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Changes to corporate investing rules could diminish China’s resilient venture landscape

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Image Credits: Nigel Sussman (opens in a new window)

Since the Ant Group IPO was canceled by central authorities, China’s government has been on a regulatory tear.

You know the broad outlines: After a lengthy period of growth, capital investment and aggressive business practices, China’s central government spent much of 2021 reining in its technology sector. While some of the actions were reasonable from an antitrust perspective, many of the changes to the country’s tech sector appeared more punitive toward entities viewed as too powerful.

The for-profit edtech sector got hit. Didi was effectively executed after it had the audacity to go public in the United States. Video game time for kids was cut, gaming titles left unapproved, algorithms put under the microscope, and more. The business climate for building tech companies under the new “Common Prosperity” push in the country appeared to take a dramatic turn for the worse.

As a result of the changes, the value of many well-known Chinese technology companies suffered.

Although the exit window for China-built tech companies is seemingly constricting to only domestic exchanges, and the space made available in the economy for tech companies to build and innovate apparently shrinking, venture capital activity was strong last year in the country.

We were surprised to see it as 2021 entered its final months, just as we were surprised when we got the full-year numbers.

But there was more. ByteDance recently “dissolved its strategic investment team, sending worrying messages to other internet giants that have expanded aggressively by investing in other companies,” TechCrunch reported. Why did TikTok’s parent company do so? We explained:

At the beginning of this year, ByteDance reviewed its “businesses’ needs” and decided to “reduce investments in areas that are not key business focuses,” a company spokesperson said in a statement. …

The “restructuring” still stirred up a wave of panic in the industry. China’s cyberspace regulator has drafted new guidelines that will require its “internet behemoths” to get its approval before undertaking any investments or fundraisings, Reuters reported. Some Chinese media outlets reported similar drafted rules.

Hot damn.

Obviously, we’re still sorting out precisely what is going on, but it appears that the ability of large Chinese tech companies to deploy capital at will into smaller companies is rapidly coming to a close.

From this juncture, our question is simple: Will government regulations slowing Big Tech investments into smaller companies in China shake up its larger venture capital market? Let’s talk about it.

Tracking corporate venture capital investment in China

The answer to our question is yes, but perhaps not lethally.

Tracking just how important corporate venture capital is to the Chinese VC scene is an interesting problem to crack. One way to view the data is to look at the list of most active investors in private Chinese tech companies in the last year.

According to CB Insights’ 2021 venture capital report, several Chinese corporate investors made the top 10 list of most active capital deployers in Asia last year. Tencent participated in some 39 deals in 2021, ranking it third on the continent; Animoca Brands took the fifth slot with 35 deals; Xiaomi landed sixth among all Asian investors with 31 deals.

Three of the top 10 investors by deal volume in all of Asia in 2021 being Chinese corporate venture capital shops is a good indicator of how important the players are the to country’s VC landscape. If the changes coming to China’s investing rules turn those results into zero, it will impact deal volume and venture dollar volume in the country and, therefore, I would argue, deal value.

But that’s just one way to answer the question.

PitchBook data provides us with a good historical view into the Chinese CVC market. Here are results for China-headquartered corporate venture capital rounds into private companies from 2015 through 2021:

  • 2015: 474 deals worth around $5 billion
  • 2016: 569 deals worth around $12 billion
  • 2017: 591 deals worth around $7.5 billion
  • 2018: 673 deals worth around $31.5 billion
  • 2019: 555 deals worth around $11 billion
  • 2020: 696 deals worth around $21 billion
  • 2021: 1,002 deals worth $37.5 billion

What this loose — I do not claim to be a god of handling PitchBook’s various data filters — look at the Chinese CVC market tells us is that deals involving corporate investors have grown in terms of frequency (deal volume) and value (dollar volume) over time. This means that China’s regulatory outburst is not an accident; it comes as CVC activity in the country ramped up to record heights.

That helps explain why it’s in trouble, I’d hazard.

More generally, when we read things from Crunchbase News like the following:

For the year, China saw funding to startups inside its borders grow 50 percent from 2020, ending at $78.5 billion. That number was helped by an extremely strong final quarter that saw $26.7 billion invested into Chinese startups—the most since Q2 2018.

We can compare the top-line numbers to aggregate deal volume involving Chinese CVCs and see that they really do matter. Losing them entirely, and overnight — which will not happen, mind — would be sharply contractionary but not lethal.

There are lots of non-corporate investors in China who are still active. So long as they persist, the numbers will not collapse. But potential new regulatory rules regarding major tech companies could prove to be a material knock to the country’s venture scene.

So is this the time when China’s venture capital market is going to contract? If the rules are enforced along strict lines, sharply cutting the ability for major tech companies in the country to invest in smaller firms — as the ByteDance news appears to indicate –then, yes.

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