Capital crunch

Startup survival in China 101

As China comes to grips with the economic impact of the novel coronavirus, Chinese startups and funds must get smart to survive the inevitable capital crunch that is coming with it. FinanceAsia offers some simple tips to help them weather the storm.

As FinanceAsia reported back in September last year, it appeared the capital winter for Chinese startups was finally passing and spring (of sorts) was on its way. For the first half of 2019, total funds raised decreased 30% year-on-year to $54.4 billion, while the number of funds raising money almost halved, according to data firm CVSource.

From July onwards, the recovery, albeit modest, was a green shoot for cash-starved entrepreneurs. Venture capital (VC) and private equity (PE) investment had increased, both in terms of activity and the number of funds in the market. 2020 was not set to be a stellar year, but appetite was coming back.

Cue the coronavirus.

Having infected more than 40,000 individuals to date, mostly in the Hubei province, and spread to at least 27 countries, the virus is reaping economic havoc.

For many capital-hungry startups, the problem is compounded – investors are staying at home as flights to and out of China are restricted. “We are having more bad news than good ones,” a financial advisor told FinanceAsia. “It is almost certain that this year is going to be tougher than last year.”

As such, the picture for startups looks bleak once more; a fundamental concern is that VCs and PEs will be unable to make investments for some time, with many being starved of capital themselves.

“In the short term, fund-of-funds are unlikely to inject money into GPs. LPs may cancel or delay their investments,” wrote Tang Jingcao, secretary-general of China FOF association and managing partner of Tsing Ventures, wrote in a column on February 4.

As an LP, Tang suggested investment firms keep themselves busy by conducting preliminary work, such as completing due diligence checks, industry research and document preparation. “When the market fully resumes, everyone has to compete for time,” Tang said.

He also suggested funds deploy their limited funds by selecting early-stage investment where companies valuations are relatively cheaper. “It is more logical for smaller funds to invest in more startups as they can diversify their risk,” Tang explained. “When it is difficult for funds to raise money, the most important thing is to survive.”

GET BUSY

“Pending investment in the first half of this year will undoubtedly be delayed to the second half,” Ran Wang, chief executive of financial advisor CEC Capital wrote in his WeChat account.

For those companies they have yet to meet, investors need at least two months for due diligence, Wang explained. Under such circumstances, most due diligence activities will only start after March assuming the virus outbreak is under control.

China TH Capital, a financial advisor, published a survey on February 6 on the thinking of 40 early stage investment institutions in China - the results were revealing; roughly half said they to intend to spend less money than they did in 2019.

For startups, the priority is to have enough cash on reserve, CEC’s Wang said. Startups need to keep sustainable cash flow and the cash reserve enough for at least nine months. It is also necessary for startups to use all methods to keep themselves alive, including reducing headcount or switching to smaller offices.

"It is also a good time [for startups] to adopt other methods [to raise capital and grow] such as issuing convertible bonds or aiming for an M&A,” Guo Ruyi, managing partner of China TH Capital said. “Getting money is the ultimate goal.”

For those startups who have already completed terms of negotiation with an investor, they should do their best to close the deal as soon as possible – the risk of losing the deal at the moment is high. For those startups affected by the coronavirus outbreak, but have enough cash to hold out, it might be worth waiting until valuations improve.

Although many are, not everyone is suffering from the outbreak of coronavirus in China. Investors should look for companies that can display resilience during black swan events such as the one we now are witnessing.

Given many people in China are housebound, sales on online entertainment products have surged. For example, some China-listed gaming companies experience a 10% jumped in stock price on February 3; this was when A shares overall witnessed an 8% drop on the same day. Tencent said the sales of its top game, Honor of Kings, reached Rmb2 billion ($286 million) on January 24, the eve of the Chinese Spring Festival.

More obvious sectors to keep an eye on are in the medical space. Supply manufacturing is an industry that performs strongly during the virus outbreak, such as Shenzhen-listed Mindray. There is also an increasing demand for professional logistics, online medical services, and online education.

Since the virus outbreak, AliHealth, Ping An Good Doctor and other online clinics all reached a peak volume in history. AliHealth had average 400,000 online inquiries in one day during the Chinese new year, according to it official WeChat account.

¬ Haymarket Media Limited. All rights reserved.