China’s ‘herd mentality’ could threaten VC returns

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.