The landscape of the venture capital (VC) and private equity (PE) industry is undergoing a significant transformation, propelled by various market dynamics and regulatory factorsAs of the end of 2024, data from the Asset Management Association suggests a contraction in the number of registered private equity and venture capital fund managers, down to 12,083 from 12,893 in 2023, marking a year-over-year drop of 6.3%. This startling decrease hints at the underlying challenges faced by players in the market.

The essence of these struggles lies in the increasing difficulty of fundraising in the primary market alongside the introduction of stricter regulatory policiesThese changes have significantly heightened the expectations for compliance and professionalism among fund managers, leading many smaller institutions to exit the market as they find themselves unable to adapt to the new standards

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The stark reality is that the industry is not just shrinking in terms of participation, but it is also being reshaped in ways that require adaptation and innovation from its remaining players.

Many industry observers acknowledge that the VC/PE landscape, especially in the A-share IPO context, is shifting from a heavy reliance on public offerings to a more diversified exit ecosystemThis ecosystem encompasses various strategies such as activating merger and acquisition (M&A) funds, secondary market investment funds known as S Funds, and options for transferring existing sharesWith these alternative exit routes, there is a concerted effort to build a healthier cycle of fundraising, investment, management, and exit strategiesIndeed, it is a sign of maturity within the market that stakeholders are actively exploring multiple avenues for returns.

One notable initiative in this evolving environment is the "Star Picking Program" recently launched by Zhang Jiang, the founder and CEO of LongRiver Investment

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This plan targets acquisition opportunities in the medical and technology sectors, aimed explicitly at providing early investors with exit channelsBy assuming the stakes from existing shareholders, this program alleviates the buyback pressure on founders while simultaneously presenting LongRiver with valuable investment opportunities in quality enterprises at lower costsSuch innovative strategies are essential to navigate the prevailing market conditions.

However, the challenge of exits remains one of the most pressing issues in the VC/PE sectorAs disclosed by data from Rongzhong, the tightening of IPO audits in 2024 resulted in a dramatic drop in approval rates, which plummeted to just 9.3%. Throughout the year, a total of 422 companies withdrew their IPO applications, and 15 were terminated, highlighting the growing scrutiny from regulators regarding profitability, compliance, and sustainability

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Many companies unable to meet these standards have been forced to abandon their IPO aspirations, further aggravating the woes of fund managers seeking to realize returns on their investments.

The contraction of exit routes through IPOs directly impacts the efficiency and returns for VC/PE firmsA mere 100 companies succeeded in going public in 2024—an alarming decrease of 68.05% from the previous yearThe total amount raised in these initial offerings dwindled to 67.35 billion yuan, just one-fifth of the capital raised during the same period in 2023. These numbers starkly illustrate the broader trend of diminishing exit value and revenue levels for private equity and venture capital firms.

The growing difficulty in exits underscores a troubling trendFor many investment institutions, IPOs were traditionally the primary exit strategyThe shrinking of this route compels firms to seek alternatives such as M&A exits, equity transfers, or secondary market trading

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However, the return rates associated with these alternatives often fail to compare favorably to those previously associated with IPOs, thereby compounding the pressures felt by the industryZhang Jiang has voiced concerns over these limitations, emphasizing the need for a robust exit mechanism that could mitigate the existing blockagesTo address this, he advocates for enhancing listing systems, streamlining M&A processes, and fostering the growth of S Funds.

In light of the persistent challenges, several investment firms are adapting by exploring diverse exit pathways as a strategic response to the adversities facing the sectorRecent policy changes, such as the introduction of the "Seventeen Measures for Venture Capital" and the "924 New Policy," have revitalized the M&A market, although activity in this domain still hasn't returned to peak levels.

Additionally, there has been an uptick in the participation of state-owned capital in the market

According to statistics from the Zhitong Research Institute, several state-owned capital managers are now collaborating with public corporations and local state-owned enterprises to establish industrial funds aimed at increasing investments in acquisitions and non-controlling stakesBy the third quarter of 2024, transactions involving non-controlling acquisitions and M&A accounted for 16.86% of all activity, signaling a shift in investment strategies.

Moreover, aside from M&A routes, Chinese VC and PE firms are increasingly turning to S Funds as a means to stimulate liquidity in the primary marketZhan Zheng, Vice President of Hanling Capital, believes that S Funds have substantial growth potential in China and can serve as patient capitalHowever, he stresses that these funds must offer regular liquidity solutions and not merely focus on discounted transactions.

The "Star Picking Program" exemplifies this strategy by focusing on medical and technology fields that are experiencing a pressing need for early investors to liquidate their holdings

Zhang Jiang explains that his firm will actively take over these older shares, which inevitably leads to a win-win situation for both parties: early investors can finally achieve tangible returns while enabling LongRiver to acquire promising ventures with stable income streams and reasonable valuations, thus diversifying their portfolio at attractive discounts.

While it may take time to resolve the challenges surrounding exits, industry observers like Zhu Shan from Rongzhong anticipate that the fundraising difficulties could ease slightly by 2025. The expected uptick in investments from financial asset management companies (AIC), insurers, security firms, and state-owned enterprises into private equity is a ray of hope for the industryThis year has also highlighted a shift encouraging venture capital funds to adopt a parent-subsidiary investment model, promoting the reduction of reinvestment ratios and emphasizing market orientation, which is anticipated to provide a renewed flow of capital into the market.

The prevailing sentiment in the industry is a foreboding one