to Caixin last month.
The startup funding gold rush seems to be the consequence of China’s 2015 stock market crash and ongoing restrictions on real estate speculation, leaving investment firms and ordinary individuals alike scrambling for new avenues of quick returns. Many wealthy retail investors leapt into the venture capital space – focusing on RMB-denominated funds aimed at domestic startups – by buying into investment options from financial intermediaries.
“Many new funds […] have been created by people with no experience in venture investing, nor entrepreneurship. Their strategy is to follow where the hot money is flowing to, including bike-sharing, culture, and film investments,” warns China Money Network.
Three Chinese startups running bike-sharing apps have attracted US$282 million in funding this year alone, according to the Tech in Asia database.
China’s government weighed in, too – vowing to support innovation and setting up state funds in conjunction with private VCs. State funds held US$336 billion for investing in the nation’s startups at the end of 2015.
However, with so few profitable deals available, the VC boom looks like a new tech bubble.
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