Foreign Investors Fuel Surge in Chinese Venture Capital Deals

In the first half of the year, foreign venture capital firms participated in one-quarter of the almost 2,400 venture deals in the Greater China region.

With deals worth $56 billion in Mainland China, Hong Kong, Macau, and Taiwan, venture capital financings have turned around sharply from 2020 when the market was slowed by the pandemic, according to a recent PitchBook report. In the first six months of the year, 24.6 percent of VC deals in the region had at least one investor based outside of China, up from 22.4 percent in 2020. If the current pace of dealmaking continues, PitchBook expects capital investments to exceed $100 billion by the end of the year, which would be only the second year on record with VC activities surpassing this level.

Cross-border VCs, notably those with headquarters in the U.S., are attracted by the country’s burgeoning middle class and rapid technology development, according to the report. While Chinese regulators have increased their scrutiny of sectors from gaming to after-school tutoring in the past few months, pummeling the value of some public stocks, the effect of the crackdown remains to be seen in the venture industry. Unlike listed stocks which can be bought and sold all day long, investments in venture funds are committed for many years. 

“VC is a very slow industry. It’s not like the stock market where things are changing daily,” said Joshua Chao, senior VC analyst at PitchBook.

But, venture-backed companies, most of which ultimately list on an exchange, are intertwined with public markets. Part of what is fueling venture capital activity in the China region is the strong initial public offering market, which gives funds one way to exit and profit from past investments. The data suggest “the current environment is generating sufficient exits to continue powering Greater China’s venture industry,” according to the report.

So far in 2021, funds have exited 20 companies that have been worth more than $1 billion. Nineteen of those were public offerings. PitchBook expects total exits, including IPOs, sales to strategic buyers and other transactions, to reach record levels in the second half of the year. “That said, recent scrutiny and new legislation from Chinese regulators could be a headwind for companies attempting to list on overseas stock exchanges and will likely push more high-profile offerings onto Shanghai-, Shenzhen-, or Hong Kong-based exchanges,” according to the research firm.

Foreign venture capital firms based in the U.S. and Europe are particularly interested in China as the growth of high-tech industries in their own countries has reached a plateau, Chao said. These investors see China as the next frontier of tech start-ups in the next five to ten years. 

“For many VCs, investing in Chinese startups represents both a paradigm shift from Western companies, given the sheer operational scale and speed of the region’s innovation economy, as well as an opportunity to invest in first-in-class startups in a rapidly growing market,” the report said. 

In the past few months, non-domestic VCs are involved in some of the hottest VC deals in Greater China, including a mega-deal led by California-based Sequoia Capital. In February, the investment firm led a $3 billion late-stage financing round for Xingsheng Selected, a three-year-old grocery app. 

But Chao acknowledges that going forward, foreign venture capitalists might need to rethink their investment strategies in sectors that have drawn inspections from the Chinese regulator. 

For example, people under the age of 18 are limited to three hours of video games per week, according to a ban issued earlier this week by China’s National Press and Publication Administration. After-school tutoring centers, one of the hottest investment targets in the country, were forced to be registered as non-profits in late July. 

“If you are investing in sectors that have been deemed non-profit, you are not going to return your fund,” Chao said. “I think investors are still trying to understand what [the regulation] means for their current portfolio and future investments.”