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Chinese startups struggled. The corona virus may be the last straw

The rise of China's 'Silicon Valley'
Written by David

So far this year, venture capital investment in start-ups across China – including the mainland and Hong Kong – has dropped more than 65% compared to the same period a year ago, according to data provider PitchBook.

This is bad news for many companies that were already struggling to find financing during what became known as a “capital winter” last year. Companies in the region raised a collective venture capital of $ 54 billion in 2019, about half of what they raised in 2018.

“Covid-19 has been another challenge among a series of setbacks for China’s venture capital landscape,” said Alex Frederick, a venture capital analyst at PitchBook.

Startups are important to China’s long-term economic ambitions. The country has jumped to the United States to become the world’s largest unicorn hub, or billions of dollars in private companies. Venture capitalists pay special attention to technology companies, which can help strengthen Beijing’s goal of becoming a global leader in artificial intelligence, electric cars and other fields.
But many Chinese start-ups struggled for court investors last year. China’s economic activity slowed as the country struggled with cooling domestic demand and a trade war with the United States.
Problems with high profile startups have meanwhile become cautionary stories for many investors. US office supplier WeWork’s initial public offer, for example, was notoriously closed last year, while the Chinese electric car manufacturer Nine (NINE) have seen it making crater 44% from a year ago to less than $ 3 per share when the company is bleeding money.

The corona virus can now provide a deadly blow to companies that are not strong enough to weather the financial turmoil. Frederick said that there is no perfect comparison with what start-ups are facing now, but he noted that the environment is similar to the companies that met during the great recession more than a decade ago.

“During the recent recession, startups financed during the crises underwent longer periods between financing, and value growth declined significantly,” the analyst added. “Efforts to contain coronavirus have led to an economic slowdown, and uncertainty about the severity and length of the slowdown is likely to further exacerbate economic volatility.”

Workers at a startup incubator in Beijing 2018. Entrepreneurs in China have been hit by a pronounced slowdown in VC operations last year which has resulted in less funding going to fewer companies.

Ghosted investors

Humility caused by the sudden economic shock has been evident among business owners and investors, while the fallout from the coronavirus pandemic feels inevitable, according to interviews CNN Business conducted with more than half a dozen people active in growing new businesses.

The uninterrupted period between Lunar New Year holidays and summer travel is usually the time of year that start-ups use business to unlock business, says Oscar Ramos, CEO of Chinaccelerator, a startup incubator based in Shanghai.

Not this year. Instead, entrepreneurs prioritize more pressing issues: Reduce costs. Prepare a contingency plan. Consider expensive growth ambitions.

Prior to the outbreak, Hong Kong-based fintech startup MioTech had worked to expand in Singapore, says CEO Jason Tu. Now these events are being arranged.

Tu told CNN Business that his team was “trying to save every penny” when its startup comrades were struggling to survive.

“I have quite a number of starting friends who are closing their doors,” he said. “Anything that relies heavily on the supply chain, delivery or offline presence is busting right now.”

Workers at a cooperation space in Beijing 2018. China surpassed the United States last year to become the world's leading hub for

Companies that have managed to hold large amounts of capital in recent months are also reviewing their priorities.

Xpeng Motors, an electric car manufacturer supported by Alibaba (BABA), raised $ 400 million last November and claimed one of the largest financing rounds in China that quarter, according to PitchBook.

The company looked at ways to sharpen spending before the outbreak, said Brian Gu, president of the Guangzhou-based startup. But the health crisis is forcing it to dig even deeper, he said, adding that Xpeng Motors is looking at what plans it can put on the back burner. It also considers other ways of raising capital, such as taking out bank loans or operating government subsidies.

Plans to meet in person with prospective investors have also been thrown out the window due to travel restrictions and city or countrywide lockdowns.

The travel industry suffers from its worst shock since 9/11 due to coronavirus

“Of course things are going slower, because I can’t meet anyone,” says Edith Yeung, director of Silicon Valley company Proof of Capital and advisor at Incubator 500 Startups. She usually spends about half a year in China and has not been able to return to the country since the outbreak began.

Abel Zhao, CEO and co-founder of Hong Kong-based AI software company TravelFlan, said he is also experiencing complications when trying to get financing. His company – which deals with customer service for airlines, hotels and other suppliers – is collecting $ 12 million from venture capitalists in Beijing, but has had a hard time sealing the deal.

“Two of the investors from China are basically saying, ‘You have to fly to Beijing to meet us before we can actually give you the deadline,'” Zhao said. “

The new normal

Some companies have found solutions, which prevent the activity from being sharpened completely.

Chinaccelerators Ramos, whose company also runs a venture fund focused on start-ups, said his team had collected more than 10 investments since the onset of the virus outbreak, totaling about $ 2.1 million. He said that several transactions were already in the works before the outbreak, while other transactions were the result of personal referrals.

Entrepreneurs have also thrown investors through video conferencing platform Zoom (ZM), with some even having virtual “happy hour” meetings for a beer and talk shop, Ramos added.

Zhao said he has taken calls from investors on Zoom every week and is trying to maintain a face-to-face contact. “I have to make sure their interest stays high,” he explained.

Drone. Disinfect robots. Supercomputers. The coronavirus outbreak is a test for China's tech industry

But there is a limit to how much can be done online when millions of dollars are at stake.

“You can’t build a relationship without meeting each other,” said Yeung, the Silicon Valley company. “No matter how many zoom calls you make. It’s just not the same.”

The due diligence process – what shareholders generally call the final review of a company’s background before a business deal is made – is usually done in person.

But that’s hard to do now, Yeung said, because that stage often includes visiting companies in person to evaluate management culture and review financial reports.

Ramos acknowledged the difficulty of closing business, but said his company had been able to work around it so far. “Restrictions [and] office access restrictions limit due diligence, “he noted.” But that does not mean that investments do not happen. “

And things are expected to bounce back: Experts, including Frederick, the PitchBook analyst, expect a revival when the outbreak ends, predicting that investors will simply stick to their capital and resume as normal as conditions improve.

The strongest survive

Although there is a potential recovery, entrepreneurs will probably be able to withstand significant difficulties before this happens. Frederick noted that during the Great Recession, venture capitalists more closely examined the economies of start-ups before taking the step of investing.

“Unprofitable start-ups that rely on VC funding fared the worst as the funding dried up for those with high burn rates and unclear paths to profitability,” he said. “The start-ups that were already profitable or those with low burn rates and clear paths to profitability performed best.”

Others said the outbreak tests how strong the leadership is at many start-ups.

“If they didn’t even prepare for at least three to six months more of the cash flow, and they have to increase now that they run out of cash, I really wouldn’t invest to begin with,” said Yeung, Silicon Valley venture firm partner.

These startups collected billions and then dismissed thousands. The workers are shocked and frustrated

For companies like TravelFlan, the crisis in 2019 was a wake-up call. Zhao acknowledged that he and his co-founder were forced to waive salaries for more than a year, while other employees left without pay for several months.

In light of these problems, he said, TravelFlan decided to rethink its entire business model by expanding its scope beyond travel to include other lifestyle providers and taking on larger partners from other sectors, including Samsung and China Mobile. Eventually it could secure an investment from several venture companies collecting $ 7 million to a valuation of $ 27 million.

TravelFlan employees in Shanghai. The Hong Kong-based startup struggled to end the meeting last year before changing its strategy and winning new investments.

Zhao said the experience has made the team in a better position to weather the uncertainty now.

“If I didn’t go through all this, I would probably still run the business the same way,” he added. “So all these things happened to force myself, force my partner to investigate the company rather than look beyond what investors wanted.”

Silicon Valley securities company Sequoia Capital summarized the situation more clearly in one open letter to the founders this month.

“In some ways, companies reflect biology,” the company wrote. “As Darwin has assumed, those who survive are not the strongest or the most intelligent, but the most adaptable to change.”


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