Startups all across China in the technology sector are looking for seed money and second-and third-round investments, and are courting foreign as well as local investors, particularly U.S.-based venture firms.
But are the American VCs interested? Do they share in the buzz, the excitement about China?
They most certainly do; the answer is definitely yes. But it’s a qualified yes. American VCs aren’t just handing out money at the drop of a Chinese hat. While there is perhaps a bit of a gold rush mentality in the semiconductor industry with regards to China, perhaps the VCs remember the aftermath of the last technology gold rush – the one that began with the letter “I” — and are treading a little more cautiously.
But that’s not to say that U.S.-based venture capitalists aren’t taking a long, hard look and China, because they are. And they are excited about what they see, and what the future holds.
Only a Matter of Time
Everybody is excited about China for one reason or another, and VCs are no different. While many, if not most VCs in the West are reluctant to invest directly in China-based startups, they often speak as if it’s only a matter of time. And it is a sure bet they are looking at their clients based outside of China and how they can help them do business in China. It is without doubt an important market.
They often cite the use of mobile technology in China, where a lack of a wired infrastructure coupled with an emerging middle class is opening opportunities that don’t exist in older and more developed Western markets, or have a much more limited demand here, such as Internet protocol television and bill paying by mobile phone.
“It’s obviously a great new customer area,” said Mark Gorenberg of Hummer Winblad. “We look at it today as much more potential for our customer base rather than investing for ourselves,” he said. “But we talk about it all the time.”
Dave Liddle, a general partner at U.S. Venture Partners, said his firm has been looking recently at several Chinese-based companies but so far hasn’t made that kind of direct investment. “But that’s just how it’s turned out,” he added.
What’s more common at this point for Western VC firms interested in China typically is to work with a Silicon Valley-based firm that actually has a few people on the ground in China, or has opened an office there, or they work with a U.S.-based company that has set up its manufacturing in China, Liddle said. In fact, China is a market that VCs are encouraging their startups to look at now, ahead of more traditional markets, like Europe, he suggested.
But that’s not to say that U.S. Venture Partners, Hummer-Winblad and others aren’t looking at investing directly in China.
But like any investment, the general rules apply: the market served has to be accessible, and it has to be a cost effective proposition, Liddle explained. “We track that a great deal,” he said of potential direct investments in China. The company maintains a lot of connections within in the U.S. entrepreneurial community that have ties to Taiwan or mainland China.
One firm that is investing directly in China right now — in what is perhaps an example of how the world of capital is changing, and not just with regard to China – is Big Blue, or rather its VC arm, IBM Venture Capital Group.
“The energy in China is just tremendous … all the legendary firms are very much focused on China right now,” said Claudia Fan Munce, a VP and the managing director of IBM’s VC Group. Incidentally, at the time she was interviewed for this article last month, Fan Munce had just returned from China where IBM had hosted a meeting of some 200 VC firms from around the globe.
Rather than make direct investments, IBM’s VC Group operates on what it calls a “give to get” strategy, focusing on relationships that will directly benefit IBM. But it works with other traditional VC firms that do make direct investments
Many foreign VCs are teaming up very quickly with local firms throughout the Asia/Pacific region, and many in China, Fan Munce observed. “Our drive is … what are the best companies and what are the best technology solutions? What kind of partner do we want to bring to market with us? How can our technology help them?”
Big Blue Puts the ‘e’ in YeePay
One of IBM VC Groups success stories in mainland China, and an example of the type of emerging market that exists in China thanks to a relative lack of existing infrastructure, is YeePay. Founded in 2003, YeePay (which translates into Mandarin as “easy pay,” according to the company) is an electronic payment service provider. It enables consumers and businesses to send and receive payments via the Internet, mobile and traditional wired telephones.
In November the two partners, IBM and YeePay, announced that in just five months after the partnership began, YeePay increased its financial transactions handling from just $120,000 per month to more than $1.2 million per month. A lot of that had to do with IBM’s association with the startup; IBM is a revered brand in China. In fact, IBM’s laptops are so venerated there that some Chinese consumers were not excited but worried when domestic PC maker Lenovo bought IBM’s PC unit, worried about the future quality and performance of the Thinkpad laptop.
But it wasn’t all just success by association, said Fan Munce. IBM provided servers and middleware to YeePay, helping them build an infrastructure based on open-standards hardware and software – not to mention access to a global infrastructure — and went with the company when it approached new customers. IBM isn’t a software applications provider; it doesn’t do industry-focused software, but needed a way to serve industry verticals, she explained. “Our mission has always been to identify a pipeline or partner,” Fan Munce said.
In a country that already has more mobile phone users than the entire population of the United States, and skyrocketing activation rates, YeePay was naturally attractive to Big Blue. There is a high risk, Fan Munce acknowledged, but huge potential for high returns. And that’s important for IBM, where more than half the company’s revenue is derived from services. And as Fan Munce observed, “We don’t really care who caries the brand.”
And there is a larger story beyond the IBM/YeePay, foreign-VC-success-in-mainland China story, and that story is the emergence of the corporate VC firm; IBM is far from the only big technology company to get involved in the venture capital game. Big Blue rival and fellow chipmaker Intel is a prime example; at the other end of the technology spectrum Cisco Systems is another.
The emergency of corporate venture capital as a means of growing a business and driving revenue is a definite trend that has emerged just within the ten years, Fan Munce agreed. And it has blossomed; just take IBM. When Fan Munce joined the IBM VC Group in 2000, it was involved with some 21 startups; as of last month, it was involved with 964 scattered around the globe.
Rules Still Apply for VCs with Regard to China
So what is the implication for China? In the future the technology industry is likely to see more partnerships a la IBM and YeePay, aside from interest on the part of more traditional VCs.
And as for VC firms looking to get involved in China, they face the same issues that anybody looking to do business in China faces, such as intellectual property protection, and establishing and maintaining the proper relationships needed to get things done. Both Liddle and Gorenberg acknowledged that while China’s government definitely seems to be stepping up its efforts on IP protection, it is still an issue to take into consideration.
“As a venture capitalist, I focus on companies where the IP has originated with the entrepreneur in China, or with these particular people,” Liddle said. “That’s different than taking IP originated in the U.S. and transferring it into China.”
IP protection is a problem that to some degree is culturally ingrained, Gorenberg observed, and that has to change. But he noted one recent example that it is indeed changing.
With the Olympics coming to Beijing in 2008, the central government has already gotten its marketing efforts well underway – and, in a somewhat ironic development, has had problems with local “entrepreneurs” selling knock-off souvenir paraphernalia, souvenirs that aren’t officially licensed, yet feature copyrighted logos and so forth. The government is already cracking down on this, and that’s a hopeful sign that it will become further involved in efforts to protect corporate IP, Gorenberg suggested.
Foreign VCs looking at China also face the age-old question they always do anywhere and anytime they become involved in a startup: how to pick a winner. This is compounded by the fact that many Chinese startups, not to mention established companies, are constantly turning to what’s hot and trendy at the moment. A year ago, for example, there were some 400 mp3 player manufacturers on the mainland.
“It is difficult,” Liddle acknowledged. Typically, VCs will categorize startups into “brave new world” companies, that have something new, or “faster, better, cheaper” companies, those that have a better product or better way of serving an existing market. In China, most of these fall into the latter category.
Because of that, it’s often not difficult to validate the market a startup wants to pursue; what is often difficult is determining the character of the team involved in a startup. In cases where an entrepreneur or executives in the fledgling company were educated or worked in the industry in the United States or Europe, evaluation is not so difficult. Where it becomes problematic is when the entrepreneurs have spent their entire career in China, Liddle observed.
“We don’t have the same type of references there,” he said. “The trickier thing is to evaluate the senior people in the firm then. That’s hard. It can be done, but it takes a lot of work and it takes a slow process”
Which is perhaps why so many VCs are either looking to take their fledgling companies from the U.S. and elsewhere into Asia/Pacific, and namely China, or looking to partner with people and companies already in China. Relationships are the critical element when it comes to doing business there.
“In China people believe — and it’s true by the way – you have to be tapped into the local ecosystem,” said IBM’s Fan Munce. “You have top know the right people.”
Editor’s Note: As explained at length elsewhere on this site, this is a news story written by me that originally appeared on the now-defunct Electronic News’ website, which is long gone. It’s former sister pub Electronic Design News (EDN) currently holds the copyright to all Electronic News copy (to the best of my knowledge). You can still see a copy of this story at EDN.