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
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.
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.
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,''
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
`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
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.''