2020 was a year of reflection and challenges for China’s venture capital industry. China’s announced private equity and venture capital deals was RMB767.9 billion yuan in 2020, which is almost "halved" compared to 2019. The number of deals was 4,000, almost half of 2019’s 7,659.
It was in stark contrast to the better days of 2018 and 2017. A total of 15,199 deals involving RMB2,066 billion were recorded in 2018, and 16,442 deals involving 1,600 billion were recorded in 2017, according to Time Finance. The deal level of 2020 dropped to just around one quarter of those hotter days in the Chinese VC market.
But it was not all gloom. After the end of the first half of the year full of pessimism, the venture capital industry in the second half of the year seemed to have "returned to 2014″, especially with the breathtaking valuation hikes of certain tech sectors from semiconductors, consumer brands, innovative drugs and many others. Investors were rushing to send money to leading startups in "hot" sectors.
"You don’t have time to do due diligence, whoever sends the money first will get the chance to invest" has become a strange pattern often seen in deals.
Wang Huadong of Matrix Partners believes that global interest rates are very low today, especially after the pandemic. This phenomenon is forcing investors to chase high-quality targets, and high-quality targets are scarce. This makes the already crowded transactions more crowded and leads to investors frantic to lock in those rare targets.
Zhen Fund’s Dai Yusen said: "With a lot of money but not many high-quality assets, the leading projects will be very expensive and will be quickly invested by those who act first.”
Jiang Ke, a partner of Taihe Capital, adds that in addition to the effect of the booming public markets, the high valuations of some companies in 2020 were affected by a variety of factors.
"The current FOMO (Fear of Missing Out) sentiment of investment institutions is relatively high, and the higher premium paid includes the pricing of the risk of miss leading projects. We communicated with investors and found that everyone can actually feel the pressure of rising valuation. But before the music stops, the show must go on," Jiang Ke believes that when the game factors in investment and financing behavior are amplified, valuation deviations from fundamentals will be relatively easy to occur.
In 2021, will the high valuations of startups continue?
The general attitude of investors is relatively optimistic. "There is no eternal valuation model, only the valuation model of one certain time," Zhang Jinjian of Oasis Capital said that the current global monetary easing coupled with increased market uncertainty, the premium will appear and strengthen for a long time.
Black Ant Capital Zhang Peiyuan also believes that there is no significant bubble in real high-quality assets. The long-term space of these assets and the company’s competitive moat can support its valuation, and it will also bring reasonable returns to investors in the long run.
Zhou Lingfei’s judgment is that this year’s medical services, chips and other industries’ valuation increases is a cyclical result. "There will be some companies whose valuations may be inflated at this moment, but solid and good companies will always be good for the long term."
But in the view of DCM’s Zhao Lei, a good company does not necessarily mean a good investment target. When its valuation far exceeds the actual intrinsic value, it is not good as an investment opportunity.
Zhang Xingchen shares this view: "When we observe the continuous emergence of various innovations in software and application layers, investors will be more optimistic about technological changes in a relatively long time in the future. At the same time, there is a premise that investors need to be soberly aware that the market is relatively hot and high. The state of valuation requires investors keeping a calm mind, insisting on looking for more lasting and innovative things, and pursuing long-term changes."
Hard Tech Investments Is A New Theme
Hard tech investments such as semiconductors, biotechnology, new energy, and smart manufacturing have all remained extremely hot this year.
GSR Ventures’ Zhang Yutong pointed out the demand for "import replacements", or finding replacement products for those foreign imports dominate, was highlighted by the pandemic and international political uncertainty. Semiconductors, IOT, and EDA fields received a higher degree of capital attention in 2020.
Wanwu Capital’s Gu Minman, echos this view. "As long as there is a big chance for China to be subject to external disruption while there is no domestic alternative products, those are the areas great opportunities exist," she said.
The chip semiconductor industry ushered in an upsurge in China last year. Sequoia Capital has the ability to view the development stage of the industry in a macro and historical perspective. They witnessed the prosperity and development of semiconductors in the US in the 1970s and 1990s. Sequoia American team invested in many successful semiconductor companies in the early stages.
Guo Shanshan said that compared with the mergers and acquisitions in the U.S. market in the second half of last year, China’s semiconductor industry is still booming and rising. “This is a historic window of opportunity for investment, just like the U.S. market in the 1970s and 1980s.”
"In China, we are optimistic about the mature process field under the backdrop of reshuffling of the international industrial chain. At present, the domestic semiconductor field that relies on mature process has clear room for development, such as pan-analog semiconductors. Among them, we are particularly optimistic about IC and discrete devices in the power field," Guo Shanshan said.
He said that Sequoia China has extensively invested in the downstream of the semiconductors sector such as NIO, Xpeng and DJI. "The rapid penetration of domestic new energy vehicles will become domestically produced in the next few years. This will provide excellent market opportunities for power semiconductor manufacturers in China." In addition, Sequoia China is also actively paying attention to advanced domestic semiconductor design companies such as computing and communications chips.
Hillhouse Capital’s Huang Liming attributed the "chip investment craze" to changes in underlying demand and application scenarios. "Chinese companies can’t wait for digital transformation requirements to greatly increase our requirements for computing power and storage, and chips are the most basic infrastructure. At the same time, the application scenarios of chips have also undergone revolutionary changes. For example, smart cars have become an increasingly important field for semiconductors."
For these reasons, Hillhouse Ventures invested in a number of outstanding companies in 2020, including Biren Technology, Horizon, Xinhua Zhang, Minxin Semiconductor, and Sinus Semiconductor.
Huang Liming revealed that companies in this field mainly differentiate themselves on two points: first is the founding team, whether they have enough practical experience in chip architecture design in the past; second, whether they have enough innovation in their business.
Even with policy support and investors’ enthusiasm, many chip projects have been exposed to suffer delays or collapse in the past two years. Zhu Jia of Lightspeed China thinks such failed investment projects is a normal phenomenon. He believes that the entire industry is still developing in a healthy manner.
In Zhu Jia’s view, the methodology of hard technology investment is very different from Internet investment: 1. The hardware industry has a high-level industrial chain, and investors must be good at all the upstream and downstream links of the entire industrial chain, understanding the research, and have a longer cycle and patience. 2. Internet investment logic emphasizes high efficiency and speed, building barriers through capital, and achieving the ultimate victory through speed, but for hard technology companies, technology is the core barrier and it takes a long time.
Wanwu Capital’s Gu Minman is full of doubts about the feasibility of burning money rapidly to secure market share, a tactic often deployed by consumer tech firms, would work in the hard tech segment.
Elsewhere, Lightspeed China’s Zhu Jia emphasized that the continuous development of artificial intelligence is also worthy of attention. In the past few years, AI has made many breakthroughs in many practical applications, and this field will still be an important direction for investments.
Challenging Year For New VC Funds
From the data point of view, the number of new institutions established in the past two or three years has indeed decreased sharply. In 2020, the number of newly established funds has shown a record low for the past five years.
Yunfeng Capital’s Li Na believes that the bifurcation among investment institutions will become a long-term trend. The future will be a "comprehensive competition" related to institutional branding, team effectiveness and stability, continued reputation in the fundraising market, and AUM (asset management scale).
Wang Huadong said that not only VCs, but also various industries have seen more and more obvious bifurcation effects. In the early stage investments, there are only 10-12 companies at the top of the competition, but in the future, these dozens of institutions can obtain more than 90% of the industry’s comprehensive income.
But in the long run, new funds will continue to be launched. Most of these institutions must seek differentiated play in the investment stage, focus on niche markets, post-investment resources and other aspects in order to break through the competitive landscape where there are many large Chinese funds dominating the field.