Chinese venture capitalists are going after failed founders, going after personal assets and blacklisting them as national debtors when they fail to pay, in moves that are throwing the country’s startup funding ecosystem into crisis.
Heavy-handed tactics by venture capital providers have been eased by clauses known as redemption rights, included in almost all financing deals struck during China’s boom times.
“My investors verbally promised not to implement them, that they had never implemented them before – and in ’17 and ’18 this was true – nobody was implementing them,” said Neuroo Education founder Wang Ronghui , which now owes investors millions. dollars after its childcare chain was hampered during the pandemic.
While they are relatively rare in US venture investments, Shanghai-based law firm Lifeng Partners estimates that more than 80 percent of venture and private equity deals in China contain buyback provisions.
They typically require companies, and often their founders, to buy back investors’ shares plus interest if certain targets, such as an initial public offering timeline, valuation goals or revenue metrics, are not met.
“It’s causing huge damage to the entrepreneurial ecosystem because if a start-up fails, the founder is basically facing asset forfeitures and spending restrictions,” said a Hangzhou-based lawyer who has represented several indebted entrepreneurs. and asked not to be named. “They can never recover.”
Lifeng, in its latest report on redemption rights, said they had turned the venture into an “unlimited liability game”. In 90 percent of investor lawsuits, the firm said, founders were named as defendants along with the companies, with 10 percent of the individuals eventually added to China’s debtor blacklist.
Once blacklisted, it is almost impossible for individuals to start another business. They are also blocked from a variety of economic activities, such as taking planes or high-speed trains, staying in hotels or leaving China. The country lacks a personal bankruptcy law, making it extremely difficult for most to escape debt.
With Chinese funds and VC firms now struggling to return capital to their overseas investors, a growing number are turning to buyback clauses to recoup as much money as possible. Lifeng estimates that 20 percent of all investor exits in 2021 and 2022 came from companies repurchasing their investors’ shares, and that more than 10,000 private equity-backed or private equity-backed Chinese groups face problems.
One startup adviser, who did not want to be named, said the situation was perversely incentivizing VCs to pursue portfolio companies that were doing well but didn’t have an immediate path to a sale or an IPO.
“VCs are putting pressure on startups that can pay,” he said. “It’s not entrepreneurship – it’s debt.”
The number of entrepreneurs caught up in legal action continues to grow. They include Wang Ziru, who a decade ago gained attention as a brash young founder and raised tens of millions of renminbi for his tech media and review platform Zealer.
By 2021, with traffic declining, Wang left for an executive role at home appliance giant Gree. Then, on August 9 last year, a court in Shenzhen slapped the 36-year-old with spending restrictions for failing to pay a Zealer investor 34 million Rmb ($4.7 million), an amount that had accrued interest from the investment initial capital of the VC, 19 million Rmb. a lawyer briefed on the case. Wang lost his job a few days later.
The founder is contesting the judgment and said on social media that he was not notified of the lawsuit and that the settlement provision was not triggered.
One of China’s most famous entrepreneurs, Luo Yonghao, turned his struggle to pay off debts from his failed smartphone start-up Smartisan into a spectacle, buying quite a few iPhones and office chairs in live video streams online to pay suppliers and remove his name from the debtor. blacklist in 2020.
Then some of Smartisan’s investors came forward demanding that Luo pay hundreds of millions more in renminbi to buy their shares.
“Investment is not a loan,” Luo wrote on social media platform Weibo in August last year. “When a venture capital deal fails, one must accept the result. Those who use underhand tactics against entrepreneurs because they cannot stand the result are undoubtedly unscrupulous capitalists.”
The cases have filled the Chinese courts. Records show Xu Mingqi lost his company and all of his other assets identifiable to investors after his Yeagood materials group failed to meet a promised three-year window for an IPO.
China’s Supreme Court ruled in 2021 that since his wife Zheng Shaoai had also worked at Yeagood, an investor could confiscate communal property including the apartment held in her name.
Wang, the 47-year-old founder of the childcare chain, has even had funds in her health insurance account seized by investors. It said its troubles began in 2021, when funds linked to state-backed investor Guangdong Cultural Investment Management asked for 16 million Rmb of its shares to be redeemed with interest because its startup had failed to reach a valuation of 500 million Rmb.
Their lawsuit overturned a funding round needed to offset the pandemic-related closings of the group’s 36 day care centers, she said. Wang now owes about Rmb30m to funds linked to GCIM, Rmb11m to banks and potentially more to other investors whose redemption clauses have yet to be triggered.
GCIM did not respond to a request for comment.
“I built my company into an industry leader—I have the skills and I have the strength—but every path I try to take is a dead end,” Wang said. “An unexpected turn of events has left me forever and completely trapped.”
