By Samuel Shen and Julie Zhu
SHANGHAI/HONG KONG (Reuters) - When Chinese venture capital firm New Vision Capital invested in two startups focusing on cloud computing and micro-optics, the plan was to eventually take them public on the Nasdaq exchange.
But with the launch of China's new STAR Market tech board - and an escalating trade war with the United States - partner Frederick Shen said it makes more sense to list loss-making DaoCloud and North Ocean Photonics in Shanghai.
"The trade war has quite a big impact," Shen said, adding that trade tensions inject uncertainty into valuations, financing and capital expenditure plans.
Listing closer to the investor base is also easier "because there's no language barrier or time differences," Shen added.
STAR Market, which allows pre-profit companies to list in China for the first time, gives venture capitalists a new way to exit investments in loss-making start-ups. The sharp deterioration of the China-U.S. relationship has also nudged more Chinese companies to list at home.
"That trend may accelerate given the perceived risks associated with a U.S. listing as the trade tensions escalate," said Oliver Nip, Hong Kong-based partner at law firm Ropes & Gray.
The new market was launched as China's venture capital sector has been cooling. Beijing's deleveraging campaign hurt fundraising by local-currency funds, and a crackdown on shadow banking sapped liquidity.
Venture capital and private equity firms in China raised just $5.5 billion in yuan-denominated funds in the first half of this year, according to data provider Preqin. That compares with $15.5 billion a year earlier, and $62.1 billion in the first half of 2017.
Bao Fan, chief executive of investment bank China Renaissance, a major player in China's tech sector, said that STAR Market "is definitely positive" for investors.
Offshore listings have not been easy for Chinese start-ups, he said, "largely because a company needs to grow to a certain size to be attractive to offshore investors."
Chinese venture capital firm Corner Stone Capital, which has backed a slew of Nasdaq-listed Chinese companies, is increasingly looking at STAR Market for listings.
Drugmaker Zelgen, backed by Corner Stone Capital, has scrapped a plan for a Nasdaq listing and applied in Shanghai. The developer of cancer medicines could become China's first listed firm with no revenue or profits.
(Graphic: https://tmsnrt.rs/2YL16ag)
DEBUT FANFARE
STAR Market made its debut last month amid fanfare and investor enthusiasm. The first 25 companies on the board - ranging from chip-makers to healthcare firms - surged 140% on average on their first day of trading.
Venture capitalists are rushing to embrace the market as a means of returning profits to investors and attracting more funding.
But the boon is limited. The STAR Market only allows listings from a handful of industries with "hard" technologies such as AI, cloud computing, green energy and biotech. And VC investors generally must wait 12 months after listing before they sell shares.
Andrew Qian, CEO of Shanghai-based New Access Capital, said STAR Market's launch has helped the venture capital sector thaw after a "freezing winter".
New Access is planning more domestic listings by its portfolio companies, and is launching a tech fund targeting companies in sectors such as AI and 5G networks.
But Zhu Fuming, chairman of Shanghai-based Vstar Capital, cautioned that most venture capital funds may continue to struggle.
With 14,000 venture capital and private equity competitors, "consolidation will definitely accelerate this year," he told a forum in Shanghai recently. To survive, the remaining funds must focus on high-tech investments, he said.
SELF-SUFFICIENCY
Some analysts see STAR Market as China's boldest capital market reform yet aimed at luring tech listings away from New York or Hong Kong.
Since Washington blacklisted Chinese tech giant Huawei on May 16, overseas-listed Chinese companies have dropped around 8%, far underperforming the S&P index, which is roughly flat.
"Many (Chinese) tech companies - either those listed in the U.S. or those thinking about listing in the U.S. - are concerned that they will be caught up in the conflict," said Xuong Liu, a China-based managing director at consulting firm Alvarez & Marsal.
With valuations of U.S.-listed Chinese tech firms hurt by the trade war, Liu suggested Chinese venture capitalists "re-consider their exit strategies."
Terence Lin, CEO of boutique investment bank World Financial Holding Group, said the trade war is a source of concern for Chinese companies seeking a U.S. listing: "Nine out of 10 clients would ask me about this issue. It's on their minds."
The U.S. market, however, remains appealing to many Chinese companies, thanks to its ample liquidity, regulatory transparency, and simple listing rules, Lin said.
Drew Bernstein, co-managing partner of Marcum Bernstein & Pinchuk, a leading auditor for Chinese companies listed in the U.S., agreed.
"If you are looking for the deepest capital markets, most sophisticated technology analysts, and ability to have offshore liquidity and a global brand, the U.S. markets remain a very compelling proposition," he said. "But it requires a real commitment."