Winter is coming, but will it be a “capital winter” or the winter of discontent for Chinese startups? China’s startup ecosystem has earned a reputation of fast rises and hard landings: during the last two years, sky-high funding rounds and valuations for less-than-ideal projects have made (over)saturation of companies and business models the new normal.

In April 2016, venture capitalist Kaifu Lee noted that a “capital winter” is just what the doctor ordered for China’s bloated tech industry. Since then, the market has been entering a slower and more rational phase.

“China’s startup industry has experienced both the so-called ‘capital bubble’ and ‘capital winter’ in the last year. However this year I see more pragmatic entrepreneurs who are getting better [in their] knowledge of entrepreneurship,” said Lee.

However, a new report released by startup database IT Juzi (IT 桔子) and Tencent News has offered a different diagnosis for the changes in China’s startup landscape. The “2017 Semi-annual Report: China Venture Capital Trend” shows that in the first half of 2017, the number of new startups in China has experienced a sharp downfall of 74% compared with the same period last year.

Screenshot from China Tech Insights.

Image credit: China Tech Insights

VCs, however, have remained active but are forming a more risk-averse funding environment. The biggest number of deals in H1 was in angel and A rounds, but companies in other rounds of investments, including strategic investments and IPOs, have raised the same amounts of funds. H1 also saw the fewest financing rounds of RMB 100 million or more compared with previous years.

Image credit: China Tech Insights.

Image credit: China Tech Insights

Explaining the results of the new research, CEO of IT Juzi Li Jingwang told TechNode that the winter China’s tech scene is facing is not a winter on the “capital side”—it is a winter on the “asset side,” or the startups themselves.

“The number of investments in the first half of 2017 remained in decline compared to the same period of 2016 and 2015, but the decline is mostly in the early stages of investments (Series A and Series Pre-A),” said Li. “Investments are still active in middle and late stages of investment. At this point, entrepreneurs might feel that financing is not good, but looking at a number of investments, it continued to grow since 2015 and 2016 till now. It’s just that a large amount of financing is concentrated on a smaller number of companies—20%. They get 80% of financing on the market.”

Li added that the amount of money available now for venture capital is still abundant but there are too few quality startups that are leaders in their field. This means that a small portion of leading startups end up getting more money while the majority remains in the “winter”.

What the future brings for Chinese startups

The current trends show that Chinese entrepreneurs will have to work harder to attract funding. As for future of venture capital in China, Li said that IT Juzi has several views on upcoming trends:

  • The capital bubble in the primary market still needs to be popped. Financing will not be easy during the next 6 to 12 months, but the coldest (and most hopeless) era has not yet arrived.
  •  Valuations of companies that are leaders in their fields are too high, and valuations are even higher compared to the secondary market. If these companies choose to go public or merge in the future, their valuations could retract or go through a down round (a round of financing that values the company at less than the previous round).
  • Financing outlets and hot industries are still concentrated in two directions. One is consumption upgrade-driven e-commerce, new retail, culture, and entertainment, educational and medical services. The other is technology-driven enterprise services, artificial intelligence, big data, cloud computing, and SaaS. IT Juzi believes there are still a lot of investment opportunities among these.
  •  When it comes to investment institutions, in the next 1-2 years, there will be a lot of pressure to “exit”. They will pay more attention to how to operate capital and exit while enthusiasm for investing in new companies will decrease. Furthermore, a portion of new post-2013 funds may not have the next phase.

What’s hot and what’s not?

Trends in popular sectors have also gone through changes. During H1, entrepreneurs were mostly going into the enterprise services, culture and entertainment, and e-commerce sectors. On the other hand, e-commerce, finance, hardware, and healthcare have been dwindling in popularity. Most startups in the e-commerce sector have died.

Image credit: China Tech Insights

Image credit: China Tech Insights

The hottest sectors sought after by VCs were also enterprise services, although cars and transportation raised the highest amounts—RMB 90.5 billion. In enterprise services, companies building IT infrastructure such as cloud services were the hottest while fresh food gained a lot of traction in e-commerce.

Image credit: China Tech Insights

Image credit: China Tech Insights

The newest trending sectors were artificial intelligence—especially AI robots, computer vision, and natural language processing—as well as the sharing economy where bike, power bank and space rental got the most deals. The success of these emerging industries was demonstrated by Toutiao in AI and Didi in the sharing economy which achieved impressive results in terms of funding.

Looking at the financing rounds in industries, most sectors were in their early stages. According to the research, fewer chances are available in real estate, finance, travel, automotive and transportation, healthcare and gaming, because they develop relatively faster. There are still big chances in 12 other sectors including local life services, e-commerce, utility apps, advertising and marketing, education, and agriculture.