CHINA: An Introduction to Private Equity: Buyouts & Venture Capital Investment (PRC Firms)
Private Equity Transactions and M&A Deals in General
Major market research agencies appear unanimous in their analysis of transaction activity in China in 2023. Deal activity, value, and volume have all dropped significantly. With the market downturn accompanied by tightening regulations, capital has become increasingly cautious. The private equity (PE) market in China is expected to remain challenging in 2024.
According to Bain & Company’s Greater China Private Equity Report 2024, Greater China's deal activity continued its structural decline to a 10-year low in 2023, with deal value falling 58% to USD41 billion compared to the previous five-year average (2018-2022) and deal volume dropping by 31%, consistent with the global trend. PwC also reports that M&A volumes and values in China have dropped sharply during 2022 and 2023 to levels not seen in a decade. M&A deal volumes fell by 27% to 8,563, while deal value decreased by 28% to USD333 billion. Despite the overall downward trajectory of transaction activities in China in 2023, outbound investments by privately-owned enterprises rebounded, with a 13% increase in volume and a 62% increase in value compared to 2022 lows (source: PwC).
From an industry perspective, industrials, high tech, and healthcare remained in the spotlight in 2023. Investments in sectors such as semiconductors, machinery, information technology, and life sciences remained active. According to CV Source (an online database maintained by the Chinese research and consulting firm ChinaVenture Group), the semiconductor industry saw 1,042 investment deals in 2023, with the investment volume reaching USD24.6 billion. Biomedicine, information technology, and medical devices each recorded around 500 deals. Artificial intelligence emerged as the next indispensable investment hotspot, with 401 deals reaching USD5.87 billion, ranking second to semiconductors in the technology sector.
There is also a growing trend of incorporating ESG considerations into investment decisions by PE firms. PwC's survey of more than 150 PE houses found that respondents overwhelmingly believe ESG management can create value, and it is now standard practice for PE firms to consider ESG factors when sourcing opportunities, conducting due diligence, forming post-acquisition plans, and deciding on deal terms. In 2023, the disclosed M&A deal volume in China’s new energy industry reached a record high of 784 deals, with a total disclosed deal value of RMB220.4 billion.
Despite the subdued performance of China's private equity market in 2023, the outlook for the year ahead is still optimistic. The central government is issuing new policies to encourage economic development, and the capital market, which seemed to have hit a low point, is on the cusp of a robust recovery. Looking ahead, the landscape is promising and ripe with opportunities.
Newly Issued Regulations
Formation and Operation of PE Funds
On July 9, 2023, the State Council officially released the Regulations on the Supervision and Administration of Private Investment Funds, which were implemented on September 1, 2023. These new regulations aim to improve the basic legal framework for supervising private equity funds in China, marking a milestone for the industry.
Prior to these new regulations, the Asset Management Association of China issued new Private Investment Fund Registration and Filing Measures. The updated self-regulation rules set the principle of “Favor top students and reject underachievers.” New requirements for private equity funds include a focus on equity investment, avoiding investments in non-equity interests such as creditor's rights and income rights, and steering clear of conflicting businesses such as factoring and P2P lending.
HKEX Chapter 18C
In March 2023, the Stock Exchange of Hong Kong introduced a new Chapter 18C to its listing rules, permitting the listing of companies operating in specified specialist technology sectors. These sectors include next-generation information, advanced hardware and software, advanced materials, new energy and environmental protection, and new food and agriculture technologies. This policy recognises that many innovative tech companies struggle to meet the financial performance requirements for main board listing due to their generally shorter establishment periods, significant initial investments, and longer commercialization cycles. But such companies are primarily concentrated in emerging industries and have good long-term development potential. Chapter 18C provides more listing opportunities for them.
The 2023 Revision of the Company Law
On December 29, 2023, the Standing Committee of the National People’s Congress promulgated revisions to the PRC Company Law, effective July 1, 2024. The revisions strengthen shareholders’ capital contribution responsibilities by setting a maximum term of five years for capital contribution and introducing a shareholder disqualification system. The new law expands shareholders' information right, allowing inspection of the company’s accounting vouchers and other materials. It also refines regulations restricting directors, supervisors, and senior executives from engaging in related-party transactions, seeking business opportunities at the company’s expense, and competing with the company in the same industry. These changes will have a profound impact on companies involved in the private equity market, including startups, companies planning to list, and listed companies. For foreign-invested enterprises, the new law provides greater legal transparency and certainty, attracting and protecting foreign investors’ interests.
The New “Nine Measures”
On April 12, 2024, the State Council issued the Several Opinions on Strengthening Regulation, Preventing Risks, and Promoting High-Quality Development of the Capital Market (the “Nine Measures”). The new "Nine Measures" propose nine key directions, including strictly controlling access to listing, regulating listed companies, and intensifying delisting supervision, forming an overall framework for high-quality capital market development. Specific revisions include raising listing standards for the main board and ChiNext market, improving evaluation criteria for the scientific and technological innovation attributes of the SSE STAR Market, requiring disclosure of dividend policies at listing, and strengthening supervision of shareholders and executives reducing holdings, dividend distribution, market value management, and delisting. The measures also support the construction and restructuring of investment banks and investment institutions to promote their high-quality development.
The new "Nine Measures" mark another significant milestone in the development of China’s capital market. By deepening reforms and expanding openness, they aim to better serve the real economy, support national strategies, and promote high-quality economic development.
Potential Hurdles and the Solutions
The current market is facing significant challenges, primarily characterised by difficulties in fundraising and exit opportunities. This is a global trend, reflecting broader economic uncertainties.
In China, the financing environment is particularly challenging, with fundraising conditions for foreign currency funds being notably difficult. In 2023, the PE/VC market completed fundraising for a total of 508 funds, reflecting a 9.1% decrease compared to the previous year. The cumulative fundraising amount reached USD110.4 billion, an 18.9% year-on-year decline. This trend underscores the heightened caution and reduced availability of capital among LPs due to current macroeconomic conditions.
Investment is increasingly concentrated in high-tech and early-stage companies. In 2023, there were 6,465 VC transactions, accounting for 76% of the market. Policy-driven LPs and state-owned LPs have become the market’s mainstay, with multiple government guidance funds and strategic funds established in regions such as Shanghai, Shenzhen, and Jiangsu. Sovereign funds, such as those from the Middle East, are also actively engaging in the Chinese investment market, bringing new opportunities. To navigate this difficult landscape, companies may actively participate in government-led investment initiatives and seek partnerships with government-affiliated institutions. By leveraging the resources and support offered by the governments, they may mitigate some of the financing hurdles and enhance their fundraising prospects.
Under the influence of macroeconomic factors, the number of IPOs has been declining for consecutive years. In 2023, a total of 415 Chinese companies went public, with 274 of them backed by VC/PE firms, resulting in a penetration rate of 66%, a 4% decrease compared to the previous year. The exit return rate slightly declined to 374%, while the proportion of overseas IPOs increased to 25%. The lengthy IPO review process, low valuations, high uncertainty of listings, and frequent post-IPO price declines are all contributing factors that make exiting through an IPO challenging. To address these challenges, we recommend that companies may explore flexible exit strategies beyond IPOs, such as exit by acquisitions and Secondary Fund. It is also crucial for investment firms to carefully time their exits to maximise returns and navigate the market’s complexities effectively.
(Data source for this section: CV Source)