Reviving China's Primary Market

By Wang Ran, CEO of Elevation Capital

At last Friday's WAVES2024, Wang Ran, founding partner of Elevation Capital, joined a conversation with Ma Yin, founder of Aranya, and Feng Dagang, CEO of 36Kr.

Unsurprisingly, they talked about the current venture capital industry. The straight-talking Wang Ran opened with a blunt assessment: "The biggest change in the primary market is that it basically no longer exists." When asked what advice he had for young people still wanting to enter the primary market, Wang Ran shot back: "Do people actually still want to enter the primary market?"

After all, WAVES is a public conference, and too much truth can be a buzzkill. So Wang Ran, still wanting to say more, wrote a 5,000-word observation after the event titled "The Primary Market Is Dead." That framing was too sweeping, so "Surging Waves" suggested something milder — hence the current headline.

As someone who has witnessed China's venture capital industry grow from virtually nothing through several cycles, Wang Ran is both an insider and an outsider. The days when he, David Zhang, and Fan Bao were dubbed the "Three Heroes of Winter" are long past. But Wang Ran is still at the table. Still a cool-headed participant, still a cold-eyed observer.

The full conversation video is below:

China's Venture Capital Primary Market Has Gone Into Hibernation

Last week at a forum in Beijing, the host asked me about the biggest change in China's venture capital primary market over the past year. I said the biggest change is that it's no longer here.

Don't misunderstand me. Entrepreneurship will always exist. Venture capital will always exist. But the relatively market-oriented primary market for venture capital that we remember and recognize — that China is gone.

Let's look at some data, starting with the investment side.

Over the past three years, the number of primary market investments in China fell from 11,000 in 2020 to 7,100 in 2023 — a 38% decline. Investment value dropped from 1.5 trillion RMB to less than 500 billion, a 68% plunge. In the first five months of 2024, investment count fell nearly 30% year-over-year. While investment value appeared to rise slightly, this was driven almost entirely by a handful of mega-projects in semiconductors and electric vehicles, led by local governments and state-owned enterprises. Strip out the purely strategic, non-market-oriented investments, and the contraction over the past three years looks even more brutal. If we treat primary market investment as an industry, among China's many trillion-RMB industries, you'd be hard-pressed to find a second one with a decline of this magnitude over three years.

Cause and effect are inseparable. The investment-side transformation reflects seismic shifts on the fundraising side.

From 2020 to 2023, fundraising appeared to grow on both metrics — new fund count and capital raised. New funds increased from just over 100 to more than 500, a threefold-plus jump. Capital raised grew from 630 billion to 960 billion RMB, roughly 50% growth. But beneath the surface, three problems emerged.

First, the three-year growth was mainly driven by 2021 and 2022. In 2023, while new fund count held flat with 2022, capital raised fell about 35%. RMB fundraising dropped 18%, while USD fundraising collapsed by 82% — a double decline. Second, and more critically, USD funds, historically more market-oriented, saw their share of the total shrink dramatically. USD new fund count fell from 27% in 2020 to 5% in 2023; USD capital raised dropped from 38% to 7%.

In other words, USD funds in China's primary market, if not completely liquidated, have been thoroughly marginalized. The market is now entirely dominated by RMB limited partners, and RMB capital is overwhelmingly concentrated in various forms of local state capital, national funds, and state-owned enterprises.

Third, despite new fund count tripling over three years, average fund size fell 60%. This indicates the industry is becoming increasingly crowded with more players, and more capital is being managed by GPs and LPs without genuine investment capability.

These numbers show that the venture capital primary market that supported Chinese tech innovation for over two decades has been fundamentally reconstructed, with state capital now the absolute dominant force.

Among state capital actors now leading China's RMB primary market, the most representative, largest in scale, and most consequential in new fund fundraising are the various forms of local state capital. Though they differ in jurisdiction, background, identity, and objectives, they share striking similarities.

First, like the A-share market, local state capital is driven by national industrial policy and local economic development strategy, with pronounced industrial orientation. This is understandable. But a healthy, sound capital market cannot serve national strategy alone; it must also serve capital needs beyond national strategy. Outside core national priorities, many fields and directions still need and deserve investment.

Yet in today's environment, these areas can barely secure support from state LPs represented by local state capital, even though such LPs play a decisive, often make-or-break role in new fund fundraising.

Second, the core priority of local state capital is not investment returns, let alone technological innovation. It is supporting and revitalizing local economies through investment attraction and industrial recruitment, injecting new growth momentum, and directly boosting local employment and tax revenue.

Therefore, they always place investment attraction first in their investment calculus, sometimes demanding unreasonable multiples of capital reinvestment in their jurisdictions. This means they treat market-oriented GPs as financial leverage tools to channel external capital into local economies — various market-oriented GPs are devolving into local government investment attraction offices operating within the investment community.

Third, local state capital's starting point for problem-solving is first and foremost risk avoidance and liability evasion: better to do nothing than do something wrong. Hence they universally prefer structured return schemes with senior/junior tranches, willing to sacrifice some commercial returns to offload risk onto others; they universally demand bulletproof decision-making and execution processes, making decision and execution efficiency extremely low; when problems arise, they universally think first of personal exoneration rather than LP economic interest maximization, preferring to suffer substantive commercial losses while ensuring "procedural justice" with "liability distancing" as the supreme principle.

More alarmingly, as capital providers, their operating style and value orientation directly influence the market-oriented GPs that accept their investment, transmitting downward level by level. This quickly makes life miserable for portfolio companies and founders when issues arise, while also pushing market-oriented GPs further from genuine market-oriented objectives in their decision-making.

Fourth, they tend to have multi-layered demands: industrial policy compliance, multiple-return investment attraction, discounted management fees, and no losses — leaving fundraisers with the impression of "wanting everything all at once."

When we say China's venture capital primary market has virtually ceased to exist, we don't mean there's no money or investment activity in the market. We mean that truly commercially-unencumbered capital — capital whose core and ultimate purpose is purely to earn investment returns, willing to fully abide by LP role boundaries without overreach according to industry norms — has become so scarce as to be virtually negligible.

Today, for a market-oriented GP to raise a fund, unless local state capital becomes its sole LP, the fund simply won't close without genuine market-oriented LP capital — even if local state capital is willing to participate. And this is becoming increasingly difficult. The fundamental reason: local state capital's priorities and intentions are diametrically opposed to, even directly conflicting with, those of purely market-oriented LPs.

This is a contradiction at the level of underlying investment logic. In eras when industries were advancing triumphantly, this contradiction could be temporarily obscured. But once entering a down cycle where making money becomes harder across all sectors, this contradiction becomes unsolvable.

Local State Capital's Influence Is Causing "Block-shaped Absences" in China's Venture Capital Landscape, Seriously Undermining Future Global Competitiveness in Technology Industries

Over the past two decades, the rapid development and rising global influence and competitiveness of China's tech industry, represented by the internet, owed much to global capital's market-oriented investment in Chinese innovative enterprises. While seeking returns, they brought crucial capital sources, global perspective, industry norms, and investment methodologies to China's venture capital primary market. Put simply: without USD capital, there would be no flourishing of Chinese tech industries, especially internet and mobile internet, e-commerce, and innovative pharmaceuticals.

However, affected by shifts in the global economic landscape, U.S.-China relations and geopolitics, COVID-19 and related control policies, and abrupt changes in certain industrial policies, USD investors' willingness to commit capital rapidly turned from hot to cold. Particularly, U.S. investors — from the world's largest capital market — did a 180-degree turn in their attitude toward China opportunities.

USD fundraising became nearly impossible over the past two to three years, forcing most GPs to pivot to RMB investors, with local government industrial guidance funds as the most important force. But while both are called "investors," RMB and USD investors are fundamentally different species.

Generally speaking, as financial investors, USD investors have a relatively singular core priority: investment returns. For RMB investors, returns rank relatively lower; they care more about industrial policy alignment, investment attraction effectiveness, and risk minimization.

In any market, investment and returns are always proportional. A complete market needs participants willing to take low risk for low returns, and those willing to take high risk for high returns. Today in China, the state-owned nature of capital providers means virtually all mainstream large-scale RMB investors are fixated on the low-risk/low-return and medium-low-risk/medium-low-return zones of the risk-return curve, with almost no one willing to touch medium-high-risk/medium-high-return, let alone high-risk/high-return zones.

The upper-right corner of the investment return curve has developed structural block-shaped absences. Such absences are extremely detrimental, even dangerous, to China's future global tech competitiveness.

Future regional competition will first and foremost be competition in technological strength, especially around core domains like artificial intelligence, aerospace, new energy, and new materials. The incubation and development of these fields requires not only capital seeking low-risk and medium-low-risk returns, but also capital willing to bear medium-high and high risks in pursuit of medium-high and high returns.

As noted, the block-shaped absences on the return curve will lead to underinvestment and structural imbalance in China's most frontier technology domains.

Meanwhile, for Chinese tech enterprises to possess global competitiveness, they must first secure global top-tier talent resources — otherwise everything is moonlight in water, flowers in a mirror.

In the Industrial Revolution represented by the steam engine, the information revolution represented by computers, and the internet era represented by super-platforms, population could generate dividends. Some inherent disadvantages could be partially compensated for, even converted into advantages, through mass manpower tactics.

But in the era of artificial intelligence and interstellar travel, abundant population is no longer an advantage. The beacons that can illuminate humanity's future development path may rest in the hands of a vanishingly small proportion at the very pinnacle. At this point, without the passionate joining and collaborative striving of the world's most top-tier talent, there is no possibility of gaining the capacity to illuminate and lead the future path, nor of occupying a dominant position in the global technology arms race.

And what is most needed to attract global top-tier talent? Beyond vast markets, they need solid rule of law, transparent and efficient business environments, and truly market-oriented capital and capital markets.

Truly frontier high-tech entrepreneurship is destined to be risky in its early stages, thus requiring capital and investors willing and able to bear risk. Therefore, if the status quo doesn't change, entrepreneurs in these frontier tech domains will struggle to secure the funding they need, while state LPs that only want structured outcomes without bearing market-oriented risks — and the GPs they back — will also struggle to attract the world's top-tier talent to gather around them.

How to Reawaken the Venture Capital Primary Market

Reawakening the venture capital primary market is no easy task, nor is it a single-dimensional one — it cannot be accomplished overnight. But based on national conditions, I believe that if adjustments and improvements can be made in the following areas, there is still opportunity for the hibernating primary market to regain vitality and shine again.

First, on the LP side, local state capital should follow the principle of mainly indirect investment (participating as an LP in funds managed by market-oriented GPs) in most regions, with a few first-tier developed areas allowed to moderately experiment with combining indirect and direct investment.

Over the past three years, various levels of local state capital, dissatisfied with GPs' performance on exits and capital reinvestment, have gradually moved from behind the scenes to center stage, bypassing market-oriented GPs to attempt direct investment. But investment as an industry has genuinely high technical barriers. The vast majority of local state capital investment platforms lack the professional talent and capability for direct investment. Today's surface bustle may well become a field of broken dreams tomorrow.

On the GP side, more market-oriented state-owned GPs or hybrid GPs should be encouraged to grow stronger — allowing entities like Shenzhen Capital Group, Fortune Venture, SDIC, China Merchants Group, Gopher Asset, Yuanhe Holdings, CICC, CITIC/JS Capital, China Science & Merchants Investment Management, and China Development Bank Innovation to assume greater responsibility for market-oriented allocation of state capital, given their relatively higher degrees of marketization and professionalism.

Second, local governments should divide their primary market investment capital into two pools: one for investment attraction, one for value preservation and appreciation, with clearly independent, non-interfering missions. The investment attraction pool, beyond seed-style direct investment, could also consider partnering with market-oriented PE firms with brand and M&A experience, participating in large-scale existing asset and equity M&A through dedicated project funds, with portfolio targets tied to local economic development objectives. The value preservation and appreciation pool should pursue its financial objectives through market-oriented capital allocation without heavy government mandates, by investing in market-oriented GPs with brand reputation and strong track records.

Third, local state capital should establish investment performance evaluation systems more focused on overall, comprehensive, and relative metrics — evaluating investment teams and measuring performance by overall return levels, comprehensive economic spillover effects, and relative investment return performance compared to peer regions during the same period and at similar development levels. They should not single-mindedly emphasize investment safety and the inviolability of state assets.

Preventing state asset loss should first mean preventing non-market-oriented loss, process-oriented loss, and loss caused by dereliction of duty and corruption — not prohibiting investment failure in individual specific projects that have gone through proper, prudent processes.

Fourth, state LPs should be encouraged to give market-oriented GPs longer investment and exit horizons, encouraging the emergence of true patient capital. Patient capital must be patient with the journey from basic scientific research to product to commercialization; patient with the gestation and formation of new demands and markets; and especially patient with exits — particularly when exit channels are varied and constrained.

Fifth, state-owned commercial banks and insurance companies should be encouraged to actively explore intermediate products with both equity and debt characteristics, such as risk debt, mezzanine debt, and revenue-sharing equity/debt instruments featuring risk tranching and cash flow sharing. They should be encouraged to participate in fundraising and establishment of relevant funds, creating a more three-dimensional, composite, and richly diverse capital market atop traditional bank lending and equity investment.

Sixth, the A-share market should resolutely return to the goals and track of the registration-based IPO system, maintaining steady progress and reducing the frequency and magnitude of sudden braking. While continuing to prioritize national strategy, the A-share market should also be all-embracing, providing entrepreneurial enterprises across all domains the opportunity to become public companies through IPO.

Simultaneously, regulations should guide and encourage A-share companies to grow stronger through M&A integration — achieving the goals of improving average A-share company quality and optimizing A-share market capitalization structure, while also providing an important non-IPO exit path for primary market investments (an increasingly large proportion of which is state capital).

China's future economic development and its position in the global geopolitical landscape cannot be separated from technological development and progress. Technological development and progress cannot be separated from gathering global top-tier tech talent. Attracting global top-tier tech talent cannot be separated from rule of law and transparent, efficient business environments, nor from a vibrant, market-oriented venture capital primary market.

Only when the most important capital sources in a nation's primary market stop thinking day in and day out solely about investment attraction, production capacity landing, tax revenue growth, and risk offloading can a true venture capital primary market be awakened. Only such a market can incubate top-tier tech enterprises with global competitiveness, and only then can it drive and ensure that China stands proudly at the forefront of global technology waves and competitiveness contests.

Image source | IC Photo

Layout | Yao Nan