(Bloomberg) — Venture capital and other private equity funds that raised money to invest in China during a tech boom a few years ago are increasingly facing a quandary. Some are running out of time to put investors’ cash to work, and the pickings have become slim.
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A number of US dollar funds that focus on China are in negotiations to extend their investment periods, so that their managers can have more flexibility to deploy capital and find a better window for exits.
Private fundraising for Asia assets has slowed sharply as global investors have broadly pulled back or limited their exposure to the world’s second-largest economy. From 2020 to 2022, when China was still a hotspot for venture capital, dollar-based private equity funds based in the country raised more than $260 billion, according to data provider Preqin.
Most private equity and venture funds have terms that require their managers to invest capital within three to five years, as the lifespan of such vehicles is usually seven to 10 years. The problem is that China has been hit hard by a deep slump in both public and private company valuations over the past few years, which has weighed on many funds’ returns.
Tencent Plus Partners, a venture firm that co-invests with Chinese tech giant Tencent Holdings Ltd., is negotiating to extend the investment period for one of its funds by a year — after already having done so at least once before — people familiar said, requesting not to be named because the matter is private. The fund’s key backers include the Canada Pension Plan Investment Board. A representative for CPPIB declined to comment. Tencent didn’t respond to requests for comment.
Beijing-based ZhenFund, another high-profile investor in early stage Chinese companies, recently prolonged the investment period for one of its dollar funds by two years, from three years originally, other people familiar with the matter said. A representative for the company declined to comment.
Funds are taking longer to find investment targets in China, partly because they don’t have a clear exit path. Hong Kong’s initial public offering market was in a lull for years until recently, and Chinese regulators have been slow to approve companies’ listing plans. Many startups need a nod from China’s securities watchdog even when seeking an IPO offshore.
The difficult environment for investing in China is leading to a misalignment of interests between funds’ general partners — who are responsible for finding startups and companies to back — and their limited partners, who allocate money to the asset managers.
Fee Matters
GPs, who have decision-making rights, are paid annual management fees that are initially calculated off the capital that has been committed to their funds. They get carried interest based on the returns of the fund’s performance.
LPs, which have limited control over decision making, stand to lose out if the managers are forced to put their capital to work when conditions aren’t favorable. As such, in order to extend the funds’ investment periods, LPs would typically try to negotiate lower management fees from GPs.
It has also become much harder for venture capital and private equity managers to raise money for new funds, which means they stand to earn less fees in the future.
Last year, 11 China-based US-dollar VC funds raised $1.3 billion, accounting for 28% of the total out of the Asia Pacific region, according to Preqin. That compares with 62 funds raising $17.2 billion — which accounted for 60% out of the same region — in 2021.
Dollars raised by China PE funds also plummeted from more than half of Asia to just 19% in the five years through 2024, the data showed.
The pool of money for venture and private equity funds has shrunk because of the retreat of North American pensions from China, and elevated geopolitical tensions may cause other large investors to remain sidelined.
In one of the latest signs of a setback, Source Code Capital, one of the earliest backers of TikTok owner ByteDance Ltd., is halving its fundraising target to about $150 million due to less-than-expected investor interest, people familiar with the matter said in February.
“We are seeing a trend of people extending the life of the fund because they can’t get to an IPO exit or a trade sale for the portfolio companies,” said Hong Kong-based Pang Lee, who specializes in fund advisory at law firm Cooley. “Liquidity in the market has been tough, so you have a lot of assets that have stalled.”
The tanking of Chinese companies in public markets has made it much harder for startups to fetch better prices during IPOs. While the Nasdaq Golden Dragon China Index is up nearly 20% this year as of Monday, it’s still about 61% below its February 2021 peak.
Rifts are also emerging at times between LPs, who may have differing goals when deciding whether to extend the investment period for a fund.
“Some LPs don’t want liquidation, some don’t want a mark down, others want to get a distribution, that’s why there are diverging interests,” said Cooley’s Lee. Even with secondaries, funds have struggled to offload their assets through such methods due to disagreements in pricing with the buyers, said Lee.
Things may be starting to look up. In February, Chinese President Xi Jinping pledged to support private enterprises after meeting with prominent tech entrepreneurs in the country. Excitement around the rise of homegrown Chinese AI champion DeepSeek has improved investor sentiment, and helped to fuel a rally in tech stocks that could have positive spillover effects on private company valuations.
It’s too early to tell if the turnaround in investor sentiment will lead global investors to increase their long-term allocations to China again.
“For a lot of the small and mid-cap GPs, their ability to raise a fund is kind of hindered in the current market. And what that means is there’s a little less incentive for them to exit as well,” said Sam Padgett, a managing director at Deloitte focusing on private equity.
“Ironically, one of the reasons people don’t invest is because investment committees lack conviction on their exit options. In five years, who will we sell to?”
–With assistance from Echo Wong and Zheping Huang.
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