“O NLY WHEN the year grows cold do we see the qualities of the pine and the cypress,” wrote Robin Li, the boss of Baidu, in a new year’s letter to staff at China’s main online-search firm. It was yet another recognition of a chill sweeping through the country’s technology industry. The lavish financing that promising startups have come to expect has dried up. Job cuts have multiplied. Even China’s tech giants have not been spared and are slashing bonuses and travel expenses.

This wintry spell is a remarkable reversal for a batch of firms, such as Meituan-Dianping, an online-services super-app, that are among China’s most vivacious. Early last year they appeared to be in rude health and were drawing in vast dollops of investment. More money was raised for venture-capital funds in China in the first half of 2018 than in America, the first time that had ever happened: $56bn compared with $42bn, according to Preqin, a data provider. By the autumn no fewer than 86 new “unicorns”—private, billion-dollar startups—had emerged.

Then the “capital winter” set in. One trigger was a selloff in tech stocks globally that included China’s biggest stars, Alibaba and Tencent. Worries have multiplied about the pace of revenue growth in a slowing economy, as well as the time it is taking for highly valued private startups to approach profitability. Even giants are seeing sales growth slow. In the third quarter of 2018 JD .com, an e-commerce group, reported its slowest quarterly revenue increase since 2014 and its first decline in new users.

During the last three months of 2018, deals to commit venture capital to young firms slumped in number by two-fifths, and private-equity financing dropped by more than a quarter, to under $10bn, compared with the previous three months, according to CB Insights, a research firm (see chart). Unable to raise money, a slew of small funds have even disappeared. Part of the downturn has more to do with supply of financing for VC funds than disillusion with unicorns. The government has cracked down on informal sources of financing from which much VC funding has flowed, for example. But larger investors have also grown cautious about tech companies. The woes of Ofo, a bike-sharing unicorn, exemplified the sort of hubris that many reckon had spread too far in tech. Ofo raised seven rounds of financing within 18 months, earning a $2bn valuation. It is now almost bankrupt. Startups looking for early-stage investment have felt the capital winter most keenly. Yuqing Guo, a partner at P w C , a consultancy, says investors are advising them to expect as little as half the valuation they might have won a year ago. Where once investors brandished term sheets before a startup had launched, now they wait. Deals are taking longer: a round of funding once raised within a month is taking six, says Nisa Leung of Qiming Venture Partners, a big investor in Chinese tech. As private cash has grown harder to come by, more established companies have been looking to public markets. But this has turned into another reckoning for the tech industry, as some anticipated blockbusters fall flat. Shares in Meituan-Dianping and Ping An Good Doctor, China’s largest online health-care app, have dropped by a tenth from their offering price.

Among Chinese bosses, meanwhile, business confidence in the three months to December was at its lowest in six quarters, according to a survey by the central bank. The country lost around 160 billionaires to last year’s stockmarket slump, reports Hurun, a consultancy which tracks the country’s super rich. The fortune of Tencent’s Ma Huateng fell by as much as 43% in 2018, to $27bn in October, as his social-media and gaming titan was hobbled by a regulatory hold-up. For the three months to June 2018 the company posted its first quarterly profit decline since 2005.

Other peppy online businesses have been hurt by tighter censorship, as the Communist Party intrudes ever more noticeably into China’s technology sector—whether by requiring the shutting down of a popular jokes app, or by announcing that Jack Ma of Alibaba, its best entrepreneur, is a party member. Meanwhile, internet firms are having to look for new ways to attract users and sources of revenue. Karen Chan of Jefferies, a bank, expects growth in China’s online ad budget to slow from the 30% of the past two years to 17% this year.

Baidu, Alibaba and Tencent, as well as Meituan-Dianping and Xiaomi, have announced restructuring plans involving a workforce trim or a reduction in new hires. Didi Chuxing, a ride-hailing giant, halved year-end bonuses for staff. Rumours of large lay-offs have circulated on social media: Zhihu, a Quora-like question-and-answer website, was reported to have fired 300 workers in December (it denied this). Job openings for the internet industry fell by 40% in the first quarter of 2018 on the previous year, according to data from Zhaopin, a jobs website.

How long will such problems persist? For the capital winter, investors say a thaw could be near. China’s stockmarket has bounced in 2019 (see Buttonwood). A new innovation board in Shanghai, modelled on Nasdaq, should encourage local tech offerings, with rules that allow even some money-losing startups to go public. The first flotations may begin in the summer.

Still, China’s unicorns will need to grow differently in future. Many are expanding not in their usual bases of Beijing, Shanghai and Shenzhen, but in second-tier cities, including Wuhan, Chengdu and Xi’an, driven by a need to reduce operating costs. These inland cities are luring talented young Chinese and the startups they want to work for. They offer housing subsidies and relaxed rules on household registrations, a system that ties Chinese to where their family came from.

Xiaohongshu (meaning “Little Red Book”), a popular social network for fashion and beauty products, made the move to Wuhan in 2017 from its base in Shanghai. Its largest office is now there. Lower costs have allowed it to grow quickly, and it entices the best to relocate by paying them rich-city salaries. It was valued at over $3bn in a funding round in June led by Alibaba. Tao Yun, who runs Xiaohongshu in Wuhan, says that the capital winter marks a threshold: startups will need not just “a good story and barbaric growth”, says Ms Tao, but solid numbers to back them up.

In a widely circulated post in December, Wang Xing, the founder of Meituan-Dianping, referred to a prediction that “2019 might be the worst year of the past decade, but it will be the best of that to come”. If firms and investors learn the hard lessons of the capital winter—when it comes to adapting, Chinese startups, after all, have strong form—such dark thoughts may be set aside come spring.



Clarification (March 22nd 2019): In an earlier version of this story we cited a social media post in which Wang Xing, founder of Meituan-Dianping, predicted that “2019 might be the worst year of the past decade, but it will be the best of that to come”. This post has since been removed from the internet. Meituan says that Mr Wang was making a joke about a statement made by someone else, not expressing a view about the economic outlook. The text has been changed online to reflect this.