Chinese venture capital firms track down bankrupt founders, search their personal assets and add them to the blacklist of domestic debtors when they fail to pay, plunging the country’s startup financing ecosystem in the crisis.
The hardline tactics of venture capital providers were facilitated by clauses known as repurchase rights, included in almost every financing deal concluded during the period. ChinaIt’s a boom time.
“My investors promised verbally that they wouldn’t enforce them, that they had never enforced them before – and in 2017 and 2018 it was true – no one was enforcing them,” said Wang Ronghui, founder of Neuroo Education, which now owes millions to investors. dollars after its child care chain stumbled during the pandemic.
Although they are relatively rare in the United States risk investmentShanghai-based law firm Lifeng Partners estimates that more than 80 percent of venture capital and private equity deals in China contain buyout provisions.
They typically require companies, and often their founders as well, to repurchase investors’ shares plus interest if certain goals such as IPO timing, valuation targets or revenue metrics are not met.
“This causes enormous harm to the venture capital ecosystem, because if a startup goes bankrupt, the founder essentially faces asset seizures and spending restrictions,” said a Hangzhou-based lawyer who has represented several debt-ridden contractors and asked to remain anonymous. “They will never recover from this.”
Lifeng, in its recent report on buyout rights, said they had turned entrepreneurship into a “game of unlimited liability”. In 90 percent of the lawsuits filed by investors, the firm said, the founders were named as defendants alongside the companies, and 10 percent of the individuals were ultimately added to China’s debtor blacklist.
Once blacklisted, it is almost impossible for individuals to start another business. They are also prevented from a range of economic activities, such as taking planes or high-speed trains, staying in hotels or leaving China. The country does not have a personal bankruptcy law, making it extremely difficult for most to escape debt.
As Chinese funds and venture capital firms now struggle to return capital to their outside investors, a growing number of them have turned to buyout clauses to recoup as much money as possible. Lifeng estimates that 20% of all investor exits in 2021 and 2022 came from companies buying back their investors’ shares and that more than 10,000 Chinese venture capital or private equity-backed groups are facing problems redemption.
One startup advisor who wished to remain anonymous said the situation perversely incentivized venture capital firms to pursue portfolio companies that were doing well but lacked an immediate path to a sale or IPO.
“Venture capital firms are putting pressure on start-ups that can pay,” he said. “It’s not a business, it’s a debt.”
The number of entrepreneurs caught up in legal proceedings continues to grow. Among them is Wang Ziru, who gained attention a decade ago as a brash young founder and raised tens of millions of renminbi for his tech media and review platform Zealer.
In 2021, as traffic declined, Wang left his position to take a management position at appliance giant Gree. Then, on August 9 last year, a Shenzhen court imposed spending restrictions on the 36-year-old for failing to pay a Zealer investor RMB 34 million ($4.7 million), an amount that snowballed with interest from the venture capitalist’s initial RMB 19 million investment, according to a lawyer briefed on the matter. Wang lost his job a few days later.
The founder is contesting the ruling and said on social media that he was not informed of the lawsuit and that the deal’s buyout clause was not triggered.
One of China’s most famous entrepreneurs, Luo Yonghao, turned his struggle to pay off the debts of his bankrupt smartphone startup Smartisan into a spectacle, eventually selling enough iPhones and office chairs in broadcasts online video to pay suppliers and remove your name from the debtor. blacklist in 2020.
Then some Smartisan investors came demanding that Luo pay hundreds of millions more in renminbi to buy back their shares.
“Investment is not a loan,” Luo wrote on social media platform Weibo in August last year. “When a venture capital deal fails, you have to accept the outcome. Those who resort to underhanded tactics against entrepreneurs because they cannot stand the outcome are undoubtedly unscrupulous capitalists.”
The cases have filled Chinese courts. Records show Xu Mingqi lost his company and all other identifiable assets to investors after his Yeagood Materials Group failed to meet a promised three-year deadline for an IPO.
China’s Supreme Court ruled in 2021 that because his wife Zheng Shaoai had also worked at Yeagood, an investor could seize communal property, including the apartment held in his name.
Wang, the 47-year-old founder of a daycare chain, even had the funds in her health insurance account seized by investors. She said her problems began in 2021, when funds linked to state-backed investor Guangdong Cultural Investment Management demanded that their RMB 16 million shares be repurchased with interest because her startup wouldn’t had failed to achieve a valuation of RMB 500 million.
Their lawsuit torpedoed a fundraiser needed to offset pandemic-related closures of the group’s 36 daycares, she said. Today, Wang owes around RMB 30 million to GCIM-affiliated funds, RMB 11 million to banks and potentially more to other investors whose repayment clauses have not yet been triggered.
GCIM did not respond to a request for comment.
“I have built my company into an industry leader – I have capabilities and drive – but every path I try to take is a dead end,” Wang said. “An unexpected turn of events has left me permanently and completely trapped. »
