Chinese venture capitalists are hunting down failed founders, pursuing their personal assets and adding them to a blacklist of state debtors if they fail to make payments, a move that has put the country’s startup funding ecosystem in jeopardy. I’m falling into this.
The tough tactics by risk capital providers have been facilitated by clauses known as redemption rights, which are included in nearly every loan deal struck during China’s economic boom.
“My investors verbally promised that they would not enforce this law, and never have, and that was true in 2017 and 2018 – no one enforced it.” said Ronghui Wang, founder of Neuroo Education, which currently owes investors millions of dollars. Childcare chains received a few dollars in aid after they stumbled during the pandemic.
Although such clauses are relatively rare in U.S. venture investments, Shanghai-based law firm Lifeng Partners estimates that more than 80% of Chinese venture and private equity deals include redemption clauses. .
These typically require a company, and often its founders, to buy back investors’ shares and interest if certain goals, such as initial public offering schedules, valuation targets, or revenue metrics, are not met. Masu.
“If a startup fails, the founders are essentially facing asset seizures and spending restrictions, which is a huge loss to the venture ecosystem,” said a lawyer representing entrepreneurs with multiple debts. A Hangzhou-based lawyer acting as a lawyer spoke on condition of anonymity. “They can never recover.”
In a recent report on redemption rights, Lifeng said it has turned entrepreneurship into a “game of unlimited liability.” The company said founders were named as defendants along with companies in 90% of investor lawsuits, and 10% of individuals were ultimately added to China’s debtor blacklist.
Once blacklisted, it becomes nearly impossible for an individual to start another business. Various economic activities are also blocked, including flying, taking high-speed trains, staying in hotels, and leaving China. There is no bankruptcy law in this country, so it is very difficult for most people to get out of debt.
Chinese funds and venture capital firms are currently struggling to return money to outside investors, with more companies turning to redemption clauses to recover as much money as possible. Lifeng said 20% of all investor exits in 2021 and 2022 were due to companies buying back investors’ shares, with more than 10,000 venture capital and private equity-backed Chinese groups We estimate that we are facing reimbursement issues.
One startup advisor, who requested anonymity, said the situation gives venture capitalists a perverse incentive to pursue portfolio companies that are performing well but lack immediate access to a sale or IPO.
“Venture capital is putting pressure on solvent startups,” he says. “It’s not a venture, it’s a debt.”
The number of entrepreneurs involved in lawsuits continues to grow. Among them is Wang Ziru, who rose to prominence as a brash young founder a decade ago and raised tens of millions of RMB for his technology media and review platform Zealer.
By 2021, as traffic declined, Wang left to take an executive role at consumer electronics giant Gree. And on August 9 last year, a Shenzhen court imposed spending restrictions on the 36-year-old for failing to pay RMB 34 million ($4.7 million) to Ziller investors. This amount had snowballed with interest from the VC’s initial RMB 19 million equity investment. to a lawyer who was briefed on the incident. Wang lost his job a few days later.
The founders are appealing the ruling, saying on social media that they were not informed of the lawsuit and that the redemption clause in the deal was not triggered.
Luo Yonghao, one of China’s most famous entrepreneurs, turned his struggles to pay off debt from his bankrupt smartphone startup Smartisun into a spectacle, eventually paying off enough iPhones and an office with an online video livestream. The 2020 blacklist for selling chairs, paying back suppliers, and removing your name from debtors.
Some of Smartisan’s investors have since demanded that Mr. Luo pay hundreds of millions of dollars more in renminbi for stock buybacks.
“Investment is not a loan,” Luo wrote on the social media platform Weibo in August last year. “When a venture capital deal fails, you have to accept the consequences. Anyone who can’t bear the consequences and resorts to dirty tactics against entrepreneurs is definitely an unscrupulous capitalist.”
The case is being fought in Chinese courts. Records show that Xu Ming-chi lost the company and all other identifiable assets to investors after his material group Egood failed to meet its promised three-year IPO timeframe.
China’s Supreme Court ruled in 2021 that a single investor could seize jointly owned property, including an apartment in Egood’s name, because his wife, Zheng Shaoai, also worked at Egood.
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Wang, 47, the founder of a child care chain, once had the funds in his health insurance account seized by an investor. She said her problems started in 2021. That was when a fund associated with government-backed investor Guangdong Cultural Investment Management asked her to buy back RMB16 million in shares with interest after her startup failed to reach a valuation of RMB500 million. .
Their lawsuit, she said, derailed a funding round needed to cover pandemic-related closures of the group’s 36 day care centers. Mr. Wang currently owes about 30 million yuan to GCIM-related funds and 11 million yuan to banks, and may owe even more to other investors whose redemption clause has not yet been triggered. .
GCIM did not respond to requests for comment.
“I’ve built my company into an industry leader. I have the ability and the drive. But every path I try to take is a dead end,” Wang said. “Due to an unforeseen turn of events, I am completely trapped forever.”
