In recent months, a peculiar trend has emerged in the realm of venture capital (VC) in China, as many general partners (GPs) are grappling with the pressing issue of extending fund durationsIt's a scene that has become all too familiar, where GPs are caught in a cycle of postponing the inevitable, and for some, this marks the third attempt at deferral.

Take, for instance, a partner from a VC firm in Beijing, who preferred to remain anonymous“This is our fund's third extension,” he confided“We've had two previous extensions, and now we are in a position where we must extend for a third timeThe fund's lifespan has surpassed the designated expiry, yet we find ourselves unable to exit successfully.” His transparency highlights a prevailing struggle among domestic investors, particularly those who established their funds during the peak years of 2015 and 2016. The unfortunate reality is that very few funds in this category have been able to settle their accounts on time, prompting many GPs to hold onto their funds longer than initially planned.

The urgency of this situation cannot be overstated

According to the insights gathered by a fund research center, the typical lifespan for domestic venture capital funds is structured around the “5+2” model, allowing for a potential seven-year investment periodHowever, the number of funds that successfully complete their liquidation during this period is alarmingly low, making extensions a reluctant yet common strategy.

During discussions with limited partners (LPs) who are integral to these funds’ operations, it becomes clear that the pressures intensify“When seeking approvals for extensions,” the Beijing-based partner explained, “LPs often put us through tough questioningThey need to know: if we extend, will we be able to exit successfully? When can they expect to get their investments back? Some government-linked LPs outright refuse to allow extensions, insisting on quick exits.” This atmosphere of tension forces GPs to navigate treacherous waters, sometimes by scrambling to find buyers for the stakes they hold.

Another case presented by a director of venture investment in Eastern China reveals a similar plight

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“While most LPs were amenable to extending the fund duration, the government LPs were obstinateWe went to great lengths to find other potential buyers for our stake on the market, but to no avail—and we ended up shouldering blame for the situation.” The implication of personal liability illustrates the grim reality that GPs face as they strive to appease their LPs while managing an underperforming fund.

For many LPs, the conditions for agreeing to fund extensions hinge on the operational status of the invested projectsIf a fund's investments are flourishing and there is clarity on potential exit avenues, LPs may accept an extension, provided that the fund has at least recouped its initial investment (a measure known as DPI, or Distributions to Paid-In). Conversely, the situation becomes dire when DPI does not reach the critical threshold of 1. “When DPI is below 1, as a government LP, we have no choice but to refuse any extension,” remarked a representative from the government LP sector

“We are bound by stricter compliance and risk management standards.”

In a crucial twist, Wu Ke, a representative from an early-stage fund in Shanghai, noted that guiding funds have begun to impose stricter conditions on their sub-funds“Our guiding fund has clauses that require automatic exits under certain conditionsWe have the right to compel exits through stock transfers or other methods, often without needing approval from other investors.” Such provisions create an environment fraught with tension, where GPs face pressure to perform or face dire consequences.

Worryingly, some government LPs have resorted to legal action against GPs over exit disputes“One guiding fund was so eager to exit that they brought us to court,” a GP under scrutiny relayed“The irony is, we’re cash-strapped and cannot do anything but hold the shares, which have now become liabilities.”

The push for timely exits also intertwines with the unique constraints faced by government LPs, which influences their aversion to extensions

One guiding fund leader spoke candidly about the necessity for compliance: “Our guiding fund itself has a deadline and we must liquidate on timeWe cannot allow our sub-fund GP to extend their timelines when we are bound by our own,” he explained“If there’s a contractual obligation, we follow it, otherwise, we must negotiate an exit or find a buyer in the market.”

In many senses, the current turbulence in the VC sector can be traced back to two overarching factors: the daunting challenges of exiting investments and a notable shift in investment focusThe overwhelming reliance on IPOs—the traditional exit route—has become problematic, especially as the volume of growth is not matched by the opportunities for exitsReports indicate that more than 90% of projects historically exited through IPOs, but growth in mergers and acquisitions is still in its developmental stages and fails to fulfill the growing demands for exits.

Furthermore, the investment direction has markedly shifted

Gone are the days dominated by internet startups and consumer brandsCurrently, “hard technology” has emerged as the primary focal point, characterized by lengthier growth cycles and inherent risksSuch transformation necessitates that investment firms recalibrate their patience, stretching timelines to better align with potential returns.

This newfound patience, intrinsic to nurturing long-term investments, must be complemented by a supportive cohort of LPs willing to adopt a long-term perspective themselvesThere is burgeoning interest in establishing a concept known as “patient capital.”

“Patient capital” embodies the critical attributes of longevity and stability, wherein investors focus on supporting ventures that navigate long-term cycles, displaying tolerance for risks and failures

Such an investment framework is vital for adapting to the uncertain landscape of technological innovation.

Encouragingly, certain guiding funds in various regions are trailblazing efforts to cultivate this patient capital modelA noteworthy example arose on June 7, when Shanghai Pudong announced adjustments to its Shanghai Pudong Science and Technology Innovation Investment Fund, extending its lifespan from a decade to a remarkable twelve yearsThis adjustment is poised to enhance the efficiency of state-funded operations and showcases the commitment to harnessing public investments more effectively.

Building on this momentum, other localities are mirroring this approachIn July 2022, the Zhuhai government extended the lifespan of its innovation fund to 15 years, allowing for further extensions, thus paving the way for a responsive investment environment that can adapt to long-term innovation trends.

As this movement toward prolonged fund life gains traction, it is clear that the connection between patient capital and extended durations is critical