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The PE/VC industry has always had problems such as "difficulty in raising funds, difficulty in investing, and difficulty in exiting". These problems exist even when the market environment is good, but they are more prominent at this stage.

Tian Huafeng, president of Jinpu Intelligent, said in an interview with Caixin that the "difficulty in exiting" caused by the tightening of IPOs since last year has further aggravated the "difficulty in raising funds". Because under normal circumstances, if PE/VC funds can bring good returns to investors through timely exits from high-quality projects, the relevant investors will most likely reinvest in subsequent funds, thus forming a virtuous circle.

Tian Huafeng has been engaged in equity investment for nearly 17 years and has experienced multiple cycles in the capital market. In his opinion, the equity investment industry is currently at the bottom of a periodic cycle and is experiencing "survival of the fittest." Compared with the bottom of previous cycles, many practitioners are now feeling the "chill."

Against this background, the "Sixteen Articles on Science and Technology Innovation", "Eight Articles on the Science and Technology Innovation Board" and "17 Articles on Venture Capital" were successively introduced in the first half of this year, linking the primary and secondary markets to promote a virtuous cycle of science, technology, industry and finance.

"The introduction of the above-mentioned policies is a timely relief for the PE/VC industry. It can effectively curb the trend of a significant decline in fundraising and investment scale in the past two years, and effectively restore the confidence of relevant practitioners and their expectations for the future. However, the specific effect will depend on the implementation of relevant policies and how the specific operating details are formulated and implemented." Tian Huafeng believes that the policy focus should be on both fundraising and exit.

"If the market mechanisms for fundraising and exit are straightened out, investment institutions will naturally open up channels between funds and innovation." Tian Huafeng also said that since the life span of most local people's funds is relatively short, most investment institutions mainly focus on technologies that can be commercialized on a large scale within 3 to 5 years, while cutting-edge technologies and disruptive technologies with a long commercialization cycle (such as more than 10 years) may require the government to coordinate and open up channels between funds and innovation.

(Tian Huafeng, President of Jinpu Intelligent Technology)

Cultivating “patient capital” requires LP patience

Since 2023, the scale of PE/VC fundraising has declined significantly, especially the investment of market-oriented LPs has been decreasing. Currently, most of the investors willing to invest in the market are state-owned mother funds and local state-owned assets with a certain industry guidance nature.

Tian Huafeng believes that there are two reasons for this phenomenon: First, the high-quality hard technology project resources accumulated over the past 20 years have been almost consumed within the five years since the establishment of the Science and Technology Innovation Board, and the downward pressure on the real economy has increased, causing many LPs to doubt the GP's ability to find high-quality projects in the future; second, the phased tightening of IPOs and the improvement of review standards since August last year have caused many projects invested by PE/VC in the early stages to be unable to exit in time through IPOs, thereby greatly reducing the scale of funds that can flow back to the primary market in the future, which in turn worsened the expectations of market-oriented LPs.

"At this stage, except for a very small number of institutions that have created good investment results in the early stage, most PE/VCs find it difficult to raise funds from market-oriented LPs. Now state-owned mother funds and local state-owned assets have become the main investors, and these LPs usually require GPs to undertake a certain multiple of the investment amount to return investment or attract investment. Therefore, in recent years, attracting investment for local governments has become the focus of GPs' work, and some institutions have even set up special investment teams." Tian Huafeng told reporters.

In his opinion, if the GP's key investment areas and the local leading industries cannot form a good industrial synergy, and the GP takes the money of local state-owned assets simply for the sake of managing scale, and then sacrifices investment returns in order to complete the task of return investment or investment attraction, this behavior will make market-oriented LPs even more discouraged. This requires GPs to balance between expanding scale and creating investment returns, and coordinate the conflict of interests between market-oriented LPs pursuing financial returns and local state-owned assets requiring return investment and investment attraction.

"We do not believe that the interests of financial LPs and local state-owned LPs are necessarily incompatible." Tian Huafeng shared his own experience, saying that, for example, the cooperation between Jinpu Intelligent and Lingang Group, "We have reinvested in multiple projects in the Lingang Group's park and introduced multiple projects to its subordinate parks. The Lingang Group has also provided strong support for us to obtain high-quality project resources and provided us with physical space and industrial chain resources to build an industrial ecosystem."

So, what is the core bottleneck of China's current development of "patient capital"? Tian Huafeng believes that the fundamental reason why China lacks "patient capital" is the lack of real long-term capital and the capital market-related mechanisms need to be further improved.

In Tian Huafeng's view, the development and cultivation of patient capital needs to start from two aspects: First, for the equity investment industry, patient capital needs patient LPs, and patient capital cannot be called on GPs, because the investment strategy of GPs depends largely on the nature and composition of the LPs behind them. The state should encourage central enterprises, large local state-owned enterprises, large financial institutions, social security funds, etc. to establish long-term mother funds for market-oriented GPs. In addition to financial returns, the assessment of GPs should also introduce relevant indicators such as the support for technological innovation. Secondly, patient capital needs to be assured of the market, and the country needs to optimize the capital market environment and improve the construction of relevant systems, especially to enable market practitioners and investors to form stable and good expectations for the future development of the capital market.

There are many difficulties in exiting

IPO has always been the most important and most profitable exit channel for Chinese PE/VC funds. Since August last year, IPOs have been tightened periodically. In the first half of this year, the capital market has also undergone a round of institutional reforms, with listing thresholds significantly raised and the Science and Technology Innovation Board's identification of "scientific and technological innovation attributes" more stringent. Are there any changes happening in the primary market exit end as a result?

"We strongly support policies such as raising the listing threshold of the Science and Technology Innovation Board and strictly identifying 'scientific and technological innovation attributes', because the improvement of IPO-related standards can guide PE/VC funds to invest in truly 'hard' technology startups that have large R&D investments and long verification cycles but possess key core technologies." However, Tian Huafeng believes that raising the IPO threshold is not in conflict with maintaining the normalization of IPOs. China still has sufficient resources for companies that meet the requirements for listing. The sustained and healthy development of both the equity investment market and the hard technology industry are inseparable from IPOs.

With the tightening of IPO policies, a large number of companies have withdrawn their IPO applications. Some companies no longer meet IPO standards due to declining profits, some withdraw their applications because their scientific and technological innovation attributes do not meet the requirements after the improvement, and some may be because applicants and intermediaries are worried about being punished for regulatory issues. From 2024 to July 10, a total of 47 companies have been listed on the A-share market, a significant decrease from about 180 in the same period of the previous two years.

"Changes in relevant policies have exacerbated the difficulty of PE/VC's 'exit'." Tian Huafeng analyzed that this is because PE/VC's early investment layout is implemented according to the original policy standards, and the invested projects that were originally expected to be able to IPO may not be able to IPO under the new regulations. Therefore, the exit of invested projects is the biggest challenge facing PE/VC at this stage.

In recent years, PE/VC has also turned its attention to mergers and acquisitions. It can be seen that the number of cases where PE/VC funds have exited projects through mergers and acquisitions has increased significantly, mainly related mergers and acquisitions in the vertical or horizontal integration of the industrial chain. However, there are also difficulties for PE/VC funds to exit through mergers and acquisitions.

"The main difficulty lies in the lack of professional capabilities and industrial chain resources of the PE/VC management team, and limited voice in the corporate governance of the seller." Tian Huafeng specifically analyzed that in addition to the need for in-depth understanding of specific industrial fields, the professional capabilities required for matchmaking between the two parties to the merger and acquisition, design of the transaction structure, and determination of the transaction price and payment method are different from direct investment. In this regard, many PE/VC institutions do not have enough excellent professionals or enough industrial chain resources. The diversified shareholders of the seller may find it difficult to form a unified opinion, and if the payment method is not a one-time cash payment, it also increases the uncertainty of exit.

Regarding specific response measures, Tian Huafeng believes that in addition to strengthening the study of M&A-related professional knowledge, PE/VC institutions also need to establish long-term cooperative relationships with industry leaders, securities firms with rich IPO and M&A experience, etc., and the most important thing is to be able to invest in the best start-ups at reasonable valuations on the investment side, because the best industry leaders and securities companies are only willing to cooperate with PE/VC institutions with high-quality project resources.

In addition to A-share IPOs and mergers and acquisitions, overseas listings have also become an important exit channel for PE/VC funds.

"We are certainly happy to see this happen, and we have seen that regulators have also expressed encouragement for this recently. However, since we are investing in related targets in RMB, there are some technical issues in the overseas listing of investment targets. For example, the domestic ODI management is strict and cumbersome, and there is no limit on the price fluctuation of overseas listed companies. This is also a big challenge for us to grasp the rhythm of reducing holdings in the future." Tian Huafeng said.

How to achieve the “dual circulation” of capital and innovation?

Currently, the equity investment industry is at the bottom of the stage cycle and is experiencing "survival of the fittest". Against this background, the "16 Measures for Science and Technology Innovation", "Eight Measures for Science and Technology Innovation Board" and "17 Measures for Venture Capital" were successively issued in the first half of this year. What impact will this have on the capital market's support for technological innovation?

"These policies have played an important role in stabilizing and improving the expectations of capital market entities and optimizing the capital market environment." Tian Huafeng said that on the one hand, the statements on "maintaining the normalization of new stock issuance" and "supporting high-quality unprofitable technology companies to be listed on the Science and Technology Innovation Board" and the support for the entire chain of venture capital funds' "raising funds, investing, managing and withdrawing" have effectively stabilized the expectations of all parties in the capital market and enhanced their confidence; on the other hand, appropriately raising the IPO threshold of the Science and Technology Innovation Board and consolidating the responsibilities of intermediary institutions will effectively improve the quality of Science and Technology Innovation Board listed companies, thereby enhancing investors' confidence in the Science and Technology Innovation Board and China's hard technology listed companies. All of these will better play the role of the capital market in supporting technological innovation.

Of course, Tian Huafeng also expects that relevant operating rules will be issued. In addition to the above-mentioned cultivation of patient capital and maintaining the normalization of IPO issuance, Tian Huafeng also suggested relaxing the investment requirements of insurance funds, canceling the current insurance fund requirement that the registered capital of the management company cannot be less than 100 million yuan, which can be relaxed to 20 million (paid), exempting insurance funds from building a two-tier mother fund structure, thereby expanding the scope of insurance funds to choose GPs; tax incentives should be implemented in place, and individual LPs in all equity funds should be levied personal income tax at 20%. At the same time, all investors in blind pool funds should pay income tax on the investment income they obtain after they have recovered all their principal, rather than calculating investment income and paying income tax on a single project basis.

"If the aforementioned policies and detailed rules can be effectively implemented, PE/VC funds will dare to invest in truly hard technology companies that have large R&D investments and long verification cycles but are fully committed to tackling key core technologies. They will even dare to invest in disruptive cutting-edge technologies that cannot be commercialized in the short term, thereby promoting the tiered development of China's scientific and technological innovation," said Tian Huafeng.

In his opinion, the establishment of the Science and Technology Innovation Board has greatly shortened the capitalization cycle of science and technology innovation enterprises from establishment to IPO, and the urgency of domestic substitution in the context of Sino-US competition has also accelerated the verification and introduction of hard technology suppliers by downstream enterprises, thereby promoting the rapid development of China's hard technology industry in recent years. For companies planning to IPO on the Science and Technology Innovation Board, the focus should be on "scientific and technological innovation attributes" and "market potential", that is, whether they "master key core technologies" and whether they have the ability to continue research and development and expand in multiple fields so as to grow into "platform companies", and some problems that can be solved over time can be appropriately tolerated.

Although PE/VC exits have been blocked in the past year, Tian Huafeng believes that now is "a good time to invest." His reason is that the valuation of the corresponding sectors in the secondary market has dropped significantly, and many small and medium-sized institutions in the primary market cannot raise new funds, so the valuations of many startups have become reasonable, and investors' voice has also increased.

"For PE/VC institutions, the biggest challenge on the investment side at this stage is to find cost-effective underwater projects, rather than blindly chasing highly valued 'star' projects. Subsequently, if IPOs can return to normal, it will greatly restore the confidence of market participants; if there are substantive benefits in terms of funding sources, taxation, etc., then we believe that China's hard technology equity investment will usher in a new round of development window." Tian Huafeng said.