Banking & Finance

A city of unicorns?

Shanghai to reimburse venture capital losses


Old Shanghai wants new start-ups

Finding a unicorn is never easy – although the North Koreans announced they had done so four years ago. This news emerged after they located the final resting place of a horned-beast once ridden by King Dongmyeong, the founding monarch of the Goguryeo, an ancient Korean kingdom. Scientists said they were able to ‘verify’ the grave – close to the capital Pyongyang – because the words ‘unicorn’s lair’ had been scratched onto a nearby rock.

The Shanghai municipal government, on the other hand, is more interested in breeding corporate unicorns (start-ups whose valuation exceeds $1 billion). In a bid to encourage more investment the government’s Science and Technology Commission recently announced a compensation scheme for venture capital (VC) investors who make losses from their seed and early-stage investments in Shanghai.

The new scheme is scheduled to run for two years. Eligible investors can apply for refunds if they realise annual investment losses up to a maximum of Rmb3 million ($461,140) per project and Rmb6 million per institution. A second cap limits compensation to a maximum of 60% for a seed stage financing and 30% for an early stage financing.

The government hopes the new scheme will turn Shanghai into a more vibrant tech hub to compete with Shenzhen (which has been reinventing itself as China’s Silicon Valley) and incentivise investors.

(Recent figures from Chinese data provider Zero2IPO show that while overall VC investment climbed 25% to $19.7 billion in 2015, it plummeted during the fourth quarter, dropping 44% by value from the quarter before.)

Shanghai’s VC industry has responded to the new policy with a mixture of incredulity and criticism. While applauding the government’s good intentions, they say it will do more harm than good. In one of its stronger editorials, Caixin Weekly concludes the policy will only “reward failure and turn the incentive mechanism upside down, creating moral hazard”.

Its warning appears to be vindicated by comments from Gui Yonggang, the founder of an O2O (online-to-offline) hairdressing services provider. He tells 21CN Business Herald: “All my friends are discussing how they can arbitrage loopholes in this policy.”

Some VC industry insiders critique the use of taxpayers’ money to bail out bad investment decisions. “Matching risk and return is a fundamental market principle. The negative consequences of using public money to compensate investment losses will be unimaginable,” Andrew Yan from SAIF Partners tells Caixin Weekly.

Bloomberg says the policy reflects a planning mentality and that a level playing field is more likely to be effective: “Entrepreneurs need the certainty they’ll be competing against one another, not bureaucrats”.

Hairdresser Gui thinks Shanghai lags behind other cities. He says it is far easier to source funding for his businesses from Beijing, Shenzhen and Hangzhou. Likewise the country’s three big tech giants (Baidu, Tencent and Alibaba) hail respectivelyfrom the three cities.

However, Shanghai is not without its own unicorns. It hosts two of the top 10 ranked by Forbes – fintech company Lufax and restaurant reviewer Dianping, which merged with Meituan last October. Other notable start-ups include online discount provider Fanli and lender China Rapid Finance.

The Chinese press says Shanghai should concentrate on creating an attractive investment environment through tax breaks, as well as making land and office space available.

But Shanghai does have two key aspects in its favour.

Firstly it has strong academic institutions that provide the kind of research, networking opportunities and stream of eager graduates that start-ups rely on.

Secondly, the city’s sheer dynamism makes it an attractive place to live and work.

A Harvard University study concluded that three quarters of VC-backed firms in the US do not return investors’ capital. The Chinese press say this ratio – if replicated in Shanghai – could cost the local government dearly.

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