After Frenetic Start, China’s VC Ecosystem Cools In Late 2018

From yellow bicycles and facial recognition to ridesharing superapps and vegetable delivery, new waves of capital fueled the Chinese startup market in 2018. Data and venture experts explain, however, that China’s less impressive finish to the year may lead to a more measured 2019.

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In this venture report on Asia Pacific, we’ll look at how the region fared in an increasingly unsure economic climate, taking an up-close look at its driving force: Mainland China.

The Numbers

Before we get to the doom and gloom, let’s look at how the Asia Pacific’s fourth quarter and full-year 2018 venture results compared to their predecessors.

According to Crunchbase data, which is indicative of industry trends, venture capitalists invested roughly $138 billion in Asia-Pacific startups last year. 1

According to the chart above, which includes preceding years, 2018’s figure is more than 100 percent increase from 2017’s own venture total. On the deal end, more than 5,000 known rounds were reported, a nearly 50 percent year-over-year increase in deal volume in the region overall.

With rounds up half and dollars up double, there were some big rounds to contend with. In 2018, supergiant deals—those worth $100 million or more—grew by around 75 percent year-over-year to 237.

While it’s clear that 2018 was a watershed year for the region, let’s take a closer look at how it panned out on a quarter-by-quarter basis:

While our first chart paints the picture of a booming venture capital economy, the second depicts a markedly different environment. Venture deal and dollar volume decreased by almost 30 percent from Q3 to Q4 2018, nearly shrinking to its year-ago quarter totals.

Don’t think that the chart shows that the startup markets of Asia Pacific are falling in sync.

China represented more than 60 percent of the total venture dollar and deal volume in the region in Q4 2018, according to Crunchbase data. That made it heavily influential in shaping the data above. For example, known deal and dollar volume in Southeast Asia (which doesn’t include China) increased over the quarterly periods detailed above, including a massive $1.2 billion deal for Indonesia-based Go-Jek spiking the region’s Q4 total to around $4.1 billion.

Next, let’s observe how China, specifically, performed on a quarterly basis in 2018.

It’s important to note that the Q2 2018 known dollar volume total for China was significantly boosted by a $14 billion Series C banked by Ant Financial (the fintech arm of Alibaba).

Let’s dive more deeply into China, as its venture results drive the region’s own.

Breaking Down The Deals

In Q4 2018, seed, early, and late-stage deal volume all decreased quarter-over-quarter. Seed-stage deals represented about 38 percent of deals of known type while commanding just 3 percent of the VC dollar volume of deals of known size and type.

Meanwhile, early-stage deals, like the $290 million Series A for Hangzhou-based electric vehicle maker Leapmotor, or the $200 million deal for Starbucks’s quickly growing competitor Luckin Coffee, represented about 50 percent of all deals of known type, raking in about 33 percent of the dollar volume among deals of known size and type.

Late stage deals represented the remaining 12 percent of deal volume and a staggering 64 percent of dollar volume for deals of known type and size. The average late-stage round totaled about $167 million. That represents a slight increase over Q3 2018’s $140 million average, and a decrease of nearly 30 percent from Q2 2018’s high of $217 million if the Ant Financial round is taken out of consideration.

Keeping a tally of the number of supergiant rounds, Crunchbase recorded 39 of more than $100 million rounds in Q4 2018. In both Q2 and Q3 2018, 56 rounds of over $100 million were recorded, while China made off with 38 supergiant rounds in Q1 2018, and 39 in Q4 2017. Here, again, we see a peak in the middle of 2018, and a slope down to the year’s end.

There are signs that efforts to curb the potential effects of a slowing economy will further that trend.

Looking Forward

Consumer downgrades, rising debt, and falling auto sales—those are just a few metrics that have contributed to a rising lack of confidence among individuals, entrepreneurs, and investors in China.

A government-encouraged push for entrepreneurship and startup growth led to a surge in the interest of banks and other state-owned institutions in playing a hand in the venture scene in recent years. But, as Nikkei Asian Review and others have reported, that encouragement brought a spike in fundraising for possibly inexperienced venture fund directors.

Under-regulated shadow banks, risky bets, and noticeably high valuations—combined with other pressures like rising debt in the country—led the government to implement more stringent financing and asset management policies last year.

Allen Yu, the VP of investments at the U.S. China Green Fund, told Crunchbase News that he believes the shift that occurred in 2018 was likely the result of those financing policies.

“Due to the tightening of financing policies for the [private equity and] VC industry, many RMB funds encountered difficulties in raising money from LPs [like] banks and financial institutions in 2018,” Yu wrote in an email, adding that the “scale back” will likely continue in 2019.

Further, he noted that the combination of those policy changes along with expectations that global stock markets may continue to underperform this year will make it difficult for VCs to afford such high valuations.

“Heavily funded [or heavily] valued startups will still be able to live up to their previous valuations,” Yu wrote. “But it will be more difficult to ask for a higher valuation in their next rounds of financing.”

If there’s a smaller pot of gold and anticipation that returns through a public exit will be less lucrative, that means that supergiant rounds like those mentioned above will likely be less common. And in an atmosphere that has been referred to as a funding winter, consolidation of industries may continue. This is particularly the case for those in the electric vehicle industry, where government subsidies that have warmed investor and entrepreneurial interest have started to scale back.

And if the stock market in China keeps significant pressure on China’s big tech market caps, it could be the case that now-infamous large corporate investments by players like Baidu, Alibaba, and Tencent in startups in China become less common. Tina Cheng, managing partner at Beijing-based Cherubic Ventures, told Crunchbase News that she believes revenue interests may occupy corporate attention.

“We are likely to see less investment activities across the board this year in China not just due to the falling share prices of tech giants but also the slow growth of the macroeconomic condition,” Cheng wrote in an email. “Corporations will need to improve their bottom lines and will have less to spend on investments as a result.”

That slowing economic condition could also mean that the companies may scale back from pursuing global growth through investment in startups in emerging economies in Southeast Asia and India. However, Vishal Harnal, general partner at 500 Startups in Singapore, told Crunchbase News that while VCs are scaling back in China, he believes fluctuations in venture capital funding in emerging markets like Southeast Asia will likely be short-lived.

“More capital is being reallocated out of traditional asset classes into alternatives, and within alternatives, from hedge funds into [private equity] and VC,” Harnal explained in an email. “In Southeast Asia, most family office wealth is significantly over-allocated stocks, bonds, and real estate, but that is quickly changing as they familiarize themselves with VC as an asset class and increase their exposure.”

China has helped lead the world of tech and VC in 2018 that brought major venture capital gains, but a slowing economy, ongoing trade tensions, and stumbling global markets foreshadow a less optimistic future. China’s government has a history of addressing domestic issues with precipitous policies that have engendered long-term repercussions. If the country is challenged by a recession, we’ll have to see if “capitalism with Chinese characteristics” will (once again) keep its economy afloat, or whether the venture community and the country’s 2025 goals will drown with it.

Methodology Notes

Companies considered in this section only include those that have listed geographical locations on Crunchbase. Companies in the Asia-Pacific include Mainland China, Hong Kong, Macao, Taiwan, South Korea, North Korea, Japan, Mongolia, Philippines, Indonesia, Myanmar, Laos, Thailand, Cambodia, Singapore, Malaysia, Vietnam, Australia, New Zealand, Bhutan, Bangladesh, British Indian Ocean Territory, Indonesia, Maldives, India, Nepal, Pakistan, and Sri Lanka.

Featured Image Credit: Li-Anne Dias

Lower Image Credit: Monique Lopez