PRIVATE equity (PE) and venture capital (VC) funds in China had another gloomy year in 2024, but many in the industry are hoping that a revival is on the cards in the wake of renewed enthusiasm in the domestic stock market after a string of supportive measures from the government.
The benchmark Shanghai Composite Index has risen more than 12 per cent since the government released a slew of stimulus measures starting Sep 24, while the Shenzhen Component Index has jumped more than 17 per cent.
PE/VC firms are waiting to see whether the fervour in the secondary market will spill over into the primary market where IPO candidates raise funds and early-stage shareholders exit their investments.
“Everyone has seen the secondary market warming up again, but for those of us in the primary market doing PE investment, we are still in the depths of a capital winter,” Shan Junbao, chairman of CICC Capital Operation, told a forum last October.
With nine IPO exits achieved in the first three quarters of 2024, CICC Capital – the PE investment arm of state-owned investment bank China International Capital Corp – was the best-performing institution in China’s PE/VC industry during that period.
The IPO market has been in a deep freeze since August 2023 when regulators announced a tightening of IPO approvals to help reverse a downturn in the stock market. Other regulations introduced since then, including more stringent criteria for IPO candidates as part of efforts to improve the quality of listed companies, have contributed to the plunge in listings.
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Third-quarter activity data for the PE/VC sector paint a grim picture. The number of new funds set up dropped 41 per cent year on year, and of the more than 12,000 firms registered with the Asset Management Association of China, only 991 were involved in setting up new funds, according to data compiled by ChinaVenture Investment Consulting, an industry information provider.
A total of 52 Chinese companies went public in the third quarter, 52.3 per cent fewer than in the same period in 2023. Of those, 25 listed on the Chinese mainland – a 72.5 per cent drop – and raised just 15.3 billion yuan (S$2.9 billion), 86.6 per cent less than a year earlier. Fourteen companies launched IPOs in the US and 13 listed in Hong Kong.
Some in the industry are cautiously optimistic about a turnaround following the top leadership’s pledges of support for the PE/VC industry and the rebound in the mainland stock market since late September.
In April 2024, a meeting of the Communist Party’s 24-member Politburo, chaired by President Xi Jinping, called for strengthening the role of “patient” capital – a term referring to investment that is willing to forgo short-term profit and focuses on sustainable long-term growth and returns – in supporting innovation.
The same month, the State Council released guidelines on promoting the high-quality development of capital markets that called for efforts to smooth the cycle of fundraising, investment, management, and exit, and to harness the role of PE/VC investment in supporting technological innovation.
In June, the State Council published a series of measures to promote venture capital, and in September, a meeting of the council, chaired by Premier Li Qiang, discussed measures to support the development of VC investment, calling for obstructions in the VC chain to be cleared, overseas listings by qualified tech companies encouraged, and the market for equity transfers and mergers developed, according to a readout of the meeting.
Nearly half of the relevant content in the document was devoted to discussing exit issues, aiming to restore liquidity in the primary market, an industry insider focused on analysing policy trends noted.
IPO gloom
“The top leadership has realised the difficulties and blockages in fundraising, investing, managing, and exiting,” the industry insider told Caixin. But exit difficulties are really the crux of the problem, he said.
Chinese PE/VC investors have always favoured IPOs as their exit channel, but a slowdown in new listings has made this an extremely difficult route, spelling trouble for both investors and startups.
As the mainland stock market slumped in 2023, the China Securities Regulatory Commission (CSRC) suggested in August that year that it would limit the number of new listings as part of a package of measures to arrest the slide.
And while the CSRC leadership knew the importance of IPOs to PE/VC investors, stock traders were constantly telling them to suspend new listings, so they had to slow down the pace, a source close to the regulator said.
In the first nine months of 2024, 69 companies went public on the mainland market, a decline of 73.9 per cent year on year, while the total capital raised crashed 85.2 per cent to 47.6 billion yuan, according to data compiled by Beijing-based industry service provider Zero2IPO Research.
As at end-September, 294 companies were waiting for their IPOs to be reviewed by the exchanges, a year-on-year drop of more than 60 per cent.
The slump in the IPO market is the biggest pain point right now for China’s capital markets, Liu Shengjun, founder of the China Financial Reform Institute, a think tank, told Caixin.
The idea that halting IPOs will improve the stock market is a misconception, he said. “The performance of the capital markets has nothing to do with the number of listed companies. It depends solely on the quality of the companies and their ability to generate profits, nothing else.”
The notion that an increase in listed companies would alter the supply and demand of funds is “absurd,” he said. “The capital markets operate like an open reservoir, not a closed one. If there are more good companies, capital will pour in continuously; without good companies, even if IPOs are paused, existing funds might flow out.”
IPOs remain the exit of choice for PE/VC investors though – a recent survey of midsize to large firms by an industry association found that more than 98 per cent of respondents prefer the route that involves portfolio companies listing on China’s tech-focused Star Market or ChiNext board.
But a tighter regulatory environment and stricter listing criteria mean that PE/VC investors will have to rethink their exit channels, according to Firstlight Capital, a VC firm. The IPO market may never return to its heyday, the firm wrote in a recent article, saying that even IPOs that do take place will prioritise big companies or those that represent “new quality productive forces” – a concept put forward by President Xi Jinping in 2023 to focus on advanced technologies.
Smaller companies with slower growth may not be able to bear the substantial costs of going public, the article noted.
M&A exit option
One alternative exit route now being promoted by regulators is mergers and acquisitions (M&As). The CSRC in September rolled out guidelines for M&A involving listed companies that encourage PE investment funds to buy listed companies if they promote industrial integration.
It also proposed a change to shorten the lock-up period to six months from 12 months for PE funds that have held assets used for share subscriptions for at least five years.
The guidelines say regulators will also support acquisitions by listed companies of high-quality unprofitable assets that would help to fill in gaps in their core business, strengthen their supply chains and give them key technologies for their development needs.
The CSRC has also relaxed standards for mergers carried out by companies listed on the Star Market under certain conditions, sources close to the regulator said.
The Shanghai Stock Exchange has already convened a meeting with multiple securities brokerages to discuss M&A, the sources told Caixin.
“The current market urgently needs M&A cases, a batch of cases, good cases. We hope investment banks can bring forward more cases,” one official told the meeting.
He stressed the need for cases that can serve as examples for regulators to gain experience and refine the rules.
The Shenzhen Stock Exchange recently compiled 12 typical M&A cases to serve as a reference for listed companies and other market participants.
Some market analysts believe that with encouragement from new policies and pent-up demand for exit routes, M&A could become a significant channel.
In particular, technology and innovation-driven companies, helped by policy “green channels”, will have more opportunities to be acquired by listed companies, allowing early investors a chance to recoup their capital.
But Liu from the China Financial Reform Institute isn’t optimistic.
“If a healthy IPO ecosystem can’t be established in the capital markets, other exit methods like M&A can only be supplements, and that will inevitably lead to pessimism in the VC industry,” he said. “Most investors, especially those top-tier VC funds, will still primarily rely on IPOs as the main exit channel.” CAIXIN GLOBAL