Venture Capitalists at a Crossroads in China

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Venture Capitalists at a Crossroads in China [Copy link]

In the past 10 years, the extracorporeal circulation model with both ends (financing and exit) outside used by international VCs when investing in China has almost determined the evolution curve of China's venture capital industry.

　　In the initial chaotic years, non-mainstream corporate-affiliated VCs in the international VC circle entered the Chinese market with so-called strategic goals and dominated the market with absolute advantage. At that time, the projects most likely to be approved by the investment committee in the United States were those that Americans could understand and had successful precedents in the United States. Most of the investment targets were overseas students who returned to China and had the advantage of being close to the water and getting the moon first.

　　The success of these American models in China shows that China’s market environment and business model are actually very different from those in Europe and the United States. As more and more international VCs and their investors are attracted by these success stories, they are surprised to find that there are many things called “local business models” in China’s business landscape that they have never seen before.

　　More importantly, only those who understand the "local business model" can truly find investment opportunities. Those savvy mainstream LPs (limited partners) have obviously noticed this. At the same time, the goal conflicts of corporate-affiliated VCs remain.

　　The combination of various factors has accelerated the pace of China's venture capital industry entering an era of fission.

　　Reload and set off

　　This is a world that changes frequently. There are no permanent losers or permanent winners.

　　Reporter: Hu Caihe

　　On February 15, 2006, Kuang Ziping left Intel Capital, where he had worked for six years, and joined hands with Gary Rieschel, former executive director of SoftBank America Venture Capital and founder of Mobius, and Ignition Partners, a venture capital firm headquartered in Seattle, to establish a new venture capital firm in China, Qiming Venture Partners. Qiming and Ignition will jointly implement a $200 million venture capital plan in China.

　　About a month ago, Kuang Ziping's boss, Intel Capital Vice President Claude Leglise, also chose to leave and joined WI Harper Group, which mainly engages in venture capital activities in China and the United States. A year ago, Kuang Ziping's new colleague Gary Rieschel had already settled in China.

　　This is just the latest epitome of a series of events in China's venture capital market that have seen a shift from quantitative change to qualitative change.

　　Around 2000, single LP (limited partner) funds with industrial or financial backgrounds, such as Intel Capital, IDGVC, Softbank Asia, Softbank China, Goldman Sachs Investment and other institutional investors that do not have capital returns as their sole purpose, occupied an absolute dominant position in China.

　　Today, the value of the Chinese market has been and is continuing to be proven for mainstream LPs whose main purpose is to return capital. During this period, the gradually mature management teams and individuals in these corporate investment institutions have become an important channel for these mainstream LPs to enter China.

　　This indicates that China's venture capital will usher in an era of independent funds supported by multiple LPs.

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　After 20 years of gestation and development, especially in the past 10 years, China's venture capital industry seems to be showing the trajectory of the US venture capital industry. On the one hand, some companies and entrepreneurs supported by venture capital have begun to invest in the venture capital industry; on the other hand, after the company has entered a relatively stable development stage with IPO or acquisition, some entrepreneurs choose to start a business again, while another group of entrepreneurs have begun to change their roles from entrepreneurs to venture investors. When this group of entrepreneurs meets the mainstream US VC China fever, they can often collide with some dazzling sparks. Although there may be more effective ways for entrepreneurs to enter the venture capital field, this phenomenon itself has developed into an unstoppable trend. "Many successful entrepreneurs abroad eventually become venture capitalists," said Huang Jingsheng. "No matter how big or small the achievement is, the entrepreneurial experience itself is a very valuable asset." "A good venture capital team needs professionals with different backgrounds, such as those who have worked in investment banks, lawyers/accountants, and executives of multinational companies." However, Huang Jingsheng emphasized that the lack of investors with entrepreneurial experience in the venture capital team for a long time may be one of the internal reasons for the overall "backward" of my country's venture capital industry. On the contrary, most of the top VCs in the United States are focused early investors. Relatively speaking, people with entrepreneurial experience can better understand the ups and downs of entrepreneurs. "Many Chinese entrepreneurs treat their companies as their own children and invest a lot of emotions in them." In dealing with some sensitive investment terms, VCs with entrepreneurial backgrounds may often show more understanding and sympathy than VCs with pure investment banking backgrounds, so "the former are often more likely to be recognized by entrepreneurs." For a long time after the investment is completed, VCs usually have to spend a lot of time and energy on the funded companies. "People who come from investment banks usually don't have this habit. Basically, once the deal is done, their connection with the company ends," said Huang Jingsheng, who once co-founded PR Newswire. Lin Xinhe, who is about to leave Sina and join DCM, said that there are always ups and downs in the process of starting a business. Since he has been through it once, people with entrepreneurial experience may show greater patience for the setbacks and difficulties encountered by the company. "People with entrepreneurial experience may find it easier to find ways to solve problems and will not be so panic-stricken; when the company is particularly smooth, they will not be very excited. Of course, with the overall 'leaning back' of China's venture capital industry, VCs with professional manager backgrounds also have a lot of room to play a role. The main reason is that the challenges faced by companies of a certain scale and companies in the early stages of entrepreneurship are different." As a group of people with entrepreneurial experience have joined China's venture capital team, whether China's venture capital industry can pay more attention to early-stage investment has become something worth looking forward to. In Huang Jingsheng's eyes, "If this is true, emerging companies in the early stages of entrepreneurship may benefit greatly." So far, GSR Ventures and Northern Light Venture Capital Fund have invested in some early projects in their respective fields, such as "The Legend of the Condor Heroes" and Mysee. "For particularly early investment projects, VCs must be very localized," said Huang Jingsheng.

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Localization vs. Internationalization "We will not raise funds specifically targeting China. We will continue to adhere to our proven global operating model." Like DCM, DFJ, one of the few mainstream Silicon Valley VCs that entered China around 2000, and the recently arrived BlueRun have always used their global venture capital funds in the Chinese market. As the co-founder of DCM, Zhao Keren is worried that some mainstream VCs in Silicon Valley have set up different funds according to different geographical regions in the past, but the long-term result is separation. "Because the operation of funds in different places is bound to be good and bad." In 2005, the scene that Zhao Keren was worried about also began to play out in China. As the best performing fund in the SoftBank system, the management team of SoftBank Asia achieved independence by successfully raising a $643 million SAIF Asia investment fund. Yan Yan, the chief partner of SAIF Partners, who created this landmark event in the history of Chinese venture capital, emphasized that "independence is the highest realm for every professional fund manager." Yan Yan also has the same dream as Xu Xin, former president of Baring Asia China, and Wen Baoma, former director of Actis Investments. The platform created by this duo is called "Capital Today". However, since the history of venture capital entering China is very short, not all VCs can now achieve a completely independent state. Therefore, in 2005, a considerable number of Chinese VC groups chose the intermediate state of "semi-independence": cooperating with top VCs entering China to establish funds targeting China as the target market. For example, Zhang Fan, former director of DFJ Global Funds, cooperated with Sequoia Capital to establish the Sequoia Capital China Fund with a scale of US$168 million and served as a founding partner. Sequoia Capital's investment portfolio includes world-renowned companies such as Google, Yahoo, Apple, Cisco, and Oracle. The VCs that appeared on this "semi-independent" list in 2005 should at least include: Huang Jingsheng, former managing director of SAIF China, became the managing director of Bain Capital in China; Fu Jixun, former director of DFJ Global Fund, joined GGV as a partner. "When making investment decisions, there is an essential difference between having this vote in the hands of Chinese people and not having this vote." Due to the heavy restrictions, Zhang Fan, who had previously "done quite well", has only invested in 3 to 4 companies in the past few years, and the amount involved is not high. In Huang Jingsheng's view, the rapid rise of the new generation such as Zhang Fan is due to "hitting the right spot." "In 2004 and 2005, the international mainstream VCs suddenly felt that China, which was a unique place, was a region they should enter, so these people with certain performance in the Chinese venture capital market would receive more extraordinary attention." In fact, it is not just Zhang Fan and other individuals who hit the right spot. Some venture capital institutions with a high degree of marketization that developed earlier in China are the beneficiaries of this wave of international venture capital in China. "There are definitely more people who lose money in China than those who make money in China." In Yan Yan's view, although there are many potential opportunities in the Chinese market, it is still very difficult to really make money in this market due to its own particularity and complexity. In the past 2005, some big-name VCs that entered China early not only truly experienced the mystery of the Chinese market, but also began to adjust and enrich their China strategies. In order to systematically grasp the opportunities in the Chinese market, these former "flying VCs" began to adopt a multi-channel approach: on the one hand, they set up offices in cities in mainland China; on the other hand, they even adopted the "Fund of Funds" approach to invest in local VCs in China. In 2005 alone, such scenes were staged several times: Accel Partners invested in IDGVC; 3i invested in CDH Ventures; DCM invested in Lenovo Capital; and so on. "With these relatively mature local capital channels, these VC bosses can reduce the risks and costs of entering the Chinese market on the one hand, and can also easily approach project sources on the other hand." Huang Jingsheng emphasized, "These should be part of their strategy, and it does not mean that they have turned themselves into a fund of funds." "Each VC has its own operating model. This may be related to their culture, resource background and what the executives want to do." Huang Jingsheng believes that each model may succeed or fail. "This may not be a competition in investment models, but more of a competition between different team combinations." However, the localization of decision-making is beyond doubt. "Startups, especially early-stage companies, may encounter problems at any time and need to be followed up in a timely manner. If the decision makers are all in the United States, it is not convenient to even make a phone call." Zhao Keren revealed that Lin Xinhe will officially join DCM in the second quarter of 2006 and stay in its Beijing office.

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Business model: from diffusion to endogenous The development and maturity of local investment funds in China are the key to the long-term success of Chinese entrepreneurial groups. At present, the Chinese market can support and accommodate enough VCs to give them the opportunity to make money. From the perspective of mainstream Silicon Valley VCs such as DCM, the business model pie chart of Chinese companies can basically be divided into three parts. One is the absolutely dominant Copy to China model, which accounts for about 60% of the share; the other is the hybrid model, such as SP-type companies. "You can say that these are local original models, but Japan already had the I-Mode model before, and Chinese companies have added some localized innovation factors to it." This type accounts for about 30%; the other type is the truly innovative model. Zhao Keren predicts that after 2006, the proportion of innovative models will gradually increase from less than 10% at present to 30%. Around 2000, many Chinese startups were simply imitating new technologies and promoting American business models. At that time, the main task of VCs was to "find the right people and do the right things well." "The Chinese model will be favored by more and more investors, while the American model will show the opposite trend." Zhou Zhixiong, partner of SAIF Partners, firmly believes that the Copy to China model will eventually give way to the local Chinese model. The reason is that even when international VCs entered China one after another and Chinese entrepreneurs copied the American Internet model in large numbers around 2000, the portals that copied the American model successfully were listed first, but the real turning point was after the rise of text messages and online games. The result of pure copying of eBay, such as Eachnet, was bought by eBay. Even so, the future is still uncertain. "The companies that can really succeed in the future must be those rooted in the needs of the local Chinese market, and must have their own business model, or localize and innovate foreign (American) business models. Among the SAIF investment portfolio after independence, Zhou Zhixiong, as a firm supporter of the Chinese model, personally likes ATA, which is in line with the business model of the Chinese market. "China is a country with a lot of exams. In a society oriented by exam results, how to test a person's skills (hands-on ability) rather than just knowledge (memorization is enough), and how to link the test results with work ability, this has always been a major challenge for companies. In order to help enterprises overcome this challenge, ATA (American Assessment Software Systems, Inc.), founded in 1999, has developed into the world's largest and most advanced company combining test technology, test services and skills education. Microsoft also uses ATA's test technology for the "Microsoft Engineer" certification exam worldwide. Acorn International, invested by SAIF, may represent another localization trend: designing a business model that is quite different from the American model based on similar market opportunities and different market conditions. "Copy to China model will still be one of our investment themes. Innovative models will also provide us with a lot of space in the future." Zhao Keren also emphasized that DCM is very optimistic about the hybrid business model and has made some investments in this regard, such as Mop and 99bill. "American TV content providers are not very willing to cooperate with companies like Mop and provide point-to-point services. At the same time, since China's financial service environment lags behind that of the United States, this also provides Chinese companies like 99bill with opportunities to survive and develop." The uneven distribution of factor resource markets in software outsourcing, especially in the semiconductor field with obvious signs of industrial transfer, provides a market foundation for the birth of cross-border hybrid start-ups. Fiberxon, which was born in the bursting of the global "optical communication bubble" in 2000, is such a company. In the context of widespread losses in the optical communication industry, Fiberxon effectively integrated the capital markets of the United States and other countries, the production factor markets of Greater China, and the fiber-to-the-home (FTTH) markets of Japan, South Korea and other countries. In 2005, Fiberxon successfully became the first Chinese company invested by the top American VC Greylock. The success of Mengniu, Li Ning and others proved to international investors the investment value of China's traditional industries. In 2005, not only Actis and CDH, which focus on investment in China's traditional industries, were sought after by investors in their new round of financing, but also top international investors such as Bain Capital began to enter the market in their own way. "It is not uncommon for Chinese companies to achieve annual profits of US$5 million." Although companies in these traditional industries may perform differently in different countries due to different factors such as consumer demand and resource conditions, as a whole, they almost follow the same industry growth curve. "The market structure of the industries we selected (pharmaceuticals and health products, daily consumer goods, electronic communication products and services, and auto parts) has not yet taken shape." Chen Bosong, global partner of Actis, has set his sights on those companies with an ambition to become industry leaders or industry oligarchs and have an annual profit of 5 million US dollars. "When the business of a company expands and the organization becomes complex, if the management structure of the company is not well established, many companies may collapse." In order to help companies avoid falling into the "Chinese trap" that Sanzhu, Giant, Qinchi and others have encountered, Actis, as a pure financial investor with 58 years of investment experience in emerging markets, makes full use of its global network to actively provide value-added services to the invested companies in terms of strategy, corporate governance, financial management, business expansion, etc. So far, three of the seven companies invested by Actis in China have been successfully listed, and another three are in the intensive preparation stage for listing. Among CDH Investment's long list of investment portfolios are Nanfu Battery, Eagle Ceramics, Mengniu Dairy, Li Ning Sports, China Mobile and other names that are familiar to Chinese people.

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Internal circulation path "80% of venture capital in the United States exits through mergers and acquisitions, and only 20% exit through listing. Of course, this ratio will change with different years. The situation in Japan is the opposite, with 90% exiting through listing and 10% exiting through mergers and acquisitions." Zhao Keren, managing partner of DCM, which mainly engages in investment activities in the United States, Japan and China, believes that it is too early to judge which model will become the dominant model in China. "As far as the current situation is concerned, these two models are sometimes 50-50, and sometimes 40-60." DCM, which entered in 2000, has invested in more than 10 companies in China, including SMIC, VanceInfo, Shangyang Technology, and UUME. As of December 31, 2005, among DCM's investment portfolios in China, 51job, SMIC, and Vimicro have been successfully listed on NASDAQ, New York Stock Exchange, and Hong Kong Stock Exchange. DCM's approach actually represents the typical path adopted by mainstream international VCs when investing in China. On the other hand, although Chinese enterprises supported by venture capital can choose to go public on international secondary markets such as NASDAQ, this will expose investors and entrepreneurs to the risk of separation between product market and capital market. Obviously, the trend of capital decision-making power and the localization of business models will likely increase this risk. Therefore, from a long-term perspective, the real future of international institutional investors in China is to change the current "two ends outside" (i.e. financing outside and exiting overseas) extracorporeal circulation model into an internal circulation model. In November 2005, the National Development and Reform Commission, the Ministry of Science and Technology, the Ministry of Finance and other ten ministries and commissions jointly issued the "Interim Measures for the Administration of Venture Capital Enterprises". The previously revised "Company Law" and "Securities Law" also began to be formally implemented in 2006. All these indicate that the institutional ice that has hindered the development of venture capital in my country has begun to melt. Huang Jingsheng expects that with the progress of institutional reforms such as full circulation of the securities market and exchange rates, when more VCs choose to raise funds domestically in five years, the domestic securities market may develop into an exit channel for venture capital. "But it will not immediately become the main channel for venture capital to exit." In Huang Jingsheng's view, the reason why such a big miracle will not happen immediately in five years is that "it will take a long time for the domestic securities market to restore trust, generate attractive transaction records and form a cluster effect." "We can't imagine what it will be like in 15 years." "Singapore, Taiwan, and Hong Kong all relied on foreign funds for investment in the early years, and finally developed to use their own money to do it, both ends are inside, not outside." While a group of VCs around 50 years old such as Yan Yan have obtained investment decision-making power, a group of young people between 30 and 40 years old like Zhang Fan are growing rapidly. "In the entire venture capital industry, 20% of VCs earn 80% of the profits." Yan Yan believes that in the future, these 20% of VCs will have a very strong ability to choose capital suppliers. At the same time, the Chinese government is retreating in the field of venture capital. Governments at all levels in China are gradually inclined to become venture capital mother funds. "The government's participation in venture capital through the Fund of Funds approach can be found in Israel and Singapore." The role change of the Chinese government from GP (general partner) to LP (limited partner) that Taiwan's venture capital godfather Xu Dalin hoped for is becoming a reality. As early as 2000, Shanghai Venture Capital Company, which has the background of the Shanghai Municipal Government, invested RMB equivalent to US$5 million in Venture TDF Tech III managed by Huaying Investment. In the cooperation between IDGVC and Jiangsu, "the Jiangsu Provincial Government played a very rare role of a pure limited partner." The Tianjin Municipal Government not only contributed money but also contributed manpower in the fundraising process of SAIF China Growth Fund, the first unincorporated (RMB) fund in China. "The Tianjin Municipal Government took the initiative to find us, and they were basically handling the relevant procedures." "SAIF China Growth Fund can explore the efficient use of tens of trillions of savings in the future." Yan Yan and others hope to become pioneers in order to provide a model for later generations to follow. "There is plenty of money in China, but it has not yet come to its senses."