The chart that made my jaw drop

THE CHART EVERYONE IS TALKING ABOUT

In my social circles, there was a chart that began circulating like crazy last week.

I am 100% serious when I say that my jaw dropped when I first saw it.

I’ll paste it below, it depicts the number of venture-backed startups founded in China from 2008-2024.

There is no way to spin this - it is an absolute implosion of the venture ecosystem in China.

And the reasons behind the collapse are so wild that they’re hard to believe.

After a 2018 peak of 51,302 startups, 2023 figures dwindled to just 1,202 - a staggering 97.7% decrease. 

2024’s partial data somehow offers even less hope - just 260 startups have been founded thus far.

That puts it on pace to come in at ~400 VC-backed startups.

In a burgeoning nation of 1.4B people, that equates to just one VC-backed startup per 3.5M citizens.

To contextualize that with the United States, one VC-backed startup was founded for every 107,419 citizens (33x more).

WHERE DID ALL THE STARTUPS GO?

This is both a simple, yet complex story. I’ll attempt to pull some threads together to illustrate what’s going on in China right now. 

To put it simply, doing business in China has had bad bad vibes for the past 5 years.

Business leaders routinely go ‘missing’, which usually means the government has whisked them away for interrogation.

IPOs have been halted by regulators mere days before trading was set to begin.

In general, doing business in China has become increasingly difficult amid the government’s crackdown on entrepreneurs’ freedoms.

Xi Jinping has become the nation’s dictator - or as timid news organizations will say, ‘lifelong leader’.

As a dictator, it is important for Xi to eradicate any threats to his rule - especially those that come from within.

Xi has kneecapped any private sector leaders who don’t tow the party lines, opting to build-up public sector industries that the government has full control over.

As a result of decimating the private sector, the country became un-investable.

Foreign money pulled out, favoring safer options like the United States & Europe.

This started the domino effect - when foreign money was sucked out of the system, the remaining LPs (entities that give money to VC firms to invest) largely consisted of local government.

In fact, it’s estimated that 80% of available capital in China now comes from state-run entities.

VC TO PRODUCE RETURNS….OR ELSE

VC firms are tasked with earning a return for their LPs by investing their money into startups.

When your LPs are pension funds, individuals, and private entities, losing money is unfortunate.

When your LPs are the Chinese government, losing money is unacceptable.

To protect themselves, many VCs in China included predatory investment terms in their deals.

Many now require startup founders to buy back shares of the company if they do not get acquired or IPO by a certain date.

A scenario that is playing out for startups in China goes something like this:

• VC invests $2M in Startup X, requires payback/exit in 2 years

• Startup X spends the $2M to grow so that they can exit

• Startup X is unable to IPO/exit because the government has kneecapped the private sector

• Startup X is obligated to pay back $2M, but they no longer have the money because they spent that money to grow

The icing on the cake is that in China, many startup founders are personally liable to pay back these investments.

This means that the VCs can seize your home, and any other assets you own.

In America, we incentivize risk-taking through limited liability corporations (LLCs). The ‘limited liability’ part means that a founder’s personal assets are not taken if the company fails.

China has this structure as well, but it is more commonplace to include personal liability investment terms that put founders and their personal assets on the hook .

One of the leading Chinese VC firms has filed 41 lawsuits since 2023, of which 35 were against companies that had largely failed to go public by a set date (and had not repurchased shares bought by the VC).

Here’s an excerpt from the Financial Times that illustrates how bad it’s gotten in China:

Another executive added:

The FT article goes on to say that many Chinese investment strategists have been laid off and replaced with lawyers specialized in enforcing payment terms.

Many founders who cannot repurchase the shares have fled the country, leading VC firms to enact even more restrictive terms to mitigate this risk.

It’s a sad scene. There are now two paths that Chinese entrepreneurs can wind up on, neither of which are particularly appealing:

1. Have your business fail and you & your family become personally liable to pay back investors

2. Have your business succeed and face being kidnapped/hamstrung by your government

People in China have extremely little incentive to start a company given these two outcomes, but that is where the country is right now.

The Chinese startup ecosystem is getting pinched from both sides of the equation:

(1) Funding has dried up as foreign investors flee

(2) Startup creation has ground to a halt given the high degree of risk

The Financial Times story has not gone without pushback - critics want to make clear that the chart is only representative of venture-backed startups.

This is true, but this story isn’t about China’s ability to open a new mom-and-pop restaurant in your neighborhood. It’s about global competitiveness and China’s ability to foster great businesses.

China’s done a great job lifting millions of their population into the middle class, but they did that in part by letting homegrown companies like Alibaba, Tencent, and WeChat grow.

It did such a great job that it convinced me to invest in Alibaba stock as far back as 2019 - scenes from China at the time were of opportunity, not government crackdowns.

Now that private sector has become a potential threat to government rule (at least as Xi Jinping sees it), China has turned its back on what’s driven their recent success.

America on the other hand has produced countless numbers of impressively successful companies, with a healthy VC-ecosystem playing a large role in the process.

It’s a simple concept that more ‘funded shots-on-goal’ will yield more successful global companies.

And although you can build a large successful corporation through bootstrapping, this is typically the exception and not the norm.

HOW THIS APPLIES TO YOU

As an investor, you need to assess all factors that can impact the startup you’re evaluating.

And this story underlines the effect that government can have on a startup.

The US government is more pro-business than China’s but can still hugely impact companies through regulations & tax policies.

I wrote about which president is better for your startup portfolio here if you want to take a look at that.