Chinese venture capitalists are harassing failed founders, going after personal assets and adding individuals to a national blacklist of debtors when they fail to pay, in moves that are throwing the country’s seed funding ecosystem into crisis.
The tough tactics of venture capital providers have been facilitated by clauses known as redemption rights, included in almost all financing agreements reached during PorcelainThe boom times.
“My investors verbally promised that they would not enforce them, that they had never enforced them before, and in 2017 and 2018 that was true, no one was enforcing them,” said Neuroo Education founder Wang Ronghui, who now owes millions to the investors. of dollars after its child care chain stumbled during the pandemic.
While they are relatively rare in the US. risk investmentMore than 80 percent of venture and private equity deals in China contain redemption provisions, according to estimates by Shanghai-based law firm Lifeng Partners.
They typically require companies, and often their founders as well, to buy back investors’ shares plus interest if certain goals are not met, such as an initial public offering timeline, valuation targets, or revenue metrics.
“It’s causing enormous damage to the venture ecosystem because if a startup fails, the founder essentially faces asset seizures and spending restrictions,” said a Hangzhou-based lawyer who has represented several indebted entrepreneurs and asked not to be identified. “They can never recover.”
Lifeng, in its recent report on repayment rights, said they had turned entrepreneurship into an “unlimited liability game”. In 90 percent of the investor lawsuits, the firm said, the founders were named as defendants along with the companies, and 10 percent of the individuals were eventually added to China’s debtor blacklist.
Once blacklisted, it is almost impossible for people to start another business. They are also prevented from carrying out a series 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.
As Chinese funds and venture capital firms struggle to return capital to their outside investors, a growing number have turned to bailout clauses to recover as much money as possible. Lifeng estimates that 20 percent of all investor exits in 2021 and 2022 came from companies buying back shares from their investors and that more than 10,000 Chinese groups backed by venture capital or private equity are facing repayment problems.
A startup advisor who did not want to be identified said the situation was perversely incentivizing venture capitalists to pursue portfolio companies that were doing well but lacked an immediate path to a sale or IPO.
“Venture capitalists are putting pressure on startups that can pay,” he said. “It’s not risk, it’s debt.”
The number of business owners affected by legal actions continues to grow. They include Wang Ziru, who a decade ago attracted attention as a daring young founder and raised tens of millions of renminbi for his tech media and reviews platform Zealer.
By 2021, with traffic slowing, Wang left to take an executive position at appliance giant Gree. Then, on Aug. 9 last year, a Shenzhen court imposed spending restrictions on Wang for failing to pay a Zealer investor 34 million yuan ($4.7 million). The amount had increased with interest on the VC’s initial RMB19 million equity investment, according to a lawyer briefed on the case. Wang lost his job a few days later.
The founder is challenging the ruling and said on social media that he was not notified of the lawsuit and that the exchange provision of the agreement was not activated.
One of China’s most famous entrepreneurs, Luo Yonghao, turned his struggle to pay off the debts of his failed smartphone startup Smartisan into a spectacle, eventually selling enough iPhones and office chairs on online live video streams to pay suppliers and remove your name from the debtor. blacklist in 2020.
Some of Smartisan’s investors then demanded 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 result. “Those who resort to underhanded tactics against businessmen because they cannot bear the result are, without a doubt, unscrupulous capitalists.”
The cases have packed 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 initial public offering.
In 2021, China’s highest court ruled that since his wife Zheng Shaoai had also worked at Yeagood, an investor could seize communal property, including the apartment that was in her name.
Wang, the 47-year-old founder of a daycare chain, has even had funds in her health insurance account seized by investors. He said his problems began in 2021, when funds related to state-backed investor Guangdong Cultural Investment Management demanded that their 16 million yuan shares be bought back with interest because his new company had failed to reach a valuation of 500 million yuan. .
Her lawsuit torpedoed a round of funding needed to offset pandemic-related closures of the group’s 36 daycare centers, she said. Wang now owes about 30 million yuan to funds affiliated with GCIM, 11 million yuan 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 turned my company into an industry leader; I have ability 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.”