What tech investors in China are looking for

After two years of struggling to raise funds, Chinese start-ups are seeing the interest of venture capitalists pick up again, as the boom in the United States crosses the Pacific.

“The capital’s winter is over, the competition for transactions is fierce,” said Ming Liao of Prospect Avenue Capital. “You have to bring something to the table more than money to close business now. “

The number of venture capital operations in China increased 56% in the first quarter compared to the previous year, the fourth consecutive quarter of activity on the rise as start-ups generated 354 billion Rmb (55 billion of dollars) of investment, according to data provider ITjuzi.

Dynamic public markets and an influx of foreign money have helped. Tencent, the most active investor, took some gains as its listed investment portfolio tripled in value last year. Venture capital firms such as GGV Capital, Qiming Venture Partners and Matrix Partners China have raised significant new funds.

In some ways, investing in China and the United States is similar; the two markets are large enough to encourage the creation of large technology groups and Chinese investors say that the valuations of start-ups are now comparable to those of their American peers.

But investing in China also has its own quirks. Each new idea often spawns a multitude of copiers and even competitive forays from the country’s tech giants. Differences in culture and government regulations add to the challenges.

Cultural differences extend to the type of business models that work. Unlike the United States, which has seen skyrocketing valuations for companies selling Software as a Service (SAAS) to large enterprises, this sector has yet to grow in China. Shaun Lim of Hopu Investments said it can be difficult for software companies to register subscribed customers.

“People here don’t place as much value on intangible services. They are more willing to pay for something they can see and touch, ”he said. Lim said that an enterprise AI software company he supports has increased sales by integrating its software applications into the servers it sells.

Other factors have hindered adoption of SAAS, including a history of free pirated software and a cheap labor force to handle some of the functions that software can automate.

Graph of start-up investments in China over the past six years

Mainstream technology has historically attracted most of the venture capital funding and produced the highest returns, dragging the hot sectors of the day into booms and recessions. While the copying of ideas is happening everywhere, it can be on a different scale in China.

During the infamous “War of a Thousand Groupons” in China in the early 2010s, research firms claim 1,880 start-ups copied Groupon’s group buying business model. The carpool wave has favored 214 competitors, at least 20 companies have embarked on bike sharing, and 208 have started businesses that rent portable power banks to charge electronic devices.

With such fierce competition, investors argue that execution and hard work can overcome not being the first in a new field.

For GGV Capital’s Jixun Foo, it was faith in founder Yang Lei that helped him support Hellobike’s push into the bike-sharing space as a rainbow of orange bike-sharing, yellow and blue were already blocking the streets of China’s largest cities.

“I was convinced that [Yang] could do this in a more operationally efficient manner, ”Foo said. “The first actor gives you a lead. . .[but] How effective are you compared to your peers? This advantage will certainly show itself over time. Five years later, Hellobike reported nearly $ 1 billion in revenue last year with fewer losses. Many of its competitors have failed.

In the equally competitive space of portable power banks, Wanlin Liu, who focuses on technology investments for Carlyle in China, decided to invest when a winner emerged from the first wave of start-ups that are emerging. are launched in the business. Even then, as she weighed an investment in Energy Monster, she worried about the arrival of big Chinese tech companies.

“You have to really understand all the top players and any potential competition from the biggest tech giants, before you can make the call,” she said. Energy Monster maintained its lead even after the entry of $ 240 billion delivery company Meituan. “It’s a matter of execution,” Liu said.

To help assess which teams have what it takes, M31 Capital’s Nathan Zhong sometimes makes unannounced visits to start-up offices the night before investing. On a recent outing, he found the desk of a data analytics startup empty.

“Their product iterations weren’t very fast – the CEO’s resolve to keep fighting was weakening,” he said. “Getting out of work early was that. »M31 decided not to invest.

Patrick Zhong leads one of M31 Capital's weekly Monday meetings

Patrick Zhong, at M31 Capital’s weekly meetings, says unorthodox night visits are a way to judge the suitability of potential investment targets © Ryan McMorrow

The unorthodox night tours are part of what M31 founder Patrick Zhong calls “feeling the heat” of potential investment targets. “Everyone in China is smart; if you sleep behind the wheel, your competition will catch up with you quickly.

Government policy can also be a source of uncertainty. In January, China’s central bank proudly said it had crushed all peer-to-peer online lenders in the country – by a peak of 6,000 – concluding a campaign that crushed a wave of VC betting.

“You should always be aware of, ‘Is this company on the right side of China’s long-term government policy?’ Said Gary Rieschel, who founded Qiming Venture Partners 15 years ago. “Chinese entrepreneurs face great ambiguity,” he added.

VCs say there are smaller differences throughout the investment process. Start-ups often hire financial advisers or FAs, as they are colloquially called, to reach out to investors. Sincere CEO references can be hard to come by. And investing in a fledgling business that may one day need a new leader may not end well. Getting top executives to “replace the trust they had in that original founder” is very difficult in China, Rieschel said. “It’s a low trust environment. “

Although SAAS companies have yet to take off in China, Zhong of M31 Capital believes software is the future and finds it useful to examine the trends underway in the United States. In a recent weekly meeting, his team spent an hour studying the re-acceleration in growth of database company MongoDB as its use cases developed and examined its valuation.

“Over the next 20 years, China will follow the United States in using software to improve business efficiency,” Zhong said. “We’re not saying it’s going to be exactly the same path as the United States, but it’s a benchmark.”

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