Series C crunch will leave hundreds of Chinese startups without funding in 2015, says local VC

Startups in China raising series A and series B rounds found it exceedingly easy to secure funding in the past two years. Evaluations skyrocketed and early stage startups repeatedly made headlines with their "tens of millions of dollars" in investment. It happened so often we couldn’t keep up with writing about them all.

But the fortunes of all those startups lucky enough to fundraise in an overheated market are about to change, according to one prominent investor. Ran Wang, founder of Chinese venture capital firm ECapital, earlier this week published an article in China’s Entrepreneur Magazine that predicts tough times ahead for growth-stage startups in China.

90 percent of those startups who soared through their series A and series B rounds will not be able to raise series C rounds, Wang writes. Here’s his logic:

In 2014, according to Chinese startup database ITJuzi, 812 companies received seed stage rounds, 846 got series A funding, and 225 got to series B, and 82 reached series C. And those are just the ones that reported their rounds.

The time between series A and series C for many startups in the country is less than one year. To match or improve on the sky-high series B rounds, those startups each need to raise anywhere from US$30 million to US$200 million.

Unfortunately for all those companies at A and B stage, the number of C stage investments hasn’t kept pace with the early stage rounds. Wang says that about 1,000 of these companies will seek series C funding in 2015, but the number of series C rounds probably won’t exceed 100. That leaves 90 percent – 900 companies – without VC capital to keep them afloat.

To make things worse, most of these startups aren’t earning much revenue yet, and many don’t have established revenue models at all. They will face what Wang calls "the C round of death."

Told you so

Back in November, Wang warned of an impending downturn in China’s startup ecosystem. He advised startups that were considering raising funds to do so while they still can. He echoed the gloomy sentiments of David Zhang, who sent an open letter to his portofolio companies warning them of a bubble on the verge of causing a major cooldown.

Many startups will look to their previous investors for salvation, but Wang says they can’t all be helped. Early stage investors don’t suddenly switch to growth stage investments because their portfolio company is in trouble. They have set investment requirements, funding cycles, manpower, and, of course, limited money. After all, the money used to fund a single series round could alternatively be used on 10 early stage rounds.

Additionally, early stage investors know full well that most of the startups they invest in will fail. That’s just the reality of early stage investing, so they will have little sympathy for those who can’t find fresh investors at the next stage.

Wang says that the oversized funding rounds for early stage companies were a double-edged sword: indeed, they accelerated growth, but they will also accelerate death.

Hung out to dry

Wang lays out which companies are mostly likely to face "the C round of death" this year. First is companies whose valuation is too high. For a US$3 billion valuation, for instance, the target market needs to be worth US$100 billion to support it. A US$10 billion valuation requires a US$1 trillion market. If startups have reached a valuation that’s already outsized its market, series C investors won’t be interested in pumping in more money, because the company can’t grow enough for them to reach a desirable exit.