A looming crisis of "contingent buyback" is casting a shadow over countless startups in China.

Recently, several well-known venture capitalists have spoken out, causing a great stir in the venture capital industry and attracting high-level national attention.

"I hope these good companies are not driven to extinction by 'contingent buyback'," said Niu Wenwen, chairman of Black Horse, and Kuang Ziping, a well-known venture capitalist from Qiming Venture Capital, among others.

If these 200 or 500 companies all have to repurchase equity, it can be said that the essence of China's entrepreneurial innovation over the past decade has been destroyed overnight.

A large number of private equity investments are nearing maturity, and a large number of companies will face the triggering of buyback clauses, with the redemption amount for a single project potentially reaching hundreds of millions.

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What worries Niu Wenwen and others even more is that among the companies involved in this buyback wave, there are no shortage of "star startups, unicorns, and near-unicorns."

They are seen as key drivers of economic development, influencing the future of China.

In just a few days, the state has also paid attention to the issues of venture investment, and the State Council has conducted a special study on measures to promote the development of venture investment.

The meeting made it clear: it is necessary to quickly unblock the bottlenecks and blockages in the "raising, investing, managing, and exiting" links, support technology companies that meet the conditions to go public both domestically and abroad, encourage social capital to set up market-oriented merger and acquisition funds or secondary market funds for venture investment, and promote a virtuous cycle in the venture capital industry.

The policy direction has changed, can it provide timely relief for the majority of startups?

Will the sword of Damocles of contingent buyback fall?

This is a matter of life and death for China's scientific and entrepreneurial ecology.

What is a "contingent buyback agreement"?

Simply put, if the invested company fails to complete the corresponding targets (such as going public, performance, etc.)

within the specified time, the investor has the right to demand that it repurchase shares, and at a much higher price than when it was sold.

Niu Wenwen mentioned that about 14,000 companies, covering about 130,000 entrepreneurial projects, are facing the pressure of buyback contingencies in the near future.

The same figures also appear in the "VC/PE Fund Buyback and Exit Analysis Report" recently released by Lifeng Law Firm: As of mid-August 2024, about 130,000 projects will face exit pressure in succession, involving about 14,000 companies facing exit pressure.

Among these companies, in addition to a few lucky ones who can "go ashore" through IPO or mergers and acquisitions, the vast majority will face buyback pressure.

Based on the widespread use of buyback clauses, it is not an exaggeration to say that tens of thousands of startups may face buybacks.

Niu Wenwen also estimates that among them are more than 200 to 500 star companies or unicorns.

Many signs indicate that many star companies in the venture capital industry in the near future are indeed facing a dilemma of "Mount Tai pressing down."

For example, the photovoltaic industry unicorn, Yida Xineng, with a valuation of over 9 billion yuan, recently withdrew its IPO application.

The prospectus shows that it signed a buyback clause.

There are market rumors that it is negotiating with CATL for acquisition to obtain cash flow.

According to the "Science and Technology Innovation Board Daily," there are many star projects in the new energy field that are facing the situation of the capital chain breaking at any time.

"A year ago, the founders of the star projects were still high up, but now some have to lower their faces to ask for help from industrial investment, because now they are facing the continuous bottoming out of various links in the industrial chain on one side, and on the other side, they are chasing the stockholders who are buying back and the banks that are withdrawing loans or not renewing loans."

On the other hand, the investors are indeed making frequent moves.

For example, as a local venture capital industry giant, Shenzhen Venture Capital has a pivotal position in the venture capital circle.

As of July 31, 2024, Shenzhen Venture Capital has invested in 1,825 venture capital projects (1,521 companies), with a total investment amount of about 109.2 billion yuan.

According to the Caixin Society Venture Capital Tong-Zhi Zhong data, since last year, Shenzhen Venture Capital has realized the exit of nearly 20 projects by requiring companies to repurchase shares, involving projects covering new energy vehicles, biomedicine, and electronic information fields.

In addition, Tianyancha shows that since May 2023, Shenzhen Venture Capital has issued 38 tender announcements for litigation legal services, most of which are caused by disputes over the exit of investment projects: At the end of 2023, WPZY company failed to go public, triggering a buyback, with an investment amount of 23 million; At the end of 2023, REGWL company failed to go public, triggering a buyback, with an investment amount of 13 million; At the end of 2022, SJJKY company failed to go public, triggering a buyback, with an investment amount of 80 million; At the end of 2022, MD company failed to go public, triggering a buyback, with an investment amount of 9.9 million; ...

This is still an incomplete count.

For example, the Interface News disclosed that the largest investment amount in all the projects that Shenzhen Venture Capital has started to repurchase is a contribution to GDKJ company in 2019, with an amount of 200 million yuan.

How serious are the consequences of triggering a buyback?

It is not an exaggeration to describe it as a "catastrophe."

Celebrities such as Luo Yonghao and Zhang Lan have all tasted it, with light consequences being unable to repay the debt and severely injured, and heavy consequences being ruined and even being sued in court.

For example, there is a Lazy Cat Travel, established in 2013, focusing on overseas travel, which was hit hard by the epidemic and failed to go public on schedule, triggering a buyback in 2023.

Founder Zhao Jun, in an interview with Southern Weekend, mentioned that after half a year of negotiations with the investor, the buyback amount was reduced, and finally he had to sell his property in Southeast Asia to fulfill the treaty.

In reality, more companies are unable to pay, and in the end, they end up in court with the investor.

At this point, there is basically only a "lose-lose" outcome.

According to the report drafted by Lifeng Law Firm, the average execution recovery rate of buyback cases in China that have entered the judicial process is only about 6%; about 10% of founders have become dishonest executioners because they cannot fulfill the buyback obligations.

Why does China's venture capital industry have such a huge "stampede-style buyback wave"?

There are at least two basic backgrounds: First, the companies currently caught in the buyback vortex mostly received investments around 2015, which was the period when the demand for entrepreneurial financing was the most vigorous.

In September 2014, the state proposed "mass entrepreneurship, innovation," and for a while, the new enterprises were surging, and the number of new enterprises exploded.

By 2016, there were an average of 15,100 new enterprises registered per day nationwide, and in 2017, there were an average of 16,600 new enterprises registered per day.

At the same time, many investors also adhered to the tenet of "better over-invest than miss," throwing money around.

Jingzhun data shows that from 2015 to 2018, the total amount of equity financing and investment increased year by year, reaching 1,403.2 billion in 2018, almost double that of the previous year.

In order to facilitate investment, buyback contingent agreements also became popular rapidly at this time.

It should be noted that the existing RMB funds have a life span of mostly "5+2" years (5 years of investment period + 2 years of exit period), which is much shorter than the "10+2" in the United States.

According to this calculation, the entrepreneurial wave of 2015 is now the harvest season.

But when you go to the field to take a look, you find that the rice is green and lying down.

Why is that?

This is related to the second background: IPO, as one of the most favored exit mechanisms for private equity investment, is now facing a serious tightening.

Data shows that since the "827 new policy" was introduced last year, there have been 126 listed companies in the A-share market, a year-on-year decrease of 70.14%; among them, only 14 in the second quarter of this year, the lowest number of companies listed in a single quarter in the past 10 years; the total financing amount this year is 42.235 billion yuan, a year-on-year decrease of 86.18%.

In terms of IPO acceptance, 135 new companies have been accepted, a year-on-year decline of 74.67%, among which 39 have been terminated, accounting for 28.89%.

The market generally believes that since the China Securities Regulatory Commission proposed to "temporarily tighten the pace of IPO," the supervision has been strengthened, the IPO issuance has slowed down sharply, and the difficulty of listing has increased rapidly.

Many project investments have no hope of exiting through IPO, thus triggering a buyback wave.

Speaking of which, the "buyback contingent agreement" is actually an imported product.

Kuang Ziping, the founding partner of Qiming Venture Capital, said that in the early days of the dollar fund's investment in Chinese projects, there would generally be buyback clauses, and occasionally performance contingent clauses, with the purpose of urging the founders to work diligently.

However, these clauses are usually not triggered, and even if they are triggered, it is on the premise of not harming the normal operation of the company.

Why does this round in China have a significant "stampede-style buyback wave"?

Many opinions believe that today, when the RMB fund has replaced the dollar fund as the dominant force in domestic venture investment, the buyback contingent agreement has become so widespread that it is suspected of "abuse."

The aforementioned report released by Lifeng Law Firm mentioned that in 2023, among the projects successfully declared for IPO on the Shanghai and Shenzhen stock exchanges, about 65% of companies have set buyback clauses in their agreements.

Some market institutions' sampling statistics show that the use of buyback rights has reached more than 80%, and even more than 90% in recent years.

In comparison, according to some market institutions in the United States, the use of buyback rights in Silicon Valley private equity investment projects has gradually decreased to less than 4% in recent years, and even dropped to 2% in the fourth quarter of 2023.

Behind the huge numbers, there is a huge difference in venture capital rules, culture, and atmosphere between China and the United States.

"I visited Silicon Valley, and a very prominent feeling is that entrepreneurs and investors are very optimistic," Zhang Wei, chairman of Cornerstone Capital, mentioned in an article.

"Because the exit is really easy, on the one hand, the IPO is relatively simple, and on the other hand, even if the IPO is not successful, technology giants are also very willing to spend a little 'small money' to buy them.

So the local entrepreneurial atmosphere is very strong."

However, in China, the state capital that occupies the dominant position in the venture capital market is naturally resistant to risk and emphasizes "preservation and appreciation," and will naturally heavily rely on buyback agreements, and the trust relationship between the two parties of investment is very fragile.Renowned investor Yang Dong once stated: "Limited Partners (LPs) often harbor an immature and overly optimistic expectation towards venture capital, such as expecting excessively high returns, demanding guaranteed principal, and the phenomenon of nominal equity but actual debt.

These are very unreasonable for the venture capital industry.

Among various asset classes, venture capital has the highest rate of return, but it also has the highest liquidity and risk.

In China's venture capital industry, LPs also need to mature."

However, distant water cannot quench immediate thirst.

What to do about the pressing problems?

One path is to "save the country through indirect means" by listing on the Hong Kong and U.S. stock markets.

Currently, the A-share market is sluggish, while the Hong Kong market is performing brilliantly, with the Hang Seng Index's maximum increase this year once exceeding 30%, leading the Asian stock market.

A major reason behind this is that mainland enterprises that are stuck on the road to listing on the A-share market have turned their sights towards Hong Kong.

According to Huayi Xin Capital, by the end of August this year, a total of 43 enterprises have successfully entered the Hong Kong stock market.

The U.S. stock market is also highly favored.

According to an incomplete count by the Securities Times, by mid-July this year, a total of 25 Chinese concept stocks have entered the U.S. stock market, with a total fundraising amount of $2.24 billion (approximately 16.1 billion yuan), both the number of listings and the amount of fundraising exceeding the same period last year.

Deloitte China predicts that more Chinese enterprises will go public in the U.S. before the U.S. presidential election on November 5th.

Among the army of companies going public, one team is particularly eye-catching, that is, AI companies.

According to LiveReport big data, by early July of this year, there were at least 12 AI companies that had submitted applications to the Hong Kong Stock Exchange and were in the queue.

Half of these star companies had valuations exceeding $1 billion before going public, such as Horizon with a valuation of about $8.71 billion, Black Sesame Intelligence with $2.23 billion, and iFLYTEK Medical with 8.4 billion yuan, etc.

For mainland enterprises in dire straits, going public in Hong Kong and the U.S. is undoubtedly a way out, and it is urgent to break free.

However, there is a bit of melancholy that "good water flows into other people's fields," after all, AI is very likely to become the next era's opportunity after the Internet.

Not long ago, the unicorn company, Yingshi Innovation, caused a sensation due to sensitive shareholder issues that hindered its IPO.

On October 28, 2020, Yingshi Innovation was accepted for listing on the Science and Technology Innovation Board.

Now, four years have passed, and after two rounds of inquiries, progress has stagnated, and there is no hope for an IPO in the short term.

Its founder, Liu Jingkang, posted two moments on social media, listing various achievements since its establishment: a fourfold increase in performance during the IPO application period; $400 million in foreign exchange earnings in one year; nine years of establishment, with a cumulative profit in the hundreds of millions; twice named by Fast Company as one of the world's most innovative companies, and so on.

In the end, he stated, "I do not seek approval, I only seek a fair characterization; do not let the hearts of the 2000 post-90s who truly want to make the world recognize Chinese intelligence and the rise of technology through technology be hurt."

Perhaps the comment of Zhang Wei, one of the investors of Yingshi Innovation and the chairman of Cornerstone Investment, can serve as a footnote to the entire whirlpool: For China, we are in urgent need of boosting people's confidence through the certainty and inclusiveness of policies, and building this positive self-fulfilling prophecy.

We are full of expectations that in the era of the fourth industrial revolution, China's technology industry can also usher in a day of a sky full of stars.

The A-share market has already missed the Internet era of Tencent, Alibaba, and Meituan, and it cannot afford to miss the AI era.