Q&A: Vitalbridge Capital’s Jinjian Zhang

Q: How difficult are conditions for China GPs right now?

A: Private funding for Chinese companies in the first quarter of 2023 was about half that recorded in the first quarter of 2022. And only one-quarter of that funding was in US dollars, compared to 50% in the first quarter of 2021. The pace of investment has slowed significantly. We’ve also seen a big adjustment in valuations. In 2021, a high-profile spinout from a large domestic technology company could have raised capital at a USD 200m valuation before even building a team. Today, the same founder might get a valuation of USD 40m-USD 50m.

Q: Has Vitalbridge’s investment pace also slowed?

A: After closing our second fund on USD 275m in 2021, we didn’t make any new investments that year. Either valuations were too high, we lost out to other GPs that submitted term sheets before we could complete our due diligence, or companies didn’t meet our minimum criteria. By the end of 2021, LPs were questioning our cautious approach. Entering 2022, the valuation bubble burst and market sentiment turned gloomy, so we started making our bets. Our investment pace has accelerated this year, especially with the emergence of new opportunities around smart hardware and artificial intelligence-generated content. It is easier to identify good entrepreneurs in a challenging environment; they launch businesses based on strong beliefs rather than just trying to catch a market tailwind.

Q: Would you agree that renminbi-denominated funds are becoming more important than US dollar funds in China, given the preference for local listings and concerns about US-China regulatory issues?

A: Managing a renminbi fund requires a different skillset to a US dollar fund. Renminbi funds tend to focus on production and supply chains, while US dollar funds are more about backing innovation and frontier technologies. However, there has been some convergence as manufacturers explore frontier technologies and technology companies prioritise supply chains. I think US dollar funds should focus on areas where there is overlap. That said, as a pure US dollar manager, we have encountered situations where founders only accept renminbi. For example, a digital healthcare company that has accumulated a large amount of patient data might be more comfortable with renminbi even though there are no rules prohibiting US dollar participation in this space. Last year, we applied to the Shanghai government for a QFLP [qualified foreign limited partner] quota, which should give us more flexibility. The pandemic has delayed the approval process, but we expect a response reasonably soon.

Q: How do you help portfolio companies navigate a funding winter?

A: Starting in the second half of 2021, we told founders repeatedly that a downturn was imminent and that they should get prepared. In the first half of last year, we encouraged some companies to push ahead with layoffs. They were very grateful for the advice. A rising market allows businesses to grow very quickly, but sometimes it leaves them bloated, which is unhealthy. With sound management, some portfolio companies broke even on a single-month basis in the second half of 2022, and they might break even across 12 months this year. The best founders can maintain vitality and tenacity in the toughest of times – a trait exemplified by the likes of Steve Jobs and Elon Musk. Some GPs saw founders quit last year; we didn’t encounter a single case. When we back up a start-up, our decision is based on a founder’s vitality, durability, and involvement. These are the key criteria, not their resources.

Q: Some China GPs have responded to the difficult conditions by switching to other markets. Would you ever do the same?

A: I think US dollar funds have picked a lot of very low-hanging fruit in China over the past two decades. It was hard for private companies to access traditional banking financing, so they needed other sources of capital. Today, GPs must work harder to find attractive opportunities. In the movie Jurassic Park, they say “Life finds a way.” Money finds a way, too. Capital gravitates towards areas offering the best returns just as water flows into low-lying terrain. Our job is to find the best returns – the low-lying terrain that will attract water rather than just following the water. The key questions are whether there is still enough growth and innovation in China and whether there are still high-quality founders.

Q: So, what are the prospects for growth and innovation in China?

A: China is still growing and opportunities around innovation are no less than they were 20 years ago. The key growth driver is demand, which relies on two factors: population size and consumption power. China has a population of 1.4bn and per capita GDP is around USD 12,000. The wealthiest 10% earn four times more than that, so there are 140m people on USD 48,000, the same level as Japan. Ten years from now, China’s GDP per capita will be USD 24,000 and the top 10% will be earning USD 96,000, which is where Switzerland is today. Their cumulative spending power will be 15x the current level in Switzerland. At the same time, Chinese entrepreneurs will increasingly tap into growth in other markets. I think Chinese entrepreneurs are the scarcest resource in the world today. They emerged in a fiercely competitive domestic market, which means they are resilient and visionary.

Q: Will policy volatility remain an obstacle for investors?

A: The whole world is becoming more political and there is a tendency to demonise China. At China’s 16th National Congress in 2002, the key takeaways were about opening up, loosening regulations, expanding the middle-income group, and legalising earnings that didn’t derive from labour. The major challenge today is imbalance – there is a widening gap between regions and individuals in terms of prosperity. What we saw at the 19th National Congress in 2017 was a prioritising of even development and a willingness to use regulation to achieve that. The opportunity set changed, and certain areas were no longer viable for investment. That’s why, when Vitalbridge started in 2019, we focused on digitalisation and didn’t touch education – even though that was my area of expertise at my previous firm. [Zhang spent seven years at Trustbridge Partners prior to founding Vitalbridge and made several successful investments in the education space.]

Q: How do you feel about Southeast Asia as an investment destination?

A: We've been following the development of Southeast Asia closely. It has huge growth potential, but unlike China, it’s not a unified market. There are 11 countries with their own languages and cultures. We’ve seen a lot of Chinese companies build factories in Southeast Asia, and they treat the region as a second manufacturing base and sometimes as a target market for products. It is an exciting trend, but we are waiting for the right time to bet on it. What we are interested in right now is Chinese technology start-ups serving domestic companies that are expanding into Southeast Asia. They are providing services such as payroll management, tax planning, outsourced labour, and even data compliance to these companies. That is more interesting to us than the development of Southeast Asia itself. We saw a similar phenomenon when US companies started going global.

Q: Are US dollar investors re-engaging with China?

A: I can only speak for Vitalbridge, but yes, we are seeing that. The number of LPs reaching out to us is rising, whether that is emails or site visits. We’ve received enquiries from some large Japanese LPs, which hasn’t happened before. Meanwhile, our US-based LPs are now introducing us to other LPs that might be interested in our strategy. I don’t find they are pessimistic on China; on the contrary, they are optimistic about the growth opportunity.

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• Topics
• Greater China
• Southeast Asia
• Technology
• Early-stage
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• Regulation
• China
• Vitalbridge
• TMT