VCS Unfazed by China Regulatory Changes - Latest Updates

China's Tech Sector Under Regulatory Scrutiny

Recent months have seen considerable attention focused on China’s technology industry, largely due to unfavorable developments. Following the suspension of Ant Group’s initial public offering, the Chinese government initiated a series of regulatory actions targeting numerous technology firms.

Several sectors experienced increased oversight. This included educational technology, on-demand service providers, ride-hailing platforms, and the gaming industry.

The government’s regulatory actions against prominent Chinese companies led to declines in their stock values. The collective financial impact exceeded $1 trillion for publicly traded Chinese companies listed on international exchanges.

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Impact on Startups

What effect did these rapid reforms have on startups operating within the affected sectors? Considering the performance of their publicly traded counterparts, it’s likely that substantial wealth was also erased during this period of increased regulation.

The Exchange investigated the consequences of the Chinese government’s interventions on the venture capital market. China’s startup ecosystem has fostered several globally recognized companies.

These include not only Tencent and Alibaba, but also Baidu, all of which have achieved prominence for valid reasons. The question arose whether these regulatory shifts would disrupt the venture capital model that facilitated the growth of China’s leading technology companies.

SoftBank's Response

Following initial inquiries earlier this week, SoftBank offered a partial response. The company announced a temporary pause in its investments within China.

The Japanese telecommunications firm, conglomerate, and investment firm had been actively deploying capital in recent weeks. This pace of investment will now decelerate, at least concerning Chinese ventures.

The timing of SoftBank’s decision is open to debate. Is the company preemptively adjusting its strategy, potentially missing out on Chinese deals? Or is it reacting belatedly to the changing landscape?

Data obtained from PitchBook and Traxcn reveals a surprising trend in venture capital activity during the third quarter of 2021.

Historical Performance

Before examining the current situation, it’s important to recall the strong performance of China’s venture capital market as 2020 transitioned into 2021.

The Landscape Prior to Regulatory Changes

Despite considerable disruption, China experienced a relatively positive second quarter of 2021.

Data from CB Insights indicates a decrease of 18% in funding for Chinese startups when contrasted with the fourth quarter of 2020. However, it’s important to note that Q4 2020 represented a peak, achieving a record $27.7 billion in investment. Q2 2021, with $22.8 billion secured, still surpassed all quarterly results since Q2 2016, excluding Q2 2018, Q4 2020, and Q1 2021.

A cooling trend within the ecosystem was observed towards the close of 2018, followed by a resurgence in momentum by late 2020.

Alternatively, analyzing the data in a comparative context reveals a relative underperformance of Chinese venture capital activity. During the same period, Q2 2021, the United States witnessed a record-breaking $70.4 billion in funding. Significant new highs were also established in regions such as Latin America, Canada, and India.

Consequently, China’s proportion of global startup deal volume diminished, and a similar trend was evident in the creation of unicorn companies.

Analysis of CB Insights data, as summarized by Tech Buzz China, shows that the U.S. was responsible for 132 new unicorn companies between January 1st and June 16th, 2021. In contrast, China saw the emergence of only three.

A modest reduction in quarterly venture capital investments and a noticeable drop in unicorn creation do not necessarily signify a downturn in the startup environment. Therefore, a review of more recent developments is warranted.

Evaluating Q3 Venture Capital Trends

The initial hypothesis suggesting an immediate and noticeable deceleration in Chinese venture capital investment doesn't align with the data currently available.

An analysis conducted by PitchBook for The Exchange examined monthly data concerning mainland Chinese venture capital activity from April through August 10th. The resulting information illustrates the performance of these months, with August figures representing both completed results and projections based on the month’s current trajectory (as reported by TechCrunch):

• April 2021: $8.16 billion across 427 deals.
• May 2021: $5.34 billion, encompassing 348 deals.
• June 2021: $8.11 billion invested in 415 deals.
• July 2021: $8.74 billion, with 420 deals completed.
• August 2021 (through the 10th): $1.77 billion, representing 126 deals.
• August 2021 (projected): $5.49 billion, anticipating 391 deals.

It’s important to note that the August numbers appear somewhat lower compared to the preceding months that saw investments exceeding $8 billion. However, venture capital data is inherently subject to reporting lags, meaning the initial figures are often the least precise. Based on the data at hand, it remains premature to conclude that August will not ultimately match the investment volumes of earlier months.

Furthermore, the venture capital activity in China during August 2021, up to the 10th, surpassed the corresponding period in 2020, making a strongly negative outlook difficult to justify. July’s data demonstrates a substantial increase in both deal volume and total investment compared to its 2020 counterpart ($5.73 billion, 383 deals) – it represents the strongest month within the analyzed dataset.

Therefore, a significant slowdown is not yet evident.

Data from Tracxn presents a slightly more cautious perspective. According to their findings, China’s venture capital market experienced a robust June, with $7.82 billion invested in equity financing rounds. However, July saw a decrease to $4.95 billion. Despite this, July’s performance exceeded that of May and was comparable to April, as tracked by Tracxn. Again, the observed changes are insufficient to definitively characterize a slowdown.

A potential shift in the latter part of Q3 could occur if SoftBank reduces its investment activity. Investments from SoftBank and its Vision Fund 2 are typically substantial and executed quickly; a curtailment of these funds could influence the overall Chinese venture capital landscape. It’s also possible that earlier-stage venture capital firms may become more cautious about investing in China given the temporary reduction in SoftBank’s funding.

A clearer picture will emerge upon the close of Q3, but initial observations offer valuable insights, suggesting the market is more stable than initially expected.

The effects of recent regulatory changes may simply require more time to materialize. Alternatively, investors may maintain a strong positive outlook on the Chinese technology sector, accepting potential setbacks in order to continue participating in the market.