Chinese venture capitalists are hounding failed founders, going after personal assets and adding them to a blacklist of national debtors when they fail to pay, in moves that plunge the country's startup financing ecosystem into crisis.
The aggressive tactics of venture capital providers were facilitated by clauses known as redemption rights, which were included in almost all financing deals concluded during the post-World War II period. ChinaBoom times.
“Investors verbally promised that they would not do it, that they had never done it before — and in 2017 and 2018 that was true — no one was doing it,” said Wang Ronghui, founder of Neuroo Education, who now owes investors millions of dollars. of dollars after its childcare chain faltered during the pandemic.
While it is relatively rare in the United States Investment in the projectShanghai-based law firm Living Partners estimates that more than 80 percent of venture and private equity deals in China contain clawback provisions.
They typically require companies, and often their founders as well, to buy back investors' shares plus interest if certain goals such as the IPO timeline, valuation goals, or revenue metrics are not met.
“It causes great damage to the investment ecosystem because if a startup fails, the founder basically faces asset confiscation and spending restrictions,” said a Hangzhou-based lawyer, who has represented several indebted entrepreneurs and asked to remain anonymous. “They can never recover.”
In its latest redemption rights report, Living said it had turned entrepreneurship into a “game of unlimited liability”. The company said that in 90 percent of investor lawsuits, founders were named as defendants alongside companies, with 10 percent of individuals eventually being added to China's blacklist of debtors.
Once blacklisted, it is almost impossible for individuals to start another business. They are also prohibited from engaging in a range of economic activities, such as boarding planes or high-speed trains, staying in hotels, or leaving China. The country lacks a personal bankruptcy law, which makes it very difficult for most people to escape debt.
With Chinese funds and venture capital firms now struggling to return capital to their overseas investors, a growing number of investors have turned to redemption clauses to get as much money back as possible. Living estimates that 20 percent of all investor exits in 2021 and 2022 came from companies that bought back their investors' shares, and that more than 10,000 Chinese venture capital firms or private equity-backed groups are facing redemption issues.
One startup advisor, who did not want to be named, said the situation was perversely incentivizing venture capital firms to pursue portfolio companies that were performing well but lacked an immediate path to sale or IPO.
“Venture capital firms are putting pressure on startups that can pay,” he said. “It's not an adventure, it's a debt.”
The number of entrepreneurs caught up in legal proceedings continues to grow. Among them is Wang Ziruo, who gained attention a decade ago as a brash young founder who raised tens of millions of renminbi for tech media and his review platform Zeller.
By 2021, with traffic declining, Wang left to take an executive position at home appliance giant Gree. Then, on August 9 last year, a Shenzhen court imposed spending restrictions on the 36-year-old for failing to pay an investor in Zeller RMB34 million ($4.7 million), an amount that increased with interest from the initial investment. In venture capital shares of 19 million renminbi, according to a lawyer familiar with the case. Wang lost his job a few days later.
The founder is appealing the ruling and said on social media that he was not notified of the lawsuit and that the clawback clause of the deal was not triggered.
One of China's most famous entrepreneurs, Luo Yonghao, turned his struggle to pay off debts for his failed smartphone startup Smartisan into a spectacular spectacle, eventually selling enough iPhones and office chairs in a live online video broadcast to pay off suppliers and remove his name from the debtor. Blacklist in 2020
Then some Smartisan investors came forward demanding that Lu pay hundreds of millions more in renminbi to buy back their shares.
“Investment is not a loan,” Luo wrote on the social media platform Weibo in August last year. “When a venture capital deal goes wrong, one must accept the outcome. Those who resort to underhanded tactics against entrepreneurs because they cannot afford the outcome are, without a doubt, unscrupulous capitalists.
These cases have occupied Chinese courts. Records show that Xu Mingqi lost his company and all of his other identifiable assets to investors after his material group Yeagood failed to fulfill its promise of a three-year IPO period.
China's Supreme Court ruled in 2021 that since his wife, Cheng Shawei, also worked at Yeagood, one of the investors could seize the joint property including the apartment owned in her name.
Wang, the 47-year-old founder of the childcare chain, even had money in her health insurance account taken away by investors. She said her troubles began in 2021, when funds linked to the state-backed Guangdong Cultural Investment Management Company demanded a buyback of its shares worth RMB16 million with interest because her startup failed to get a RMB500 million valuation.
She said their lawsuit torpedoed the round of funding needed to offset pandemic-related closures of the group's 36 daycare centers. Now, Wang owes about RMB30 million to GCIM-affiliated funds, RMB11 million to banks, and possibly more to other investors whose redemption terms have not yet been triggered.
GCIM did not respond to a request for comment.
“I've built my company into an industry leader — I have the ability and I have the drive — but every path I try is a dead end,” Wang said. “The unexpected turn of events has left me permanently and completely trapped.”
