As China’s venture capital (VC) funding plummets to historic lows, extension rounds — defined as additional capital sourced from existing or new investors under similar terms and valuation levels as the previous financing rounds — have been on the rise.
For venture capitalists and startups, extension rounds help avoid the daunting down rounds that lead to a decline in valuations.
There is no dearth of startups raising extension rounds within the same year. Shanghai-based eVTOL aircraft developer Volant’s funding is one such example. It closed a 100-million-yuan ($14.1 million) Series A round in March; then subsequently it sealed its A+, A++, and A+++ rounds in April, June, and August respectively, according to the company releases.
“This is a hard reality,” said Ian Goh, founding partner of Shanghai-based venture capital firm 01VC, adding that some of its portfolio companies have resorted to extension rounds. 01VC specialises in supply chain, industrial automation, business-to-business solutions, and cross-border investments.
The uptick in extension rounds, however, is not a new development in China — the first flurry of extension rounds happened in 2018 when the country faced its double whammy of intensifying trade tension with the US and the slowest full-year GDP growth hitting a 30-year low.
A total of 677 extension deals were sealed in 2018. Both the number of extension round deals and proceeds hit a 15-year-high at that time, according to Chinese data firm ITjuzi.
Cut to 2024, the comeback in extension rounds signifies an even more challenging time compared to 2018. It paints a bleak picture of how privately-owned firms have been adapting and surviving during a time of paradigm shift in which RMB-denominated government capital has emerged as a driving force in the VC-PE ecosystem.
Meanwhile, a number of macro factors such as the slowdown of global and Chinese economic growth, the shifting global supply chains, and the upcoming US presidential election have continued to weigh on the country’s VC-PE market.
Dire fundraising climate pushes startups to cut costs
Year 2021 marked the second peak of the extension rounds — fundraising proceeds and the deal count both surpassed the level of 2018 that year, according to DealStreetAsia’s analysis of startup fundraising data provided by ITJuzi from 2004 to September 15, 2024.
One significant point to note here is the drop in extension rounds since then. While 2024 saw the completion of 500 deals in this space worth 44.3 billion yuan ($6.2 billion), in terms of deal value and volume, there was a 44.3% and 75.2% drop from the record highs of 2021.
However, venture capitalists are not celebrating yet — several industry players told DealStreetAsia that the downward trajectory of extension rounds signals how the overall startup fundraising scene continues to be squeezed in the country, as is evident from the overall funding scene as well.
According to DealStreetAsia’s proprietary data, funding raised by Greater China startups in Q2 this year fell below the levels seen during the pandemic in 2020, pointing to low confidence among VC and PE investors in the market.
Jeffrey Lee, co-founder and senior partner of early-stage VC firm Northern Light Venture Capital (NLVC), who is no stranger to extension rounds, said “tens” its portfolio companies did extension rounds in the past.
“Often, the ones that raise the extension are in product development or R&D, but the companies just need to survive on cash flow,” he explained. With a $4.5 billion asset under management (AUM), NLVC invests in enterprise technology, healthcare, and consumer technology companies across the Chinese and Asian markets.
The recent uptick in extension rounds also means that startups have taken a longer time to raise capital. “Now the fundraising [process] could last from six to nine months. I won’t be surprised if a fundraising [process] lasts for one year,” said 01VC’s Goh.
Lee added that the long duration of the fundraising process naturally forces startups and founders to cut costs, resulting in headcount reduction and the pull-back of R&D plans.
Generative AI, biotech, semiconductor see most extension rounds
Even for some of the country’s most-invested sectors, extension rounds are unavoidable. Take semiconductors for example. It is one of the top three sectors to be witnessing extension rounds this year.
Part of the reason could be attributed to the investment slowdown gripping the semiconductor industry — Q2 was particularly sluggish for chipmakers in the country, as the semiconductor deal count hit a four-quarter low, per DealStreetAsia’s data.
“The semiconductor industry requires intensive capital investment. Chip design, in particular, is one area that garnered massive investor attention over the years, but it is a very labour-intensive sector and it requires a long time for those firms to come up with advanced chips that can directly compete against their overseas counterparts,” Hoi Tung Li (Wallace), managing director of Chinese deep tech VC firm G&O Capital, explained.
“Chinese chip design companies have seen their valuations taking a hit, thanks to the valuation reset since 2022. Many of them have to resort to down rounds. But for those firms taking the path of extension rounds, they are likely lagging behind in their product development,” Li added.
G&O Capital, a spinoff of Z&Y Capital, specialises in semiconductor and AI opportunities. Founded by Tsinghua University alumni in 2016, the firm, which operates independently from Z&Y Capital, now counts Chinese high-net-worth individuals as well as state capital investors among its list of LPs.
More extension rounds than down rounds
Despite the sectoral development, investors that DealStreetAsia spoke to, have adopted a positive take on the extension round phenomenon and some even argue that there are more extension rounds than down rounds in the market.
Part of the reason is that Chinese GPs are scared to see a markdown in their portfolio, especially those who raised their funds in the pre-COVID time, according to NLVC’s Lee. “They probably gave some expectation to their LPs. They’re not able to give distributions,” he said.
Lee highlighted that while it is common to see key employees or co-founders in Silicon Valley quit and start a new company when down rounds happen; it is rarely the case in China as it creates a reputation problem. Chinese VCs have less intention towards pay-to-play rounds too, per Lee.
The pay-to-play provision incentivizes existing investors to join a new funding round but it is typically structured as a punitive term for investors choosing not to participate in the new round.
For example, Silicon Valley VC major Sequoia Capital reportedly resigned from the board of crime-tracking app Citizen after the app offered the VC firm a “pay to play deal” that mandates the firm to join the new round otherwise the firm could risk wiping out its shareholding at the firm, according to a Financial Times report in February 2023.
Investors push for stronger downside protection
But as the bleak exit landscape continues to loom over, Chinese VC-PE investors, which have long counted on IPOs for outsized returns, are increasingly pushing for deal terms with stronger downside protection. Some would go as far as to force the founders to buy back the company shares if the firm falls short of its IPO timeline or performance expectation.
A minimum of 41 litigation-related tender announcements have been issued by Shenzhen Capital Group, the venture investment vehicle of the Shenzhen government, since 2023, in which 85.3% or 31 of the announcements were associated with buybacks, according to an investigation story published by Chinese news outlet Caixin in September.
Known as bet-on agreement, it is a common clause across many of the private equity deals in China – it is often taken as a gentlemen’s agreement among investors, meaning that it is not something forceable. But the recent enforcement of the clause signifies how investment firms have been navigating through this challenging time.
“What we’re seeing [in] the last two years is that in later-stage rounds that were done [during] pre-COVID [times] anywhere from 2017 to 2020 – especially those that were done by PE firms or hedge funds – there are a lot of redemption requests,” Lee said. “We see this in a number of our companies,” he added.
There are also requests for liquidation preference — which puts investors on top of the stack in case of a liquidity event, per Lee.