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21st Century Business Herald reporter Chen Zhi reports from Shanghai

Faced with the difficulty of project exit, venture capital institutions have begun to find other ways to solve the problem of "investment fund recovery".

Recently, "dividend-type investment" has suddenly sparked heated discussions in the venture capital industry.

The so-called "dividend-based investment" is mainly an agreement between venture capital institutions and invested enterprises that the enterprises must provide a certain percentage of profit dividends every year in the future as an important measure for venture capital institutions to recover their investment capital. Some well-known people in venture capital institutions even shouted that "the profit dividends in five years will exceed the investment funds."

"However, it is very difficult to implement dividend-based investment," a venture capital firm partner told reporters. Recently, they have tried to negotiate with several investment companies in the growth stage to see if they can take out a certain percentage of profits as dividends every year after the companies become profitable, as a measure for the venture capital firm to recover part of the principal of the project investment. However, this suggestion was opposed by almost all investment companies on the grounds that they need to use more profits for product technology iteration and upgrading.

In addition, some invested companies have privately complained that dividend-type investment is equivalent to "transforming" equity investment into bond investment. If venture capital institutions all require dividend-type investment, companies would rather look for banks for loans. After all, loan interest expenses are lower than "dividend-type investment."

Some of the invested companies also suggested that venture capital institutions should focus their main efforts on enabling companies to develop better, and strive to obtain returns higher than dividend-type investments by selling some old shares in the next round of equity financing.

It is worth noting that venture capital institutions also have mixed opinions on "dividend-type investment".

Many people in the venture capital industry have stated that through internal evaluations, they all believe that the feasibility of "dividend-based investment" is very low - once the invested company provides profit dividends every year, it will greatly reduce the company's capital reserves and technological research and development investment capabilities, resulting in a decrease in the company's IPO success rate, which will in turn affect the venture capital institution's project IPO exit process.

"To some extent, there is a contradiction between the profit model of dividend-based investment and the project IPO (merger and acquisition) exit advocated by equity investment," the partner of the venture capital institution analyzed to the reporter.

However, as more and more venture capital funds enter the liquidation stage, faced with the difficulty of exiting projects and recovering investment capital, venture capital institutions can only resort to legal proceedings.

Since May last year, the number of tenders for litigation legal services procurement by a large domestic venture capital institution has continued to increase. Most of the legal proceedings are related to the venture capital institution's requirements for its invested companies to fulfill their equity repurchase obligations.

The aforementioned venture capital firm partner believes that if a dividend-based investment mechanism is introduced, venture capital firms may be able to recover part of their investment principal and ease the pressure of seeking funds during the maturity and liquidation phase of venture capital funds.

"However, dividend-based investment is more like a transitional product as current projects are difficult to exit. Once the IPO/M&A market improves, venture capital institutions should quickly abandon this practice and focus their main energy on enabling companies to develop better and seek IPO/M&A exits to obtain higher returns," he emphasized.

There are many obstacles to the implementation of “dividend-based investment”

"We have talked with overseas investors (LPs) about dividend-type investments, and these overseas investors find this incredible because they believe that the way venture capital institutions make profits from investments should not be through profit dividends from the invested companies, but through project IPOs/mergers and acquisitions exits." An investment director of a large domestic dual-currency venture capital fund revealed to reporters that, however, when facing domestic investors (LPs), many domestic high-net-worth investors and investment institutions are quite supportive of dividend-type investments because this can solve the problem of recovering the investment principal of investors and venture capital institutions to a large extent.

This has also prompted some domestic venture capital institutions to begin trying to introduce dividend-type investment clauses when investing in new projects - requiring the invested companies to set aside a portion of their profits for dividends each year after they achieve profitability.

But they soon discovered that this approach was "resisted" by many investment companies, because these investment companies believed that they needed to introduce "equity investment funds" instead of "loan funds."

"During this period, some investment companies also said that they could consider increasing the profit dividend ratio after the company's IPO to reward venture capital shareholders, but before the company's IPO, they need to invest more profits in technology research and development and product iteration, further expand market share and establish business barriers, and do not intend to provide profit dividends to venture capital shareholders." The investment director of the venture capital fund told reporters. Some investment companies even believe that in the current economic environment, companies need to reduce costs and increase efficiency and reserve more funds. If the funds are used for profit dividends, it will weaken the company's own survival ability.

Many people in the venture capital industry also believe that the expected effects of "dividend-type investment" will most likely be "disappointing" - if the investment company uses part of its profits to distribute dividends to venture capital shareholders, the company's cash flow will become further strained, so the investment company will apply to the venture capital shareholders for new bridge loans or equity investments, and the result will still be "the sheep pays for the wool."

The reporter learned from multiple sources that many venture capital institutions are currently unwilling to popularize and promote "dividend-type investment."

"If our investment companies have good profitability or good operating cash flow, we may consider introducing a dividend-based investment mechanism, but this is more of a case-by-case approach and will not become the mainstream practice for venture capital institutions to recover their investment principal." The aforementioned venture capital fund investment director said. In fact, many investment companies with good profitability are also sought after by venture capital institutions and are not very willing to accept the "dividend-based investment" clause.

Correspondingly, many venture capital institutions also believe that the timing of dividend-based investment is "not good" - in the past, thanks to the traffic dividend, many 2C-end companies often ushered in explosive performance growth, and had the confidence to give venture capital shareholders a certain amount of profit dividends; but now, both 2C-end and 2B-end companies are reserving capital to "survive the winter", and requiring them to distribute profits and dividends at this time is tantamount to cutting off the source of funds, which will increase the difficulty of survival of enterprises. Moreover, many investment companies have given considerable profit dividends early, which will have some negative "impact" on their IPO capital operations.

Venture capital institutions prefer "buyback clauses" to recover investment capital

However, another effect of "dividend-type investment" that makes it difficult to implement is that when venture capital institutions encounter product expiration and liquidation, they can only resort to legal proceedings to force the invested companies to fulfill their equity repurchase obligations in order to achieve the goal of recovering the investment principal.

A lawyer familiar with equity investment business told reporters that since this year, there have been more and more cases of venture capital institutions requiring investment companies to fulfill their equity repurchase obligations through legal proceedings. Behind this is that more and more venture capital funds are facing liquidation due to maturity, and investors (LPs) are demanding the return of investment principal and interest. Venture capital fund managers (GPs) can only take this approach to urge investment companies to repurchase corporate equity to recover investment funds and protect the investment rights and interests of LPs.

In his opinion, if dividend-type investment can become popular in the venture capital market, allowing LPs to obtain part of their investment capital through corporate profit dividends in previous years, perhaps the solutions for venture capital institutions and invested companies to negotiate on the recovery of the remaining investment capital will become more flexible, without the need to go through legal proceedings, which would make the relationship between them become "tense."

Some people from venture capital institutions also pointed out that at present, the equity repurchase clauses signed by venture capital institutions and invested enterprises are mainly corporate IPO betting agreements, that is, if the enterprise fails to achieve IPO within the agreed time, the venture capital institution has the right to require the major shareholders of the invested enterprise to repurchase the enterprise equity held by the venture capital institution. Therefore, even if a dividend-type investment clause is introduced, as long as the invested enterprise fails to IPO within the agreed time, the venture capital institution may also initiate legal proceedings and require the invested enterprise to repurchase the equity - the correlation between the two may not be very high.

"In fact, whether the investment enterprise repurchases equity or distributes profits through a dividend-type investment mechanism, the core is still whether the LP can get back the corresponding investment principal and interest when the fund matures and is liquidated." The aforementioned venture capital firm partner analyzed. To solve this problem, in the current environment, compared with introducing dividend-type investment, venture capital institutions should do two things well. First, try to persuade LP to further extend the duration of venture capital funds, using time to exchange for operational space for project exit; second, actively negotiate with S funds to allow LP to get back the investment principal and interest in one lump sum through share transfer.

Many venture capital industry insiders told reporters that they still prefer to sign equity repurchase clauses with investment companies rather than introduce dividend-based investment mechanisms. The reason is that business operations are highly volatile and may not provide ideal profit dividends every year. In comparison, equity repurchase clauses have greater certainty in terms of investment principal recovery and are more operational.

“Although dividend-based investments have been hotly discussed in the venture capital community recently, in terms of actual operations, there are only a handful of real cases that can be implemented,” the venture capital firm partner said bluntly.