• Onshore listing drought shifts focus to offshore IPOs as alternative to redemptions
• Hong Kong is accessible but lacks liquidity; US has depth but with heightened risk
• Regulation, alignment of interest are paramount in IPO-centric growth equity market

Mainland China exchanges bestrode Asia’s private equity-backed IPO scene for two years, accounting for an average of 80% of region-wide proceeds per quarter in 2022 and 2023. That run ended in the second quarter of 2024. With companies cancelling IPOs seemingly in their droves, the mainland share fell below 20%, according to AVCJ Research.

Suddenly, offshore listings are back in vogue. More than 100 candidates – including health-tech specialist Taimei Medical and car-hailing platform Caocao – are targeting Hong Kong, while autonomous driving unicorns WeRide and Momenta have filed in the US. In the background, impatient investors are exploring their redemption options.

“Over the past 12 months, confidence in listing on China’s A-share market has waned, with uncertainty about the timing and the result of onshore IPOs. Companies that have received investment are facing a lot of redemption pressure. As a result, they are now seeking exit routes for their investors abroad,” said Qing Xu, a managing partner at Oriza FOFs, a local fund-of-funds.

There are multiple reasons why a company would switch its listing ambitions from onshore to offshore. However, references to redemptions – whereby founders repurchase shares from investors at a pre-agreed price if an IPO fails to materialize – says everything about China’s exit problem.

Realisations since the start of 2022 amount to USD 20.3bn; the annual average for the prior eight years was USD 25.2bn. In a market where minority deals remain in the majority, the lack of clarity on IPOs is troubling. Investors are asking when, where, and how they can get their money back.

Redemption rights feature in more than three-quarters of PE and VC transactions structured offshore and in over 90% of those onshore, according to law firm Han Kun. They are regarded as a legally fraught last resort: for the investor, it means a suboptimal return; for the company, one redemption is typically followed by others, perhaps necessitating a liquidation of assets.

A Shanghai-based banker noted that his corporate clients are most concerned not by market turmoil or volatile valuations but by mounting pressure from PE and VC investors. “In that case, they will try every means to move forward,” the banker added.

Hong Kong or bust?

For companies where an IPO is possible, at present, most roads lead to Hong Kong, followed by the US. Jean Thio, a partner at law firm Clifford Chance, has seen an increase in enquiries about other listing venues such as Frankfurt, London and Southeast Asia, but as yet there is nothing concrete.

Annual average proceeds generated by PE-backed companies listing in Hong Kong were USD 12.9bn for 2014-2021. They just cleared USD 2bn in 2022 and failed to reach that mark a year later. The total for 2024 as of end-June is USD 735m, with little happening outside of consumer and biotech.

Lower listing requirements and accelerated processes for technology companies – under the Chapter 18C regime, which follows a similar initiative for biotech – are offering some hope. Moreover, several industry participants noted that “sentiment has come back a bit,” citing an upturn in IPO proceeds last month plus a slight recovery in the market and signs of economic stabilisation in China.

“Speed of regulation approvals is picking up, a couple of large caps have gotten approvals. For Hong Kong and China, we are at a bottom, there has to be a catalyst,” said Selina Cheung, co-head of Asia equity capital markets at UBS.

Recent success stories include Laopu Gold [HKG:6181], a jewellery brand backed by BA Capital and Fosun Capital, which raised HKD 905m (USD 116m). The company secured Tencent Holdings, Nanfang Funds, and CPE and cornerstone investors, and the overallotment option was fully exercised. The stock price has more than doubled since its late June debut, giving Laopu a market capitalisation of HKD 14.6bn.

“The key factor behind the positive market performance is the quality of the asset, which is reflected in its higher profit margin and return on capital investment compared to its peers,” said Michael Zhang, co-founder and managing partner at BA Capital.

Ian Goh, a founding partner at 01VC, added that the positive momentum will continue if quality assets come to market. He hopes that Lala Tech – which has filed to list in Hong Kong and would be 01VC’s first IPO – can be one of these.

While Laopu had sufficient momentum to trade at a premium to its IPO price, 30% of companies that listed in the first half of 2024 did not. RoboSense [HKG: 2498] is down 65% with a market capitalisation of HKD 6.6bn (USD 847m). The post-money valuation for its last private round was CNY 16.5bn (USD 2.3bn). Black Sesame [HKG:2533] was valued at USD 2.2bn; it is down 30% with a market capitalisation of HKD 11.2bn.

“Pricing will be a struggle. [Home appliance maker] Midea is expected to price at 15% discount to its target, but investors may need it to be 20% as downside protection,” said one hedge fund investor.

The valuation squeeze shouldn’t be a huge burden for large established companies like Midea, which have relatively straightforward shareholder structures. It is more challenging for start-ups that have been through several rounds of early and growth-stage funding. Some investors might oppose IPOs because they don’t want to realise a substantial loss in the public market.

Cornerstone conundrum

Laopu was also boosted by the credibility of its cornerstone investors. Increasingly, local government investment platforms are performing this role, with research firm Ryanben Capital finding that these entities participated in 40% of offerings and accounted for 51.9% of overall proceeds in the first half. Several sources claimed that companies are readily tapping friends and family networks as well.

“The smaller size caps find it easier to go out because it’s easier for them to find investors, and they’re probably more flexible in terms of valuation,” said Thio of Clifford Chance. “We are seeing a lot of deals where investors are not necessarily the typical names. There are also investors whom the company has tried to bring in themselves, which may explain smaller deal sizes.”

One Hong Kong-based banker noted that their firm continues to underwrite Hong Kong IPOs but asks companies to source their own cornerstone investors. Drug discovery startup XtalPi [HKG:2228] is said to have done this. According to Christine Zheng, a founding partner of Fangyuan Capital, an investor in XtalPi, it shouldn’t be a problem for companies with strong management and technology.

“Nowadays, being a founder is not easy. They should be able to handle financing and pressures from shareholders in addition to focusing on R&D and business development,” Zheng said.

Even willing cornerstone investors might ask for clauses – like redemptions – that minimise their downside exposure. Qingchuan Lu, a lawyer at AllBright Law Offices, noted that Hong Kong-listed companies have faced civil actions in mainland China after trying to renege on side agreements with investors guaranteeing returns. However, he thinks they have little choice but to accommodate these demands in the current market.

Alternatively, companies agree to price their offerings conservatively to protect the interests of cornerstone investors. “If there are higher uncertainties in the public market, the investors – including cornerstone or anchor investors – will be looking for a more conservative pricing in IPOs as a downside protection,” said Charlie Chen, head of Asian research at China Renaissance.

Risk factors in NYC

The US, as a much deeper market than Hong Kong, boasts plentiful investors and abundant liquidity. On the other hand, geopolitical tensions, economic and regulatory uncertainties, and concerns over reputation and performance make for a tricky combination.

The market for Chinese IPOs in the US shut down completely after Didi’s mid-2021 offering prompted Beijing to launch an investigation and impose restrictions on the business. Didi ended up delisting. There were hopes of a resurgence after the US and China resolved a longstanding audit dispute in late 2022, but only a handful of PE-backed IPOs have been completed since then.

WeRide could be the blockbuster everyone is looking for, with the PE-backed company expected to close the books this week on a share sale of up to USD 120m. It has already agreed to raise another USD 320m through a private placement. The target valuation is just over USD 5bn, which is roughly in line with the most recent private round. However, the hedge fund investor dismissed it as a “fake IPO.”

“They opened the book but are not pushing hard because they have the placement tranche filled and Bosch [a German automotive supplier and an existing investor in WeRide] will take up to USD 100m of the open book,” the investor said. “That leaves a maximum of USD 10m-USD 15m for the public, or a 0.3% free float.”

Didi’s problem was partly timing – it pre-empted China’s revised data privacy law. Now the rules are in force, attempted US listings by the likes of Xiaohongshu have faced pushback. Fashion retailer Shein positioned itself as global, but has fared little better. Industry participants variously blame its uncertain IPO trajectory on regulatory compliance, company profile, and geopolitical tensions.

The consensus view is that companies originating from China can still pursue overseas listings as long as they are modest in the scale of their fundraising ambitions. Mingzi Tian, a partner at law firm Jingtian & Gongcheng, added that companies should think carefully, and consult external counsel, as to whether they need to make a filing with domestic regulators before launching an overseas IPO.

“In China, the principle of substance over form has always been a fundamental regulatory practice,” she explained. “Whether a business falls within the scope of Chinese regulation depends on factors such as the nature of the enterprise, the structure of its assets and operations, and the composition of its shareholders and senior management.”

Ocean Link, a Chinese private equity firm focused on tourism and consumer technology assets, claims to have several portfolio companies on track to become global in terms of revenue and operations. “It is also important to ensure compliance with regulations if operations are based relatively more globally,” said Tony Jiang, a co-founder and partner at Ocean Link.

Scrutinised onshore

Regulation remains top-of-mind for companies contemplating an onshore listing. Indeed, the number of withdrawn IPOs is less surprising when viewed in the context of intensified scrutiny. In addition to financial performance and risk management, regulators are looking at shareholding structures, client bases, cash flows, ability to collect payments and repay debts, and related-party transactions.

There were 25 PE-backed IPOs across mainland China’s exchanges in the first half of 2024, with proceeds reaching USD 2.8bn. Nearly USD 150bn was raised via 733 listings between 2020 and 2023.

Technology companies appear to be the only ones getting traction. They include Hunan Xiangtou Jintian Titanium Technology, a materials supplier to the defence and aerospace sector, which recently received approval to list on the Science & Technology Innovation Board, or Star Market. TH Capital, an investor in the company, hopes to add to its 37 IPOs on domestic exchanges.

“Many of the companies TH Capital has backed over the years align with national development goals and lead China’s transformation to a global technology leader, providing an excellent market environment for fast and profitable growth,” said Yu Li, a director for post-investment management at the firm.

Although never been officially stated, the China Securities Regulatory Commission (CSRC) guides IPO candidates and advisors before listing documents are filed, according to several sources familiar with its workings.

Notably, there is a sector-based traffic light system: red is for sectors, like real estate and education, where listings are banned; amber for sectors, such as consumer, where only the top players would have a chance of going public; and green for sectors – like those targeted by TH Capital – that are encouraged because they contribute to national policy objectives.

Voluntary IPO withdrawals are typically driven by weak market or business performance, procedural uncertainties, or high compliance costs. A second Shanghai-based banker suggested another reason: companies withdraw because they recognise inconsistencies in financial documents or inadequate internal controls would easily be identified by inspectors and may result in punishment.

In this sense, heightened scrutiny is a net positive. “The current regulation is a part of the future development of China’s capital markets. We are crossing the river by feeling for stones. This will improve the quality of listed companies in the long run,” said Chen of China Renaissance.

Exploring alternatives

Given the uncertain IPO outlook, investors have sought to develop other exit channels. Several VC investors emphasized the appeal of sales to trade buyers and through growth-stage rounds, with Goh noting that 01VC secured eight substantial exits via these routes last year. On the private equity side, GL Capital and Ocean Link said they expect more trade sale and sponsor-to-sponsor sale activity.

Vera Liao, COO of Shenzhen-based financial advisor Starrysea Capital, has observed increased interest in sponsor-to-sponsor deals but questions the success rate. In the context of a down round, even for a well-funded unicorn, new and existing shares are typically sold at 30% to 50% discounts. This can be difficult for selling sponsors to stomach.

It points to a wider issue concerning alignment of interests. Selling at a discount might mean an early-stage investor is still in line for a windfall while a late-stage entrant is facing a significant loss. A trade buyer might insist on a 100% acquisition, but this is opposed by the founder, who took external investment on the understanding that an IPO would enable him to retain control.

Industry participants claim that founder reluctance has eased, partly because of more challenging economic conditions. Nevertheless, strategic investors were only responsible for 7.4% of transactions involving PE and VC-backed assets in 2023, according to Han Kun. Financial sponsors still dominate.

Julie Fu, a partner of Clifford Chance, added that size can also be an obstacle. There isn’t necessarily much strategic demand for large-size assets held by private equity firms.

Ultimately, it comes down to asset quality. Robert Chang, a founder and managing partner at GenBridge Capital, said that companies with significant size, industry influence, and substantial free cash flow will have their choice of exit routes, including IPOs.

“They may attract strategic investors if they emerge as a new force in their sector. If a company demonstrates structural growth and potential for high valuations despite current challenges, it may attract interest from private equity investors,” he observed.

“Additionally, strong cash flow generation allows a company to implement downside protection measures, even if it is rarely visited by strategics or sponsors.”

According to Frankie Fang, a founding managing partner at Starquest Capital, a China-based fund-of-funds, the cohort of well-funded start-ups from the 2017 and 2021 boom period includes members that display some of these characteristics or will do so in the near term. He advises investors to focus on developing even more rather than fixate on exit routes.

Mapping the future

Doubling down on value creation and portfolio management doesn’t come at the expense of exit planning. Rather, they are part of an integrated process. Lydia Hao, a managing director at HarbourVest Partners, an international fund-of-funds, recommended that investors, especially those with control positions, map out exit scenarios and identify likely strategic buyers.

This view is endorsed by Xu of Oriza FoFs. “Don’t linger around. Be decisive about what should be held for an IPO and what should be sold through trade sales to realise returns,” she said. “If a good opportunity arises, consider exiting early – either to get back the cost or make some returns.”

There is an expectation that Chinese GPs will revert to IPOs when the market eventually rebounds. From an LP perspective, this approach would be misplaced: they want managers to establish a broader set of competencies that can be implemented as needs arise.

“We should steady ourselves and reassess the current market to identify which companies genuinely have opportunities to achieve potential returns, rather than fixating solely on achieving IPOs as the main goal,” Xu added. “The public market is of secondary importance.”