Venture Capitalists from Valley See Golden Opportunity in China
By Matt Marshall

Venture capitalists across Silicon Valley are falling for China.

Tom Shields, partner at the Woodside Fund, sticks a teach-yourself-Mandarin CD into his car player as he heads to his office in Redwood Shores.

Down the Peninsula, Joseph Tzeng, partner at Crystal Ventures, packs for another trip to Beijing. He's teaching himself to skip breakfast and stay up late, so he can hang with Chinese entrepreneurs who pitch to him at a Beijing pub until 3 a.m. over Chinese Maotai nightcaps.

A few blocks away, Cliff Higgerson, partner at Palo Alto's ComVentures, recently returned from China and is evangelizing his other partners to invest in telecom there. ``We feel China is the most important single event in a generation,'' he says.

For years, if not decades, entrepreneurs have dreamed of making it in China, salivating at the prospect of more than a billion people and an economy growing at 9 percent a year. But for the most part, those dreams have so far remained just that -- dreams, with few and limited cases of success.

Now, new developments are drawing the eyes of VCs, and they see money. A raft of recent successful initial public offerings of Chinese companies show that foreign investors finally have a way to recoup profits from investments there. The companies, which are listed on Nasdaq or Hong Kong stock exchanges, are producing gains that some say could make U.S. ventures pale in comparison.

Take SMIC, the big Shanghai semiconductor company that went public in March. It grew its revenues to $1 billion within four years -- perhaps the ``fastest growing company in the history of the world,'' says Dick Kramlich, partner at Menlo Park's New Enterprise Associates. He invested more money into SMIC -- $120 million -- than any other start-up in his 25 years of investing. Two years later, he has already earned a paper profit.

Eastward ho
Despite risks, a rush to get there

Stories like SMIC are sparking a veritable race among investors to get to China, despite the long list of risks and caveats involved with doing business or investing there. In June, Silicon Valley Bank took 25 local venture capitalists to China to meet with local politicians and entrepreneurs. Many had never been before. On their heels came about 200 Israeli venture capitalists on a similar mission.

The interest is already translating into action. Venture investments into China companies grew to $1.6 billion last year, up from $420 million in 2002. And they increased to $1.2 billion during the first six months of this year, according to the Asian Venture Capital Journal. Last year, 172 venture firms operated in China, up from 38 in 2002.

Some of these are old-time players such as IDG Ventures, which has offices in San Francisco. In the 1980s, it became the first U.S. venture group to invest in China and has had the most success there. Other valley-based players with long-time operations in China -- Walden International, H&Q Asia Pacific and Intel Capital -- have prospered.

For a long time, few others cared about China -- mainly because few start-ups had made it big. But since 2000, a string of success -- from the early portal companies Sina and Sohu to the more recent SMIC, Shanda and CTrip.com -- have made mainstream VCs realize they could no longer ignore China.

The trickle of China converts has since turned into a flood. Draper Fisher Jurvetson was among the first of the new wave, with search engine Baidu among its several investments. Other VC players beefing up their presence include Kramlich's NEA, Crystal Ventures, Doll Capital Management and Accel Partners -- though few have opened an office. A dozen other VCs are still mulling plans.

Kramlich recalls his partners' response when he suggested they invest $100 million in China's SMIC two years ago. ``They said I was crazy.'' They feared the geopolitical risks, he says, but Kramlich responded that risks in the United States were as great. So NEA sent a team of six to China to research SMIC.

Kramlich cross-examined contacts who knew about SMIC, including the U.S. Commerce Department representative in China who confirmed SMIC's local bankers were reputable. A decision by the local governments of Shanghai and Beijing to invest into SMIC on terms similar to NEA's also consoled him. After a week's visit, NEA invested its first $90 million.

Changes galore
Income per capita on the rise

Several other forces have converged to push China into the VC limelight. China's income per capita has risen sharply over the past decade, giving consumers real purchasing power. Half the population in several major cities has phones, compared with only 1 percent in 1990. A large tide of U.S.-educated Chinese entrepreneurs and engineers have returned home to China, taking back valuable management experience.

Finally, the massive growth of foreign direct investment in China from corporations is helping spur China's economy. About $1 billion in capital is invested in China per week, according to McKinsey & Co. China draws more in a year than India does in a decade, says Ram Shriram, an angel investor and early backer of search engine Google. He has invested mainly in India, but China is grabbing his attention. It ``makes the industrial revolution look lame in contrast,'' he says.

Bob Grady, partner at the Silicon Valley office of the Carlyle Group, is convinced Shanghai will be the financial capital of the world within 20 years, perhaps even sooner. He says going to Shanghai today is like arriving in San Francisco in 1849 amid the Gold Rush: ``If I was 22, I'd move to Shanghai, print a business card, and I'd figure it out,'' he says.

Other VCs say they want to go, too, but fear huge risks. Arcane regulations, nuances of local custom, loose accounting and legal standards, and fickle government policy pronouncements -- all make for hazardous conditions. Chinese banks are burdened with debt, and electricity and transportation services are strained to keep up.

`Fools rush in'
Many obstacles, some failures

U.S. venture firms are hampered because it takes time, energy and luck to hire the right Chinese speakers who can manage things on the ground from thousands of miles away. ``There are a lot of fools rushing in right now,'' says Len Baker, partner with Sutter Hill Ventures, declining to name names.

Don Valentine, the leader of highly regarded Sequoia Capital, predicts a coming crash in China that will make the U.S. downturn look ``meaningless.''

Most agree that it's easy to lose money. Early investors in China, including Walden International and H&Q Asia Pacific, concede they were lucky just to make their money back during the 1990s.

And there are numerous horror stories. Tony Huang, former head of Silicon Valley Bank's international venture group, said he lost $500,000 in a personal investment in 2000, when the management of a start-up bolted with the technology: They ``left to form a competing company,'' he said.

The recent activity itself is creating bubble-like conditions there, many complain. Foreign investors, who make up about 90 percent of the VC investments, are bidding up the price of investing in private companies -- offering more money for the same amount of ownership stake.

That pushes up expectations, and many companies are destined to miss the mark, experienced investors agree. China's government is trying to engineer a ``soft landing.''

Long-time Silicon Valley investor Sandy Robertson, who helped form one of China's first domestic VC firms, Chengwei Ventures, says he's worried things have gotten out of hand. A New York hedge fund manager recently sent an e-mail asking Robertson to invest in a new VC fund in China. ``He was sitting in New York, and wanted to do this,'' Roberston said. ``I'm like `Oh my god, this is like the Internet boom.' ''

However, others say China is too big to simply write off. People who blast China as too risky have a point, but they also should acknowledge its potential, says Sutter Hill's Baker.

``We're sitting on the beach looking at this tsunami offshore,'' he says. ``We're seeing people surfing out on it, and saying it looks pretty dangerous to be surfing out there. But we're totally oblivious that the tsunami is about ready to hit the beach.''

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