In the eyes of a VC entrepreneur, the real venture capital market

Author|Brother Spear

Source: Chang Lai Capital (ID: conswall_cap)

-Epigraph-

"Dead trees are forced to bloom before they sprout

Mom said she wanted to be happy, but she didn't tell me how

VC: It taught me that failure is not terrible

It's scary that you still believe this sentence"

Halfway through 2024, the venture capital industry has once again reached a watershed.

As mentioned in our previous article (2023, a watershed for VC investment), if we say that after 630 last year, the exit of US dollar funds in China was basically determined (there are external environmental impacts, as well as the subjective wishes of investors); At present, China's venture capital market is undergoing a new round of painful transformation.

In the past few months, I have had the privilege to participate in research and discussion sessions conducted by the State Council, the National Development and Reform Commission, the Ministry of Science and Technology and other departments. But there is still a process to go from finding a problem to solving it.

As a result, we have seen that in the past two weeks, various ministries and commissions of the state have expressed their attitudes and determinations towards the current venture capital market through different occasions, and have also issued notices and guidelines. But the restoration of confidence is not by shouting, and everyone is waiting for the implementation of specific policy details. It may take a little more time, because there is an important meeting ahead: the Third Plenum.

For the current environment, complaining and complaining will not solve any problems, as an entrepreneur in the prime of life, but also stick to the venture capital industry, today I will also throw bricks and jade, and do some discussions with you.

01 Arbitrage, the essence of finance

In fact, China's local VC venture capital has never really experienced early investment and small investment.

Some practitioners may be indignant, our organization has insisted on investing early and investing small for many years; Then I would seriously ask rhetorically, has your organization really made money at scale over the years? Your institution may be just a drop in the ocean of China's local venture capital market.

Looking back at the development of China's venture capital market over the past 20 years, there are two waves behind the success:

1. The overall rapid growth of the economic market

2. Continuous reform of the capital market

Note that the first article above refers to the overall rapid growth of the economic market, not a partial, which is the lowest logic.

On this basis, there are constantly good seedlings to thrive, and the first half of the reform of the capital market (05 years of non-lifting of the ban, 09 years of the launch of the gem), has achieved remarkable results, and the effect of wealth creation has emerged.

However, every time the capital market is reformed, the original intention of the state has never been to create wealth.

The picture above is a microcosm of the financing of local startups in China, and it is normal for a Chinese company to usher in the first investment in the real sense after 5-8 years of establishment.

Looking back at the first wave of GEM listings, local venture capital VCs have become the catalyst for this wealth-creating effect, but they have not actually participated in much reaction, nor have they given charcoal to the real industry. It's just that because the overall economic market was growing at a rapid pace at that time, various industry sectors were blooming, and investors were making money.

Let's take a look at the second half of the capital market reform, that is, the launch of the science and technology innovation board after 2019.

At this stage, it is no longer the overall rapid growth of the economic market, but a local growth effect, which actually buries hidden dangers.

Short-term policy encouragement and substitution effects have made the performance of some hard technology companies explode rapidly, but when there is a problem with the terminal demand of the industrial chain, the seemingly local high growth, once the time is extended, many companies have been beaten back to their original shape, and the so-called specialized, special and new stocks have instantly become micro-cap stocks.

Let's take a look back at a number of highly representative companies that have been listed on the Science and Technology Innovation Board in this round; Some of them sprouted in the 02 special project, and some of them sprouted in the Chinese semiconductor manufacturers who returned to China after 08 years. For the above-mentioned companies, local venture capital VCs did not participate much in the early stage of their entrepreneurship, and to be honest, everyone couldn't see it clearly at that time, and they couldn't understand it. On the contrary, state-owned capital is the earliest sponsor of these hard technology enterprises, helping them to achieve from 0 to 1.

Whether it is early investment or investment in technology, everyone has just begun to practice local mainstream VC venture capital.

In the past few years, if we have to say that China's local VC has begun to invest early and hard, then commercial aerospace, domestic computing power GPU, and domestic large models may be a real start.

The data comes from IT Orange's "Analysis Report on the Financing Mileage of China's Listed Companies in the Primary Market", which can be obtained by copying the link https://cdn.itjuzi.com/pdf/bc6bf43dda3a37e8317de637e5f38a06.pdf.

The figure above is a statistical analysis of the IPOs of Chinese companies in various markets in the three years from 2020 to 2022. We see that even in 2020, nearly 80% of A-share listed companies still raise less than one time before the IPO. Over the past two decades, China's local venture capital VCs have been more of a catalyst for the most part. They rely on their keen sense of smell and interpretation of China's local capital policies to earn the difference between the primary and secondary markets, and what they do is actually arbitrage.

Arbitrage is actually a neutral word, and it is precisely with the behavior of arbitrage that the deviation or underestimated value will quickly return to a reasonable range; This allows for quick fixing of loopholes in pricing and policies, as well as a quick standout for valuable assets.

Arbitrage is the essence of finance, and it is also an important internal factor to complete the financial closed loop.

$02 funds are also arbitrage

The U.S. dollar and the Internet are the first practitioners of China's local venture capital market, investing early and investing small, but they have actually been doing arbitrage.

After the bursting of the NASDAQ bubble in the millennium, the Internet quietly entered China from Silicon Valley.

In the past few decades, for Americans, although there is a bubble in every wave of technology, it may be accidental or fateful, and they can always usher in the darkest moment of technological maturity when the bubble bursts. As a result, over the past few decades, Silicon Valley VCs have developed a strong belief in technological innovation. Every time a technology matures, it means that all industries deserve to be redone.

After 05 years, with a belief in technology, US dollar funds began to quickly enter the Chinese domestic market.

Then began the golden age of the next decade.

The highlight moment of a number of Chinese concept stock companies listing in the United States also confirmed that China's local policies were not in sync with the development of national conditions at that time; Of course, this is still the case today.

But looking back at the logic of the dollar fund's golden decade of making money, the answer is still arbitrage.

In hindsight, dollar funds are making growth money in the Internet era, because they bet on an epic track. But looking back on this history, the essence of their ability to make money comes from their understanding and expectation of the U.S. capital market. With the same income and the same daily active users, there is a fair pricing in the U.S. market, and they follow this formula and copy it in China to complete the closed loop of making money. Perhaps they never realized that once China's demographic dividend was activated, it could burst out with such great energy.

The above highlight is also accompanied by a unique phenomenon, that is, the time period for US dollar funds to obtain high returns in China is very short. From the establishment to the IPO in the United States, the average time for Chinese concept stocks to be listed in the United States is about 7 years, and the fastest or even 3 years can be realized. Therefore, the general impression of Chinese people on VC is still stuck in: the time is very short and the income is very high. If we look at the time, we will find that in the past 30 years, for Chinese companies, the short and fast has not been the norm.

Even so, for a USD fund to perfectly implement the closed loop described above, it needs two prerequisites:

1. It must be based on the premise of a huge demographic dividend, otherwise the story will not make sense

2. The trend of globalization is accelerating, and China is accelerating its integration into the world, whether it is the capital market or the industrial chain

Based on the above conditions, Chinese concept stocks have found a place between China and the United States, but the underlying logic of making money is arbitrage.

03 Trapping is the current status quo

When the preconditions for arbitrage are gone, all that remains is deep lock-in.

As a result, the venture capital market is no longer circulating.

A lot of people used to talk to me, and they would think that the dollar fund was more patient and showed a higher pattern. I usually follow up with the question: Why? The answer is usually uniform: because US dollar funds have a longer duration. So, I've heard a lot about patient capital lately.

The long duration of US dollar funds is only a superficial phenomenon. In the past few decades, there are two very important underlying logics for the long-term success of US dollar funds in Silicon Valley:

1. Their belief in technology and long-term consistent expectations

2. Almost every ten years, new technologies can indeed lead a new wave of industries. As long as your fund lasts for about 10 years, you can get at least one chance to get enough dividends

This is the essence of the continuous survival of VCs in Silicon Valley.

So I would like to ask, what is the belief or consensus expectation formed in China's local venture capital market over the past two decades?

The answer is simple: arbitrage, or arbitrage.

Simply shouting the slogan of patient capital and encouraging everyone to take a long-term view will not solve any problems.

In China's local venture capital market, there was once a handful of investors who believed in technology, but they were eventually looted by the reality of "pseudo-technology" and frequent policy adjustments. They also showed patience and kept telling themselves that this time was different, but they found that it was not different.

Poverty is not socialism, and not making money is not the core of the capital market.

04 This time it's really different

Nowadays, the most heard slogan in the venture capital market is: invest early, invest small, and invest in technology. Let's take a look at the main players in China's local venture capital market.

We have seen that in this round of economic cycle, governments at all levels, from the central to the local, are firmly determined to innovate in science and technology, incubate early, and move from virtual to real. This attitude and determination once reminded us of Chinese football in the past few years.

Regarding Chinese football, we once tried to revitalize campus football from the baby; At one point we spent a lot of money to build our own professional league; At one point we naturalized a group of high-quality players.

On June 25, Beijing time, Luo Guofu, a 36-year-old former naturalized national football player, announced his retirement

A week ago, Lo ended his 18-year career. Four years ago, we spent 130 million yuan to naturalize him as a Chinese citizen, and then he played 5 games for the national football team, scored 1 goal, and then there was no more.

This scene is very similar to the current government investment promotion. Many times, the government tightens its belt, squeezes out money from the treasury, spends a lot of money, but attracts a bunch of tech scam companies, and in the end, it is a chicken feather.

In the past, state-owned assets of governments at all levels successively went to Hefei to visit and study, learn the courage of Hefei production and investment, and learn their cognition and layout of the industry.

But they are all confusing two words, epoch and cycle.

What's the difference?

There are peaks and valleys in the cycle, and if you are patient, wait a minute, it is not a big problem.

But if the times have changed, then the entire underlying logic has changed, and you are still waiting in place, just like carving a boat for a sword, you will definitely be eliminated.

In the last cycle, the Hefei government embraced panels, semiconductors, and new energy vehicles, and achieved Feifan's success. Nowadays, if the governments and state-owned assets in various places do not fully understand the changes of the times, do not think clearly about their own advantages and characteristics, and just blindly repeat the actions of the former with courage and funds, the outcome will be tragic.

The country firmly puts forward the guiding principle of investing early, investing in small, and investing in science and technology, which is a very correct decision in itself, and it is also the road that must be taken in order to cope with the current complex international situation. But if you want to go well on this road and not go astray, patience alone is far from enough.

There are also a series of problems waiting to be solved.

For example, can the fault-tolerant mechanism and financing policies of China's capital market make entrepreneurs with real ideas and ideals dare to start a business?

For example, whether the theoretical research and scientific experiments being done by our universities and research institutes can not be disconnected from the current cutting-edge scientific and technological innovation and industrialization, so as to truly realize the close integration of production, learning and research.

Another example is whether our state-owned capital has matched venture capital in terms of investment decisions and performance incentives

Another example is whether our capital market has formed a multi-level exit cycle and trading mechanism, so that the capitalization of technology can be coherently closed-loop, so that investors can form relatively clear and consistent expectations.

In many cases, only when the underlying problems are thought out clearly, and the right medicine is truly realized, will it not become a slogan to invest early, invest small, and invest in technology.

05 Economic development needs to be focused, but it cannot be unbalanced

In different periods of national development, the government needs to tilt and support certain industries according to national conditions.

However, this tilt and support cannot be premised on sacrificing other industries.

The picture above is a complete summary of the new quality productivity given by the official, and it is also a propositional essay given by this government. New quality productivity is also the word that has been mentioned the most in recent times,

Today, what China's local VCs should invest in is basically in the box in the above figure.

For the industries listed in the above figure, I raise my hands to agree, it not only represents the cutting-edge process of the world's science and technology, but also summarizes the current industrial characteristics of our country.

But if the industry you are in today is not in the box in the picture above, then unfortunately, everyone should not be doing well, but these not so good industries may be the basic market in China at present.

Of course, China's industry needs to be transformed and upgraded, but the upgrading of the industry is not a one-size-fits-all involution, and we must leave a little time for transformation.

The economy is a cyclical body, and the fact that several industries have fallen does not mean that money will pour into the remaining ones. The reality is that once several industries come to a standstill, the cycle of the economy may suddenly break down.

As we can see from the graph above, the goal of the national vision is perfect. The central government guides the financial sector to turn to science and technology innovation, and uses science and technology innovation to drive the industry, so as to realize the transformation and upgrading of China's industry in this round of economic cycle. However, the current situation and the data presented are not the same as originally envisaged.

Because development is by no means simply local.

We imagine that if every industry is thriving, then the practitioners in the industry can make money, and these people will form a consistent expectation for the future, and if this expectation is positively optimistic, they will dare to spend. And then continuous consumption, which will drive the development of other industries, because there are more people willing to pay.

If all industries are developing well, it means that companies in the industry have surplus funds for new product experiments, and will increase investment in new technologies, rather than what they see at the moment, reduce costs and increase efficiency.

This virtuous economic cycle itself will accelerate the commercialization of new technologies. After all, it is still too limited to rely only on government subsidies to promote technology, and at the beginning of the birth of a new technology, it is still difficult to cover the cost of new introduction in the short term.

Social progress and economic development must come from everyone's yearning for a better future and quality life, rather than today's consumption downgrade.

The figure above is a recent survey conducted by McKinsey on Chinese people, according to the figure above, the population is divided into five categories:

G1: People aged 58-65 in first-tier cities, the beneficiaries of the first generation of reform and opening up

G2: Middle-aged and elderly people in third-tier cities; G3: The current post-00s; This group of people or the parents of this group of people rely on real estate reserves to complete the original accumulation, and the safety cushion of life is relatively high

G4: Young adults (26-41 years old) in first- and second-tier cities, they are the fuel of the times

G5: Middle-aged and elderly people in rural areas (42-65 years old) have never gone out of the countryside and have not felt the dividends of the times

It is worth noting that the main group of the current venture capital market is highly consistent with the G4 crowd......

Consumption does not need to be encouraged. If everyone's disposable income continues to be abundant and they are hopeful about the future, who wouldn't spend?

Recently, there is also an interesting finding that although the overall profitability of the last wave of Internet giants is still far from the peak before the epidemic, in 2023, they have shown high year-on-year growth. It should be noted that these Internet giants, as an important private force in the venture capital market, have invested a lot in the current hard technology (GPU, large model).

Every reform policy launched by the state is based on the established goals, adapts to the current national conditions, and keeps pace with the times.

The ultimate purpose of the operation of the state must be: the country becomes stronger; People have become happier and hopeful for the future. The two should work together in harmony, not at the expense of one or the other.

Similarly, the secondary market is sluggish, and many people blame it on the diversion of funds from IPOs. This is essentially a problem with the economic base or underlying demand, and we should find a solution to the problem from first principles, rather than simply giving way to the secondary market in the primary market. Without a healthy primary market, truly innovative enterprises will lose the soil for growth, and it will be difficult for the secondary market to achieve truly high-quality growth in the future.

Of course, in the process of development, the gap between the rich and the poor must also be taken into account.

After all, wealth creation is only a product of the process of economic development and the market economy, but it has never been the ultimate goal of the state.

06

One more thing

Is your fund still investing?

This year's venture capital market is indeed relatively sluggish, and for VCs who have not yet been lying flat, their focus is only on a few things.

Startups in China were previously divided by tracks; In the next few years, it will be more divided by function, and they will be broadly defined as the following two categories:

1. It can be capitalized

2. Business dividends

Recently, I've started to rethink the phrase: "Stick to what is hard but right." ”

I always felt that something was wrong, but later I found that the chicken soup was still a little poisonous.

First of all, the vast majority of people can't do difficult things, let alone work hard to accomplish them.

Second, what is the right thing to do at a given time? The vast majority of people don't know either, and most of them just go with the flow.

Instead, I prefer to be realistic, or follow the trend as a guide to action.

Many of the so-called difficult but correct are just a review of different people's endowments after they hit the general trend and succeeded.

Yesterday I chatted with a CEO who has done a very successful job, and every time we discuss it, we will have new inspiration

He said: Ah Mao, you see that the success of an enterprise looking for the second curve is mostly after the foundation of the first curve matures, and gradually crosses and finds the second curve model;

Instead, the old business can't do well, and you hurriedly switch to another business, the so-called rush to the doctor.

Sometimes finding the second curve fails and it's not the second curve problem, but the enterprise itself, and I agree with that.

In the past few years of entrepreneurship in the VC field, I also have my own personal feelings:

1. Be open and tolerant of anything, but grasp the essence of the problem;

2. Make a good prediction in advance, whether it is investment behavior or daily work; This kind of prediction needs to be trained, and after repeated training, the probability of making the right choice will increase;

3. Keep iterating, constantly correct your wrong views, and constantly self-criticize.

Over the years since I started my business, I have been drinking American style, and I gradually lost my awareness of suffering.

I accidentally bought a cup of milk tea last week, and I felt really good, and I felt younger in an instant.

Many times, the hardships of life are inflicted on oneself.

The venture capital industry is still accelerating its adjustment, but it always needs a group of people to stick to it.

In 2024, we are still on the road......

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