Private Equity News & Analysis

China’s ‘herd mentality’ could threaten VC returns

Greater competition for a limited number of assets has diluted equity ownership, delegates told an industry conference on Tuesday.

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9 July 2019; Speakers, from left, Harry Man, Partner, Matrix Partners, Nisa Leung, Managing Partner, Qiming Venture Partners, Yuan Liu, Managing Director, ZhenFund, and Shuli Ren, Columnist, Bloomberg Opinion, on Venture Stage during day one of RISE 2019 at the Hong Kong Convention and Exhibition Centre in Hong Kong. Photo by Stephen McCarthy/RISE via Sportsfile

Heightened focus on a fewer number of targets could impact Chinese venture capital returns, a conference has heard.

Speaking at RISE in Hong Kong on Tuesday, Yuan Li (second from right), managing director of Beijing-headquartered seed investor ZhenFund, told delegates that an absence of innovation was partly responsible for valuations increasing “drastically” over the past few years.

Fewer targets had prompted a “herd mentality” among Chinese venture capital investors, he noted.

Chinese venture capital investments have been trading at a 21.7x median EV/EBITDA so far in 2019, a three-year high, according to S&P Global Market Intelligence.

Although venture capital deal volumes in China reached a decade-high peak last year, confidence waned towards the end of 2018. Spending fell from more than $35 billion in the second quarter of last year to less than $10 billion in the fourth quarter amid concerns over the US-China trade war and continued adjustments in the Chinese economy, according to KPMG.

A decline is at odds with the $7.4 billion raised for China-focused venture and growth capital last year, the highest total since 2015, according to PEI data. Firms have collected $3.7 billion for the strategy so far this year.

Greater competition for a limited number of assets can dilute equity ownership, added Harry Man (far left), a partner at San Francisco-headquartered Matrix Partners, which invests across China, the US and India.

“My main concern is not actually about valuations, it’s more about how much of the ownership we, as a venture capital firm, can own,” he said. “Oftentimes we still have to split it with another co-investor who’ll squeeze in at a very late stage of the conversation. At the end of the day you don’t want to own 2 percent of a $10 billion company; there’s not going to be any return for the VC.”

Global median pre-money valuations have risen in dollar terms across all segments since 2012, according to KPMG.

Series B valuations climbed from $21 million to $73.5 million as of 31 March, while seed pricing has more than doubled to $7.5 million. Series D valuations rocketed to $560 million, up from $93 million seven years prior.