China's venture capitalists are hunting failed founders, chasing their assets and adding to the list of defaulters, in moves that put the country's startup funding system at risk.
Hard tactics by providers of risk capital are facilitated by clauses known as exemption rights, included in almost all loans made at the time. in Chinaboom times.
“My investors promised not to force them, if they didn't force them before – and in '17 and '18 it was true – no one was forcing them,” said the founder of Neuroo Education Wang Ronghui, who now owes investors millions. dollars after her childcare chain collapsed during the pandemic.
While they are rare in the US venture capital investmentShanghai-based law firm Lifeng Partners estimates that more than 80 percent of corporate and private equity deals in China contain exemption provisions.
They typically require companies, and often their founders as well, to buy back investors' shares and interests if targets such as planned initial public offerings, valuation goals or revenue metrics are not met.
“It causes a lot of damage to the ecosystem because if the startup fails, the founder faces confiscation of assets and spending restrictions,” said a Hangzhou-based lawyer who represents several bankrupt entrepreneurs and asked not to be named. They will never live.
Lifeng, in his latest statement on the release rights, said they have turned the business into an “unlimited debt game”. In 90 percent of investment cases, the company said, founders are named as defendants and companies, and 10 percent of people have been added to the list of debtors in China.
Once blacklisted, it is almost impossible for people to start another business. They are also banned from a range of economic activities, such as taking flights or high-speed trains, staying in hotels or leaving China. The country has no bankruptcy law, which makes it very difficult for many to avoid debt.
With Chinese funds and VC firms now struggling to recoup capital from foreign investors, an increasing number are turning to repatriation clauses to recoup as much money as possible. Lifeng estimates that 20 percent of all investor exits in 2021 and 2022 will come from companies that are buying back their investors' shares and that more than 10,000 VC or private equity-backed Chinese groups are facing solvency issues.
The first adviser, who did not want to be named, said the situation was perversely encouraging VCs to go after portfolio companies that are doing well but don't have a fast track to a sale or IPO.
“VCs put pressure on start-ups that can pay,” he said. “It's not a trip – it's a debt.”
The number of entrepreneurs caught up in legal action continues to grow. They include Wang Ziru, who ten years ago grabbed attention as a young founder and raised tens of millions of renminbi for his tech media and review platform Zealer.
In 2021, with declining traffic, Wang left for an executive role at home appliance maker Gree. Then, on August 9 last year, a court in Shenzhen slapped the 36-year-old with spending restrictions for failing to pay Zealer's investor Rmb34mn ($4.7mn), an amount built up with snow and interest. from the first VC investment of Rmb19mn, according to. to the lawyer who was informed of the case. Wang lost his job a few days later.
The founder disputes the ruling and said on social media that he was not informed of the lawsuit and that the arrangement for the redemption of the contract had not started.
One of China's most famous entrepreneurs, Luo Yonghao, turned his struggle to pay off the debts of his failed Smartisan smartphone into a show, eventually selling enough iPhones and office chairs in online videos to pay off suppliers and clear his name as a debtor. blacklist 2020.
So some of Smartisan's investors came demanding that Luo pay hundreds of millions more in renminbi to buy back their shares.
“Investment is not a loan,” Luo wrote on Weibo in August last year. “When a venture capital deal fails, one has to accept the outcome. Those who resort to business tactics because they cannot bear the consequences are, without a doubt, dishonest capitalists.”
These cases have filled the Chinese courts. Records show that Xu Mingqi lost his company and all of his other tangible assets to investors after his Yeagood equipment group failed to meet its promised three-year IPO deadline.
China's supreme court in 2021 ruled that since his wife Zheng Shaoai also worked at Yeagood, one investor could take public property including a house held in his name.
Wang, the 47-year-old founder of a childcare chain, even had money in his health insurance account seized by investors. He said his problems began in 2021, when funds linked to state-backed investor Guangdong Cultural Investment Management demanded Rmb16mn of their shares to be bought back with interest because his startup failed to get the Rmb500mn valuation.
Their case created the funding cycle needed to end pandemic-related closures at 36-day care facilities, he said. Now, Wang owes about Rmb30mn in GCIM-related funds, Rmb11mn in banks and possibly more from other investors who reject the bailout yet to be raised.
GCIM did not respond to the breathalyzer request.
“I've built my company into an industry leader – I'm strong and driven – but every path I'm trying to take is the end,” Wang said. “An unexpected turn of events left me permanently and completely stranded.”