As China looks to reignite growth, what role will its technology industry play? Is there enough capital flowing to support a new generation of tech startups that could keep China competitive?
It’s not a secret that the Chinese economy slowed in recent quarters, thanks to global macroeconomic turbulence, geopolitical matters and the country’s now-fading zero-COVID policies. The policies, which China’s government is presently dismantling, resulted in frequent lockdowns in the nation’s populous cities, while other precepts of the policy disrupted trade and transit.
The zero-COVID policies worked to limit the spread of the pandemic in the country for some time, but the cost of the policy — in human and economic terms — appears steep today as the nation begins to endure a wave of infections that were perhaps delayed instead of avoided.
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Other factors played into China’s slowing economic growth. The country’s highly leveraged real estate market has taken blows thanks to changing regulations and a history of debt-fueled expansion, the price of which eventually came due. And China’s government cracked down on its domestic tech industry starting in late 2020 with the scuppering of Ant’s then-planned epic fintech IPO.
After Ant was put into the penalty box, a host of other regulations rained down from the Chinese Communist Party’s pen, whacking gaming, e-commerce and edtech, among other technology subsectors. Unsurprisingly, venture capital activity in the country declined.
Why did China pull an about-face on its zero-COVID policies? Internal unrest was presumably part of the calculation, but easier to understand are the economic issues that, after piling up for quarters, were likely no longer palatable. For example, retail sales in China fell 5.9% in November from the year-ago period, per the country’s own accounting. Industrial production came in at 2.2% for the month. Economists had expected a smaller 3.7% decline in retail sales in China this November, and a greater — 3.6% — expansion rate in industrial production.
With zero-COVID in the rearview and expectations that China intends to limit its regulatory barrage in key industries including technology, perhaps the times are about to change. Our question is pretty simple as the nation looks to shake off economic malaise: How much ground do Chinese venture capitalists have to make up to bring the country’s investing pace back to what we might consider par?
History
China’s venture capital market has seen its share of ups and downs. The country’s startup community once managed to raise more in VC dollars than those in the U.S. In the intervening years, however, there has been a reversion to prior results.
After seeing $15.0 billion to $36.7 billion raised per quarter in 2018, China’s venture capital totals steadily declined during 2019. CB Insights data tracks a Q1 2019 result of $11.6 billion, which fell to $7.7 billion by Q4 of the same year. Fundraising continued to lag at the beginning of 2020, with Chinese startups raising $17 billion in the first half of the year and $41.2 billion in the final two quarters.
As you can imagine given that ascent, 2021 was a great year for Chinese founders, raising $95.2 billion in the year and capping off the fourth quarter with a local maximum of $27.7 billion. That final figure was greater than the $12.6 billion and $10.2 billion that Chinese startups raised in the first two quarters of 2022, followed by a dismal $8.5 billion in Q3.
China’s Q3 2022 venture capital activity was a “10-quarter low,” CB Insights noted in its report on the period. In percentage terms, the Chinese venture capital market fell a bit over 65% from Q4 2021 to Q3 2022, a brutal comedown from recent results.
Inside the numbers, late-stage rounds became increasingly scarce this year in China. In 2021, some 22% of Chinese venture rounds were what CB Insights calls “mid-stage,” and another 13% “late-stage.” The late-stage figure dropped to 7% this year, though that can be viewed as somewhat optimistic: If late-stage rounds return as the Chinese economy opens up, we could see not only a race of capital back into its startup sector, but, in addition, the startups that raised earlier-stage rounds in 2022 could find access to the growth capital that they need to keep scaling.
Given high youth unemployment in China, often blamed partly on increasingly parsimonious tech companies, a return of late-stage deal-making would be welcome.
What do we expect?
Because zero-COVID policies are just winding down, partially in response to unwelcome economic results, we are not expecting Q4 2022 data to be indicative of the result of the end of the policy. Instead, Q1 2023 data and later will be a clearer directional guide.
There are some positive signs. PitchBook data has fourth-quarter capital raised in China by startups already ahead of Q2 numbers and potentially ahead of Q3 as well (the data sources disagree modestly on how rough Q3 2022 was, which is why we consult several sources when parsing venture data). Crunchbase data paints a similarly warm picture, with Chinese venture investment in Q4 besting what we saw in Q3.
There may have been, and we’re speculating at this point, a little rebound in venture activity ahead of the country’s reopening. If so, there could be a modest tailwind for venture deal-making during the opening months of next year.
But the climb back could take time. The country’s startups would need to roughly triple their Q3 2022 fundraising pace to get to where they were at the end of 2021. That won’t be quick. But because 2021 venture investment was a bit overheated, the ground that Chinese startups need to recover to be back at “pace” is a bit less than a tripling.
One advantage that China does have presently is an active IPO market. If early 2023 debuts perform well, perhaps China’s startup market will have another accelerant in its pocket to help it get back up to speed.
Much like with the U.S. startup market, macroeconomic issues loom. Many expect the United States to enter a recession next year; that could harm the larger Chinese economy. China still has to deal with rising debt, a property sector in distress, an increasingly remote international position and other matters. If those issues slow China’s larger economy, tech startups could find themselves swimming upstream regardless of whether VCs turn the taps back on.