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Perspective on China’s venture capital ecology and seize the golden period of ten years From Mckinsey

The following is the Perspective on China’s venture capital ecology and seize the golden period of ten years From Mckinsey recommended by And this article belongs to the classification: Venture capital, Investment & Economy, research report, Mckinsey .

The venture capital industry is the link between capital and innovative and entrepreneurial enterprises. A healthy ecology is not only conducive to the development of the industry itself, but also can effectively guide and promote the innovation of the whole society. This paper focuses on the core ecosystem of China’s venture capital, focusing on three key issues: 1) what are the characteristics of China’s venture capital ecosystem compared with developed markets? 2) Where are the investment opportunities in China’s venture capital ecosystem? 3) How do leading asset management institutions seize these opportunities?

The American venture capital industry has a history of nearly 70 years. Unicorn listed companies incubated and supported by venture capital account for more than 50% of the market value of the stock market [1]. Although China’s venture capital industry has only a history of about 30 years, the market value of Unicorn listed companies cultivated by it has also reached about 35%. Since March 2020, the state has issued a series of policies to raise the innovation and venture capital industry to the national strategic level, and the venture capital industry has also ushered in a period of vigorous development.

According to McKinsey’s analysis, the core ecosystem of the venture capital industry includes five elements: investors (LP), investment institutions, invested enterprises / entrepreneurs, capital market and supervision. The peripheral ecosystem should be extended to other financial businesses highly related to the venture capital industry, including early investment, private equity investment such as M & A, master fund, s fund and debt financing for small and medium-sized enterprises (see Figure 1).

The first part analyzes China’s venture capital ecology

1、 China’s venture capital will usher in a golden decade

In the 1990s, a large number of foreign venture capital institutions entered China, setting off a wave of Chinese venture capital. They cultivated and achieved a large number of Chinese Internet giants. At the same time, they also promoted the explosive growth of China’s venture capital industry. After 30 years of hard work, China’s venture capital market has grown into a prosperous market comparable to the United States. By the end of 2019, the total asset management scale (AUM) of China’s venture capital industry had reached RMB 1.2 trillion, with an average annual growth rate of 50% in the past five years (see Figure 2). After the fund-raising peak in 2015-2017, the amount of investable funds of venture capital institutions has risen rapidly, reaching 576.6 billion yuan by the end of 2019, with an annual growth rate of more than 45% in the past five years[ 2]

However, compared with its American counterparts, China’s venture capital industry still has great room for development in terms of penetration, transaction scale, institutional scale and innovation vitality. Looking forward to the future, with China’s continued investment in key science and technology fields and business model innovation, various innovative investment themes such as consumption upgrading, intelligent manufacturing upgrading, green energy and biomedicine will continue to emerge. The number of intellectual property applications and newly established start-ups in China will further increase, and relevant indicators will continue to lead Asia and even the world. We expect that China’s venture capital industry will be very active and will usher in a golden period in the next decade.

2、 China venture capital 2.0: break through the traditional model, with larger fund volume, more yuan background and polarization of playing methods

As early as the beginning of development, China’s venture capital industry has a completely different ecosystem from the United States. It has Chinese characteristics in terms of entrepreneurial ecology and start-up companies, capital market and supervision, investors (LP):

From the perspective of entrepreneurial ecology and start-up companies, Chinese start-ups follow the national economic development trend, and small and medium-sized science and technology enterprises have become the most innovative enterprise group in China. However, China’s small and medium-sized enterprises have narrow financing channels and limited means, and venture capital institutions have become their primary financing source.

From the perspective of capital market and supervision, the Chinese government has widely participated in the venture capital industry and carried out both supervision and guidance. While actively promoting the development of entrepreneurship, the government also strictly regulates the risk of financial assets. With the introduction of the new regulations on asset management, the central and local governments have actively formulated industrial guidance policies and issued a series of policies (registration system, science and innovation board, etc.) to promote the evolution of China’s capital market to a mature market. These policies will have a profound impact on all stages of venture capital fundraising, investment and exit.

From the perspective of investors (LP), the fund-raising of dual currency funds (USD and RMB) is still the mainstream of fund-raising of Chinese venture capital institutions. US dollar fund-raising depends on the global fund-raising ecology, and the Chinese government is widely involved in RMB fund-raising and is the most important and influential contributor (see Figure 3).

In order to adapt to China’s unique venture capital environment, Chinese venture capital institutions (GP) are actively evolving, breaking through the traditional boutique venture capital business model, and are building a new model that is different from their American counterparts:

First of all, the super venture capital fund with a single period of more than $1 billion flashed, and the Matthew effect of the industry intensified

From the perspective of institutional structure, the venture capital industry has experienced a development process from the silence of thousands of horses to the tide. From the initial small volume (US $100 million to US $200 million) and pure US dollar funds introduced overseas, to the medium volume (US $200 million to US $300 million, RMB 1 billion to RMB 1.5 billion) dual currency raised funds, and then to the current super large volume and dual currency raised funds (single-phase US dollar funds exceed US $1 billion and single-phase RMB funds exceed RMB 10 billion), it has experienced different development stages. Now, a large number of venture capital institutions with outstanding historical performance have exceeded the 50 billion yuan mark in the scale of assets under management.

After comparing the average fund size of Chinese and American venture capital institutions, we found that due to the existence of a large number of small and medium-sized fund managers in China, the average size of a single fund in China is still lower than that in the United States, but China’s head venture capital institutions have actually overtaken the head institutions in the United States and began to raise funds with a scale of more than US $1 billion.

The trend of capital concentration to head institutions is obvious. Among the newly raised venture capital funds in 2019, about 65% of the funds flow into the 20 largest funds, while the first 20 funds accounted for about 40% five years ago.

In recent years, the single transaction scale of venture capital projects has been growing, and the average single transaction volume has increased from about 43.81 million yuan in 2015 to 72.28 million yuan in 2019; The valuation multiples of project investment have also increased. Combined with the advantages of large venture capital institutions in brand endorsement, project coverage, decision-making efficiency and post investment system, the competitive pressure faced by small and medium-sized institutions has increased sharply.

Secondly, the background of China’s active venture capital institutions is more yuan, and the investment institutions with state-owned assets and strategic investment institutions with industrial background are more active, forming a unique industry landscape

State owned capital continues to play an important role in China’s venture capital industry, and its importance will be more prominent in the future. In view of the dual identity of state-owned assets as investors and industry players, state-owned assets background institutions and market-oriented private capital institutions supported by state-owned capital will be more prosperous. Compared with market-oriented private capital institutions, state-owned background institutions usually focus on RMB investment, and some institutions have certain sustainable capital. With the forward-looking interpretation of national policies and deep ties with local governments, state-owned assets background institutions can undertake investments with strong social effects, great strategic significance but poor returns. As long-term patient capital, their investments are more resilient. In addition, the risk control requirements of state-owned assets background institutions are more stringent, and there are many restrictions on the internal management mechanism, which once restricted the long-term development of their venture capital business. However, in recent years, with the increasing marketization of the state-owned mechanism system, such as the reform of market-oriented salary incentive system and mixed ownership reform, the trend of “marketization of state-owned venture capital and nationalization of private venture capital” is obvious, and the competitiveness of state-owned venture capital has been significantly improved.

Strategic investment institutions with industrial background, especially strategic investors with scientific and technological background, are gradually becoming a new force in China’s venture capital ecology. Under the new normal of the overall stabilization of the economy, the incubation and growth of emerging enterprises are increasingly dependent on the introduction, feeding and support of industrial resources. The advantage of industrial investment institutions is that, on the one hand, they have a source of innovative projects incubated internally, on the other hand, they can import traffic, management and business in the critical period of enterprise development. Industrial investment institutions are in full bloom. There are many forms, such as enterprise venture capital fund (CVC), enterprise direct investment fund and financial investors attached to industrial institutions. They are an important part of China’s venture capital ecology.

Finally, the investment stage of Chinese venture capital institutions shows polarization, and the unique early case source coverage, identification ability and platform business construction ability become the standard configuration

Facing the increasingly severe horizontal competition, Chinese venture capital institutions are showing polarization in the investment stage in order to ensure the return on investment, either focusing on earlier investment projects (before Angel round and a round), or focusing on more mature projects (after C / D round and pre IPO). The head organization has specially established an early project fund to lock in excess returns while ensuring track coverage. At the same time, with the successful raising of a large number of super venture capital of US $1 billion and more than RMB 10 billion, a large amount of funds will be invested in medium and late mature targets with relatively stable return and low risk. In order to comply with this trend, investment institutions are focusing on their own industry resources, cultivating their original ability, and striving to build unique early case source coverage and identification ability, as well as platform business construction ability.

Early case source coverage and identification ability: the competition of head institutions in early investment is intensified. Each early investment institution has built a unique early case source coverage and identification ability by virtue of its own resource network.

Platform based business construction capability: the influx of a large number of funds into more mature targets is bound to push up the valuation of mature targets and transform the venture capital industry from the original buyer’s market to the seller’s market.

3、 The trend of domestic and foreign capital integration is beginning to show. Domestic institutions generally adopt the dual currency fund method, and foreign institutions plan RMB fund-raising

In the past, due to different sources of funds and exit channels, the investment direction, investment stage and arbitrage methods of US dollar funds and RMB funds in China were often different. However, this clear-cut pattern began to be broken around 2010, dual currency funds continued to emerge, and the two types of institutions began to fight each other in all aspects of raising, investment and withdrawal.

On the fundraising side, different institutions are going the same way, and the number of managers managing US dollar and RMB dual currency funds is increasing.

On the investment side, China’s venture capital industry stands out and develops rapidly. All major foreign investment institutions hope to enter China, and with the fading of Internet dividends, US dollar funds have gradually cut into high-end manufacturing, industrial technology and other industries that have been neglected in the past, and collisions and clashes with RMB funds occur frequently.

At the exit end, China’s capital market is gradually opening up, increasingly in line with international standards, and enterprises have more options for listing and exit. For example, Internet, large consumption, biomedicine and other enterprises that gave priority to overseas listing in the past will also consider returning to Hong Kong shares and a shares. At the same time, the complexity of exit supervision forces investment institutions to choose a more flexible dual currency fund-raising path.

Part II venture capital opportunities in China

In order to explore themed venture capital opportunities in China’s economy in the future, we have summarized the following four main trends. In addition, opportunities such as the first and second generation of entrepreneurs and wealth inheritance, China’s successful model going to sea, aging population structure, entrepreneurship of excellent returnees and so on also deserve attention.

Trend 1. China’s consumption is innovating and upgrading, domestic goods and online Red economy are in the ascendant, and the innovation mode has evolved from “replication” to “China’s native”;

Trend 2: China’s medical and health industry venture capital has entered an outbreak period;

Trend 3. The hot spot of science and technology investment is from Internet business model innovation to hard core science and technology breakthrough;

Trend 4. ESG (environmental, social and corporate governance) investment, especially the theme of carbon neutralization, has increasingly attracted investors’ attention.

Part III winning ways of leading venture capital institutions

In the era of great changes in China’s entrepreneurial ecology, various types of investment institutions compete with each other. Among the head institutions, the first RMB trillion level comprehensive investment institution is ready to come out, but it is still full of imagination who will be spent in the end. The waist mechanism should find the right position to realize differentiated development. In addition, there are a large number of new gold miners pouring in, and characteristic venture capital institutions emerge in endlessly. For all players in the ecosystem, they should plan their own winning ways based on the following five strategic judgments.

First, RMB fund is still a medium – and long-term opportunity point. All institutions need to start from the end, formulate fund-raising strategies with their own unique value proposition, and break through the short-term dilemma of RMB fund-raising.

Investment institutions should fully understand the ecological characteristics of Chinese venture capital, and then face the demands of different LPS, actively screen the LP categories matching their own investment strategies, and raise funds targeted at specific LP groups. For example, investment institutions with expertise in specific industries can actively contact local governments with the same industrial development demands, which can not only give full play to their industry expertise, but also relatively easy to meet the reinvestment needs of government funds. For another example, asset management companies operating a variety of asset classes have more opportunities to win the favor of Chinese insurance funds at this stage. They can design asset portfolio packages with period returns to meet the period return needs of insurance funds.

Second, fully embracing overseas fund-raising is the key to the scale breakthrough of RMB institutions.

Overseas investors usually have rich experience in alternative investment, have established long-term and stable cooperative relations with leading institutions, and are cautious and picky about cooperation with new institutions. In view of this, RMB institutions should design targeted fund-raising strategies for overseas investors, especially highlight the differences of their own strategies, and fully elaborate the unique themes, industries and regional investment opportunities brought by this strategy to overseas investors. In addition, overseas investors attach great importance to investment compliance. Full and clear disclosure of past investment performance, the establishment of a transparent and professional investment decision-making mechanism, and a conflict of interest resolution mechanism with other funders are details that can not be ignored when RMB institutions raise funds overseas.

Third, actively seek sources to bring decision-making closer to the front line.

For investment institutions, forging proactive sourcing capability is the top priority. They should build an industry map, expand the geographical coverage of the team, accurately focus on entrepreneurial groups, expand and deepen the industry ecology, tap investment opportunities as soon as possible, and widely cover high-quality projects from the source. In addition, from the successful experience of foreign institutions in China, giving the Chinese investment team full decision-making power is the key to obtain high returns. Fully authorizing investment decisions will also further promote the comprehensive upgrading of the fund risk control system and improve the fund operation efficiency.

Fourth, three investment and seven responsibilities. Active post investment value-added services should go from the background to the front desk.

Leading institutions have actively reshaped or built post investment value-added system and capacity, and transformed the functional orientation of post investment management from the middle and back office to the front office. They have established a set of phased and type post investment enabling system in line with their own investment strategy, with high linkage before and after investment, so as to deeply tap value. At the same time, they also strengthen the private operation of the invested enterprise ecology, actively explore high potential continuous entrepreneurs and entrepreneurial teams in the invested enterprise ecology, and provide support for their continuous entrepreneurship. They also invested heavily in promoting the level of digital intelligence, looking into internal and external resources, expanding the management scope of the management, improving the visualization level of decision-making, and comprehensively revitalizing the available resources of investment institutions.

Fifth, join forces vertically and horizontally to seize the Chinese venture capital market.

Chinese funded institutions have advantages in local environment, supervision and business culture, while foreign funded institutions have rich experience in complex transactions, capital strength, docking of overseas resources, exit channels and so on. Therefore, the trial and error risk of the model of strong combination is lower, the success rate is higher, and it is easier to succeed than fighting alone. Venture capital institutions can refer to the practice of other asset management institutions to find their own model. Both the joint-stock model and the model of Deep Participation in the operation of CO GP with strategic partners are worthy of reference for venture capital institutions.

To sum up, China’s venture capital industry has a distinct ecological personality, and the tide of venture capital is in the ascendant. Under the overall competition situation of head institutions doing ecology, waist institutions building expertise and new institutions looking for differences, we believe that China’s venture capital industry will move forward in a hundred flowers and waves, and an institution that can stand out in the fierce competition, It must be a trendsetter who understands the ecological uniqueness of China’s venture capital, follows the trend and responds flexibly.

The next ten years will be the golden period of China’s venture capital market. To seize this historic opportunity, venture capital institutions need to shoot three arrows at once, keenly grasp the venture capital ecology outward, focus on investment opportunities forward, and practice the unique martial arts of raising, investing, managing and retreating inward, so as to live up to the times and write a brilliant future.

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