10 Milliarden, Wetten, ein Unicorn zu töten

Another unicorn with a maximum value of ten billion yuan has failed before going public.

The e-commerce unicorn My Universe Collection has collapsed: The Shanghai headquarters is empty, the founder has disappeared without a trace, and it owes suppliers more than 400 million yuan in goods prices. The beginning of this tragedy was a failed bet.

Such stories are not an exception in the investment industry. The bets signed ten years ago during the booming phase of the primary market have now reached a phase of massive problems: The pre-IPO logic has failed, the review of the Chinese stock exchange (A-shares) has become stricter, the liquidity of the Hong Kong stock exchange has declined, and the US stock exchange is less interested in Chinese stocks. Many buyback clauses, which were regarded as a "formal procedure" at that time, are now like swords hanging over the heads of founders and investors.

Won the bet, but didn't get the money back

At nine o'clock on Monday morning, the consumer investor Zhang Lin (pseudonym) had just taken her seat and opened her emails when the world seemed to collapse beneath her feet.

The sender was a project she had been following for six years. A consumer brand that had been financed up to Series C and was supported by several leading institutions. In the hottest years of this sector, this project was almost the best in her career. When the agreement was signed back then, the founder looked at the bet clause, hardly hesitated, and signed. It was agreed that the company had to go public within a certain time, otherwise the buyback would be triggered, with an annual interest rate of 8%. At that moment, both thought this was just a formality. Going public was just a matter of time, and this clause would most likely never come into effect.

The email contained only one sentence: The company was having difficulties with its solvency and was currently unable to fulfill its obligations. It was willing to negotiate a solution.

Zhang Lin made a simple calculation: The buyback principal plus the interest accumulated at 8% in recent years was a sum that the founder simply couldn't afford personally. The cash in the account was reserved for paying salaries and operating the company and couldn't be touched. The founder's personal assets had already been invested in the company, and there was nothing left. What could one expect from a negotiation? At best, one would only get a promise to "wait a little longer." She stared at the screen and didn't know what to reply.

For Wang Lei (pseudonym), it was a different kind of suffocation.

He is the founder of a technology company that was financed from the angel round to Series C over seven years. There was a bet in each round, and the clauses of each round fit together - listing date, buyback interest, joint liability. Back then, he didn't have much of a choice. If he needed the money, he had to sign. If he didn't sign, the investors would just leave. He told himself that these clauses would automatically be cancelled once the company went public. It was no problem.

But the listing didn't happen on time.

The review became stricter, the documents were repeatedly questioned, the intermediary institutions were changed, and so time passed. When the bet deadline arrived, Wang Lei immediately sent a message to each investor, saying that the project was still in progress and asking for leniency. Some investors replied and said that they could talk about it. Others didn't reply. Every morning when he woke up, he immediately looked at his phone. He wasn't afraid of the business data, but that an investor's attitude would suddenly change.

There was still money in the company's account, but it was earmarked for employees' salaries and suppliers' goods prices, and he didn't dare to touch it. According to the combined buyback amounts from the several bets, even if he sold the company, it wouldn't be enough to pay off the debts. He privately told a friend: "When I signed these agreements, I thought I was borrowing a ladder. Now I know I signed a noose."

Wang Lei and Zhang Lin are at two ends of the same dead end.

This dead end is currently playing out intensively in the Chinese primary market. From 2018 to 2021, these were the most exciting years in the primary market. The pre-IPO logic prevailed. There was a lot of money, but few projects. Investors fought for participation, and founders had the power to choose. In these years, the bet was almost a standard in every financing round - investors used it to get a discount on the company valuation, and founders used it to achieve a higher financing amount. Both assumed that going public was just a matter of time, and no one seriously thought about what would happen if the exit options closed overall and these clauses were triggered at the same time.

Now this situation has occurred.

The listing dates agreed in these agreements mostly fall in the years 2023 and 2024. Unfortunately, in these two years, the reviews of the A-shares listing have become stricter, the liquidity of the Hong Kong stock exchange is limited, and the US stock exchange is unfriendly to Chinese stocks. The exit channels have become narrower overall. Investors are increasingly receiving notifications of the "inability to fulfill obligations." In some projects, the founder takes the initiative to inform; in others, only after being asked; and in some, the founder simply disappears, doesn't answer calls, and doesn't reply to messages. Regardless of the situation, it all leads to the same result: The bet is triggered, the money can't be recovered, and the project is in limbo and stuck like this for a year or two.

It's neither sensible to pursue it nor to let it go.

If one were to inevitably demand the buyback, it would put the brakes on the company's financing, the team would feel uneasy, and a company that still has self-sufficiency capabilities could quickly deteriorate. If the company collapses, as shareholders, investors are behind all creditors in the repayment order. Most of the time, they can only get back a fraction, sometimes nothing at all. Everyone knows it's a lose-lose situation. But if one lets it go and waits, the GP can also not do justice to the LPs - the DPI is there, the bet is in writing, and if it ends up with no result, these problems will be individually reviewed in the next fundraising cycle.

What catches everyone is not just an agreement, but a collective misjudgment of the exit period.

Why did they sign the agreements back then?

Let's go back to the year 2019. That was the happiest year in Zhang Lin's career.

The consumer sector was as hot as an oven. New brands doubled their value within a day, LPs rushed in wildly, and institutions had plenty of capital. In this year, she looked at over two hundred projects and invested in seven of them. There was competition for each project. Sometimes a term sheet was sent out, and within two days, it was snatched up by another institution. The market was advancing so fast that if one didn't act quickly, one was a step too late.

The bet was a standard procedure at this pace.

Investors used the bet to get conditions. If the company valuation couldn't be brought down, they added a clause to the agreement: The company must go public within a certain time, otherwise the buyback will be triggered. This was a seemingly balanced exchange. Investors accepted a higher company valuation, and founders bore the risk of the exit if the listing didn't happen. At the negotiation table, this clause didn't seem very threatening: In those years, the exit logic in the primary market worked smoothly, the IPO channel wasn't as crowded as it is today, and the success rate of pre-IPO projects was quite high. Signing a bet wasn't really a gamble, but more like signing an insurance contract that would most likely never come into effect.

For founders, the logic was also clear: If you needed money, you had to sign.

In the financing market, investors had the money, and founders had little room to negotiate the clauses. More importantly, entrepreneurs in those years generally believed that their company would go public. Going public was the goal, and the bet was an obstacle on the way. If you ran fast enough, you'd never touch it. Some founders even took the initiative to propose adding bet clauses to get a higher company valuation or quicker decisions. Both sides agreed, and the agreement was signed - all happy.

This logic was actually consistent in a market with open exit channels.

From 2015 to 2021, these were six years of the golden age in the Chinese primary market. The opening of the STAR Market, the introduction of the registration system, the implementation of Rule 18A on the Hong Kong stock exchange... The number of IPOs increased year by year. Star projects reached a value of over ten billion yuan at the listing. Investors in the pre-IPO round often had high book profits, a good DPI, LPs were satisfied, and GPs had an easy time raising the next capital. The bet was a smoothly functioning gear in this system, tightly interlocked and without noise.

No one could have foreseen when the euphoria would end.

From the second half of 2021, signals of stricter regulation were successively sent out. The IPOs of star projects in several sectors such as the Internet, education, and medicine were postponed, and the market sentiment declined rapidly. In 2022, the review speed of A-shares IPOs significantly slowed down, the number of inquiries increased, the review period was extended, and many companies in the queue voluntarily withdrew their applications. In 2023, the comprehensive registration system was introduced, but at the same time, the requirements for the profit threshold and information disclosure were increased. Many projects that thought they would soon go public found that they were still far away. On the Hong Kong stock exchange, the liquidity continuously decreased, and it became the norm for new stocks with small and medium market capitalizations to be traded below the issue price. Investors calculated that sometimes it would be better not to go public.

So the exit options were closed almost simultaneously in all directions.

Another structural problem with the bet clauses is the snowball effect of interest accumulation. An annual interest rate of 8% doesn't seem high, but if a project gets into a long waiting period, the interest grows year by year. After three years, it's 24%; after five years, 40%. Together with the principal amount, this sum quickly exceeds the actual affordability of the company. Even more difficult is that for a project that has gone through several financing rounds, there is a bet in each round, and the interest rates, deadlines, and joint liability clauses of each round are different. When combined, no lawyer can clarify in a short time who is subject to which obligations towards whom, let alone implement them.

An experienced investor said when reviewing a series of agreements he had signed: "These clauses were designed in the best time of the market. Each individual clause seemed reasonable, but no one thought about what would happen if the market as a whole changed and these clauses interacted. Now we can see that we didn't manage the risk back then, but just pushed it into the future."

In the end, one couldn't push it anymore.

What should we do now?

Wang Lei (pseudonym) is currently doing something: He is calling the investors one by one.

Not to ask for money, but to negotiate. His strategy is simple: Before the company completely collapses, he takes the initiative to sit at the negotiation table and tries to discuss everything. Some investors are willing to extend the buyback deadline by two years, on the condition that the interest rate is increased. Others are willing to reach a discount adjustment and reduce the buyback amount to 70% or 80% of the original investment capital, and both sides put the matter aside. Another investor directly proposes to convert the claims into shares, hoping that the company still has a chance to find an exit. Each investor has different demands and limits. Wang Lei negotiates with each one individually and concludes the negotiations one by one.

He privately said: "This is even more strenuous than the financing back then. When financing, you ask for money; when negotiating, you ask for relief. Both require humility, but the latter is more difficult because the people on the other side of the table already regret it."

Zhang Lin is not the only investor who regrets.

In the last two years, more and more institutions have recognized that the bet instrument systematically fails in the current market environment. The forced buyback leads to a dead end. Waiting increases the pressure on the DPI. A discount adjustment requires an explanation to the LPs. No way is easy, and each has its price. Therefore, more and more investors are starting to shift their energy from "how to get the money back" to "how to find an exit." This is a subtle but important change - the recognition that recovery is a dead end and the search for another way.

Extending the deadline is currently the most common first step.

Both sides agree to postpone the buyback trigger date to give the company more time to go public or find a merger or acquisition. The logic of this plan is simple: Time for space, in the hope that the company still has a chance. But extending the deadline is not free. Investors usually demand an increase in the interest rate.