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Chinese startup investment soars to record heights

Investors flock to smartphone services, high-tech ventures

Bike-sharing service Mobike, along with rival Ofo, have raised hundreds of millions of dollars from investors.

SHANGHAI -- Venture capital deals in China surged 70% to a record 236.4 billion yuan ($34.3 billion) last year, while smartphone-based consumer services such as bicycle-sharing company Ofo have been among the big winners recently, though whether this meteoric growth will continue remains uncertain.

When Ofo raised an additional $450 million Wednesday at a higher valuation than expected, the venture capital world began buzzing about the world's first bike-sharing "unicorn," as nonpublic startups valued at $1 billion or more are called. China is believed to be home to no more than 20 or so unicorns, among them smartphone maker Xiaomi.

Ofo customers can rent bicycles for about 1 yuan an hour, picking them up and dropping them off at numerous locations. The accompanying app, which lets users easily verify their identities and pay by smartphone, helped the service take off. Ofo was established in 2014 and has raised some $600 million so far, some of which the company plans to use for forays into foreign markets.

"We want to offer this convenient service to the world," CEO Dai Wei said.

Tech takes over

China's $34.3 billion in startup investment last year -- based on data from research firm Shanghai DZH -- is equivalent to more than half the value of U.S. venture funding in 2015, though differing standards preclude a direct comparison.

Much of the money has gone to smartphone-based services such as Ofo and rival Mobike. Investors include big internet companies looking to foster the growth of young businesses. Mobike has raised money from Tencent Holdings, operator of the WeChat messaging app, while Ofo is funded partly by Didi Chuxing, China's largest ride-hailing service, which in turn counts tech titan Alibaba Group Holding among its shareholders.

Another area attracting interest is online-to-offline services, which seek to draw consumers to bricks-and-mortar stores. One example is Koubei, an Alibaba affiliate that offers coupons and provides user reviews, which raised more than $1 billion in January.

The industry with the most investment deals in 2010 was machinery and equipment, accounting for 10% of the total, with internet-related companies close behind at just over 9%, DZH data shows. But machinery and equipment accounted for just 0.5% of deals in 2016, while internet companies' share surged to nearly 36%.

The changing makeup of venture investment deals reflects a shift in the sectors driving China's economy. Investors started paying more attention to artificial intelligence, robots and big data in the latter half of last year, accounting giant KPMG noted.

The deals themselves are getting bigger as well. Startups raised an average of 340 million yuan per round last year, a sharp rise from less than 200 million yuan in 2015. Didi Chuxing received $4.5 billion in funding from investors including China Life Insurance, the country's top life insurer. A Chinese government-backed fund participated in a $4.5 billion funding round for Ant Financial Services Group, the Alibaba affiliate that operates mobile payment platform Alipay.

Exit strategies

One factor driving the surge of activity is a soft stock market that has left investors with fewer promising places to put their money. Chinese shares slumped more than 10% last year.

Venture capital firms also have more ways to cash out. Data from Zero2IPO Research Center shows around 2,000 exits last year, a roughly 10% increase from 2015. About 1,200 of these came via the National Equities Exchange and Quotations market, also known as the New Third Board, an over-the-counter market for shares in nonpublic companies. By comparison, initial public offerings accounted for just 280 or so exits.

The number of companies on the New Third Board swelled from around 1,500 at the end of 2014 to 10,000 two years later. Businesses need not meet any financial or earnings requirements to list there, which is a plus for venture capital firms seeking to recoup their investments.

But thin liquidity is an issue, and a lack of oversight has led to scandals. An executive at a New Third Board-listed apparel business went missing last year, just after the company's listing, and illicit fund outflows have been discovered as well. But setting stricter standards could dampen activity on the board.

A pivotal year

This year looks similar to 2016 so far in terms of funding deals, with 100 in January and February compared with 135 in January-March 2016, though 2017 has seen more small-scale rounds.

Capital controls imposed by financial authorities amid China's dwindling foreign-currency reserves likely will further encourage startup funding. Authorities have refused to approve some overseas acquisitions, a development that could push risk-seeking investors toward fledgling companies.

But elevated long-term interest rates could yield the opposite effect. Long rates climbed to 3.4% at one point in December -- up 70 basis points from October -- and remain in the 3% range. Higher interest rates make investment more costly and affect startup valuations as well.

How the venture capital market fares this year probably will provide a good indication of whether the funding boom has legs.

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