China: VC and Angel Investing About To Explode
Brian Perry
01-Jan-07
All great empires that have come and gone have given their citizens great opportunities for trade, economic growth, business success and personal wealth. From Roman trading to British colonisation to American industrialism to Japanese manufacturing standards, empires come and go and perhaps the largest the World has ever witnessed is on the verge of explosive growth. Enter China.
1.3 billion people, the vast majority have yet to reach middle class (by Western standards), over 50 cities with more than 1 million people, an industrial manufacturing machine, resource rich, a talented and growing educated population and floods of outside investment pouring into the country over the last few years. China WILL prove to be a Venture Capitalists dream and hotbed of opportunity as the country comes into its own.
China is becoming the new Silicon Valley of start-up and venture backed activity. 2005 was a milestone year for venture capital in China: Chinese venture-backed companies launched a second wave of successful IPOs on the NASDAQ; China-dedicated funds raised US$4 billion in committed capital (up from $1.3 billion in 2004 and 29% up from 2003); foreign venture capitalists advanced the deployment of various operating models in the country; and the government revised regulations that had temporarily restricted the ability of foreign venture capital investors to exit investments in Chinese companies, clearing the way for continued foreign investment.
Sure, over the past decade, foreigners have pumped half a trillion dollars of foreign direct investment into China, much of that as manufacturers ramped up operations. But within the Chinese entrepreneurial communities, not a whole lot of excitement in terms of outside investment. Up until around 2002, most Chinese private enterprise was funded strictly through friends and family (love money) and not until this time was there any real VC activity. Byearly 2004, U.S. VCs started pouring into China, looking for deals and it has not stopped since.
Many Chinese business people say there’s a good reason for their interest and dependence on VCs from the USA, UK and other countries: funding options are simply few and far between for Chinese start-ups. Obtaining funding from Chinese banks rarely happens to start-up or non-proven companies. Up until very recently, organised venture capital didn’t exist. There are a few Chinese companies investing in Chinese based start-ups such as Legend Holdings, parent of PC maker Lenovo, but that is certainly not the business culture yet.
One Silicon Valley VC firm, DCM, established in 1996, that initially started out investing in U.S. start-ups but then started making investments in Japan. They were perhaps one of the first to see the future with China. Since 1999, DCM has made eight investments in China.
According to an interview with Kevin Maney at USA TODAY, DCM states; “We are probably the most exposed (U.S. VC firm) to China and one of the few that has made money,” says DCM co-founder David Chao. One of the attractions for U.S., UK or Japanese VC firms is that China has not reached the level of development and technological infrastructure as already happening in various other “Western” markets. Software, technologies or business models that have been successful in these developed markets, they are hoping will also find a place within the Chinese market. For example, DCM invested in Shanghai-based 51Job, a Chinese version of job-search site Monster.com. The company went public in October 2004 at $21 a share.
Two of the other big names coming out of the Chinese tech sector and have attracted U.S. VCs are Sohu.com (a Chinese version of Yahoo) and Baidu (a Chinese search company, up 145% since its August IPO). There are a number of Private Equity success stories such as Focus Media Ltd., an operator of elevator and supermarket flat-screen TV advertising signs whose NASDAQlisted shares are up 112% since the company’s July initial public offering. Yahoo! Inc.’s $1 billion purchase of a 40% stake in Alibaba.com Corp., the operator of online marketplaces, has further focused interest on Chinese tech companies.
I am sure many of you reading this are thinking; “China, how scary is that! Not only is it far away, communist and a non-English speaking language, but what about all those horror stories about trademark and copyright infringement?” This isn’t to be taken lightly and contract law isn’t well developed in China. China’s culture lends itself to ‘doing business with a handshake’ and is based largely uponpersonal influence. However, with the influx of outside investment, the powers that be recognise the importance of such necessary business acumen and changes are taking place.
Despite any business culture problems, the money just keeps coming in. IBM, Japan’s NTT DoCoMo, Sierra Ventures, Disney and The McGraw-Hill Companies, the parent of BusinessWeek, have all recently contributed to VCs pools of capital.
IDG-Accel China Growth Fund’s new China fund raised $150 million, Sequoia Capital China attracted $200 million, and JPMorgan Chase recently launched funds to invest in China. Carlyle Group paid $375 million for an 85% stake in state-owned Xugong Group Construction Machinery, and Warburg Pincus ponied up $115 million for a 22.5% stake in Harbin Pharmaceutical Group. Last December, US based SVB Financial Group, an institution specialising in VC financing for technology, opened a Shanghai office.
Perhaps other VC firms have the forsight like Sequoia Capital’s YouTube investment. In April, Toodou.com, a video podcasting site that serves up amateur films, was launched and although the company doesn’t have any revenues, the company founder says he spoke to nearly 30 different VC firms. He finally agreed to an investment from IDG of several hundred thousand dollars for a minority stake.
But watch out. With so much money sloshing around, there’s bound to be trouble. Deals that were passed over by seasoned investors a year ago are now getting resurrected, a sign that the market is overheating. “There’s a lot of exuberance in the market,” says Wayne Tsou, managing director of the Carlyle Group in Hong Kong, which has been investing in China since the late 1990s. He feels the market might be showing signs of being overheated. He was also reported as saying he felt sectors such as mobile-phone services and Internet gaming have over-hyped expectations. The largest US based angel investment group has also recently taken notice of all the early stage activity and excitement in China as well. Silicon Valley based Keiretsu Forum opened an office in Beijing. Keiretsu expects their Beijing chapter to invest in similar kinds of start-ups as they do in the U.S., heavy on technology, real estate, industrial and other start-ups thrown in.
Many regard China as the bright hope for developing new ways to use technology, the way investments sparked the Internet boom in America. Not only is China home to the second-largest number of internet users in the world (behind only the U.S.) but is also the world’s biggest mobile phone market, with over 400 million subscribers.
China will be an exciting and promising investment market for at least the next few years. Will it shatter all Silicon Valley records? I am not sure but I have a feeling it will. Let’s just hope the doors will remain open to outside investors and the opportunities will also allow for angels to take part along with the larger VCs. Assuming this all happens and goes the way it should, let’s just hope it doesn’t collapse like Silicon Valley!
