While stricter regulations were expected with China looking to ease pressure on children and the cost burden on parents that has contributed to lower birth rates, private equity industry sources say they were surprised by the severity of the rules that could kill many companies and block their exits.

"Every company is going to take a hit with large layoffs coming," said a Shanghai-based private equity (PE) investor whose firm invested in a number of online education apps targeting school-aged children. "There is zero VC (venture capital) and PE investors can do at the moment.

"We are all waiting for death."

Several PE investors bemoaned a lack of clarity on how China would implement the rules, even as some said this may not be the end and that bulking up on non-academic tutoring could help soften the blow for firms.

Under the new rules, which have triggered a massive fall in the shares of Chinese private education firms, all institutions offering tutoring on the school curriculum will be registered as non-profit organisations, and no new licences will be granted.

The rules ban these firms from raising money via listings or other capital-related activities, and also bar listed Chinese companies from investing in such private tutorial institutions, an official document shows. Foreign investments too are disallowed in such companies.

Private equity-backed investments into China's education sector hit a record high of $8.1 billion last year as pandemic-induced lockdowns boosted demand for online education, Refinitiv data shows. That is more than half the total deal value of $15.5 billion since 2016.

China's two leading unlisted online education platforms, Yuanfudao and Zuoyebang, accounted for the biggest chunk of the private capital raised in 2020, according to data provider Zero2IPO Group.

Yuanfudao, backed by Tencent Holdings (0700.HK), completed three fundraising rounds totalling $3.5 billion in 2020, with the company's valuations more than doubling within 12 months, according to Zero2IPO and Reuters reports.

Its investors include billionaire Jack Ma's Yunfeng Capital, DST Global, Hillhouse Capital Group, Boyu Capital, and Singaporean sovereign wealth funds GIC and Temasek.

Zuoyebang, which raised over $2.3 billion in two funding rounds last year, counts Alibaba Group , SoftBank's Vision Fund, Sequoia China, and Fountainvest Capital Partners among its investors.

All the sources declined to be identified due to the sensitivity of the matter.

'JUST SCRAMBLING AROUND'

Some PE investors believe their portfolio companies could look at transforming their businesses from curriculum-based tutoring to vocational and extracurricular courses to soften the blow of the new rules.

China's $120 billion private tutoring sector could seek to separate its business segments and bulk up non-academic tutoring, analysts said on Monday.

Over 70% of the education sector fundraising in the first half of 2021 went to corporate services, extracurricular education and vocational training companies, local research firm EDU INSIGHT data showed, amid expectations of new rules.

Some PE investors in the tutoring groups said it was unclear how China will implement the new rules and if and how investors would exit.

"There is always a time gap between the issuing of China's policies and the implementation of them. And there is always room for interpretation," said a Zuoyebang investor.

"Right now everybody is just scrambling around."