VC invasion

Robin Li (fourth from left), CEO of Baidu.com Inc, rings the NASDAQ closing bell on August 5, 2005 at NASDAQ's Market Site in New York City.

When Robert Theleen set up his China-focused private equity fund in 1982, the American venture capitalist was faced with a dilemma: there were few Chinese entrepreneurs with whom to make a deal on the mainland.

The reason was simple: a planned economy simply needed no entrepreneurs. And following Deng Xiaoping's move to reform the economy in 1978, the first group of private businesses were still struggling to accumulate their first fortunes.

Theleen's ChinaVest, the first foreign venture capital fund focused on the mainland, had to cast its sights on entrepreneurs from Hong Kong and Taiwan instead. And as there were basically no hi-tech industries on the mainland at the time, ChinaVest could only put its bets on the export-oriented manufacturers, thanks to the nation's enormous pool of low-cost labor.

Twenty years later, Theleen's dilemma was gone. Venture capitalists, from abroad and home, are flying into the nation to bargain with picky entrepreneurs for deals that could make them millions of dollars. The nation, still labeled a manufacturing powerhouse, is showing the potential to fashion itself into an innovation hotbed, as investors spend heavily in a bid to cultivate the next Baidu, Sohu.com and SunTech.

"I am excited about the entrepreneurship and the potential for innovation we are seeing here," Timothy Draper, a veteran Silicon Valley venture capitalist, said in an interview with China Business Weekly last year. "We may see some world-class (businesses) coming from this nation in a few years."

'Briefcase company'

Although ChinaVest made its first deal in the 1980s, its first substantial payout came about 10 years later. In 1997, Zindart Manufacturing Limited, in which ChinaVest invested $12 million in 1993, became the first Chinese company to be listed on NASDAQ.

It's difficult to find the information about the deals ChinaVest made in the 1980s. And when Zhao Jun, the company's executive director, recalls the period, he only says: "When it comes to investment, you can't lag behind the others. However, you also can't be too fast. You need to do things according to the overall economic environment."

Like many other novel concepts that have sprung up in China in the past 30 years, venture capitalists like Theleen were initially met with skepticism and mistrust.

"People used to call us 'briefcase companies', which often referred to the ones set up by swindlers with only a briefcase and a rented office," recalls Xiong Xiaoge, the founding partner of IDG Technology Venture Investment (IDGVC).

Xiong was also among the first group of venture capitalists in China. After completing his graduate studies at Boston University, Xiong joined the International Digital Group, an IT research and media corporation. In 1993, Xiong helped the US company establish IDGVC in China, which later invested in 100 startups in the nation, including Baidu Inc, Ctrip, Sohu.com, and Tencent. The venture capital fund had 1.5 billion yuan under its management.

Nowadays, when Xiong appears at an investment forum, eager entrepreneurs swarm to his side to ask for his business cards, which only contain the telephone number of his secretary.

"But back in the '90s, entrepreneurs often saw us as charlatans," says Xiong. "We agreed to give them money, only asked for a minority stake, promised to cash out sometime, and weren't fussy about dividends. It took a lot of talk to make people believe that such good deals exist at all."

To make his so-called "briefcase company" look more reliable, Xiong and other venture capitalists also chose to partner with the government.

In 1993, IDG invested $20 million to set up a joint venture capital firm with the Shanghai Municipal Science and Technology Commission.

This strategy offered a shortcut for foreign venture capital firms to tap into innovations held by government-funded research institutions. It also helped government officials to become familiar with the concept. A series of incentives to spur the development of China's venture capital sector were later rolled out.

However, for every shortcut, there is a price. Some venture capital firms were required to invest only in the precincts of their government partners in order to boost the local economy. This meant some promising opportunities had to be sacrificed simply due to the target company's location. And some venture capitalists also complained about the low-efficiency of their government partners.

Forerunners

The Chinese who received their PhDs abroad were the first entrepreneurs who benefited from the rise of China's venture capital sector. Charles Zhang, founder and chairman of Sohu.com, is often recognized as a poster child for the venture investment boom.

Zhang, a Xi'an native from West China's Shaanxi province, completed his undergraduate studies at Tsinghua University in 1986 and later received his PhD in experimental physics from the Massachusetts Institute of Technology in 1993.

In 1995, Zhang returned to Beijing and a year later, he persuaded Nicholas Negroponte and Edward Roberts, two prominent MIT professors, to invest $225,000 in a website which later became a leading portal in China - Sohu.com.

Zhang's company later received venture investments from Intel Capital, IDGVC and went public on the NASDAQ exchange in 2000. Besides making a fortune for himself, Zhang also earned a name as one of China's digital elite and became a business idol for China's college students.

After Zhang, a number of returnees also jumped on the bandwagon to set up their own businesses in China. And governments across the nation started to set up science parks and incubators to offer low-rent offices and other incentives for the startups to encourage homegrown innovations. Meanwhile, the nation's booming economy and rising consumer market meant companies in the nation could grow at a speed unprecedented anywhere else.

Robin Li and his Baidu.com is another example of how foreign venture capitalists helped to create a Chinese hi-tech legend. Li received his master's degree in the US and went back to Beijing to establish Baidu.com, a Chinese-language search engine, with funds secured from investors such as DFJ and IDGVC.

Li's company quickly rose to become the largest search engine in China and it also went public on the NASDAQ in 2005, with a dazzling 354 percent rise on its debut.

"In terms of promotion of scientific development, Baidu's listing is even bigger than the Shenzhou-6 spacecraft (which made China's second manned spaceflight)," says Chen Liwu, an economics professor at Yale University. "Li's wealth amounted to $900 million just overnight, and the company spawned more than 100 millionaires, most of whom had just graduated from college three or four years ago. Media coverage of Li's story will inspire young people's interest in science and technology and help them realize that they could be the next Robin Li to create the next Baidu."

Despite their success, Baidu and Sohu.com are sometimes seen as copycats, as they are modeled on US counterparts such as Google and Yahoo. They were not alone in doing so as one can easily find the Chinese versions of Ebay, Amazon and other Internet mainstays.

When the Chinese entrepreneurs started to talk with would-be foreign investors, they could simply say, "We are the Chinese version of the US company. And we will be as successful in China as it already is in the US."

VC paradise

But in recent years, homegrown entrepreneurs have begun to create novel business models tailor-made for the Chinese market.

Jiang Nanchun, a former top executive in a local advertising agency, was bored waiting for elevators and suddenly realized the downtime could be a golden opportunity for advertisers.

He then established Focus Media, which put flat panel TVs on the office buildings and in elevators to display commercials. After he acquired funds from venture capital firms such as Softbank and Wi Harper, Jiang's company quickly rose to become a leading advertising agency and launched its initial public offering in 2005.

Homegrown venture firms have also started to emerge in the past few years. In 2001, Legend Holdings Ltd, the parent company of Lenovo Group, set up its venture capital arm Legend Capital. And in the past two years, some wealthy homegrown entrepreneurs also joined the game.

According to Zero2ipo, a researcher on China's venture capital sector, venture capitalists spent $3.25 billion on local startups in 2007, up 82.7 percent compared with a year ago.

Meanwhile, private equity investors spent $12.82 billion to get stakes in 177 deals. This has made China one of the largest destinations for venture capital investment in the world.

With the sudden inflow of foreign capital, some industry insiders have become alarmed at the possible overheating of the venture capital sector. Some investors began to complain about the ridiculously high valuations required by the entrepreneurs of the fledgling startups. There are also concerns of an oversized bubble in China's venture capital sector.

Some disagree, however. "China is a paradise for venture investors and it will continue to be for a long while," says Andy Yan, founding partner of SAIF Partners. Founded in 2001, SAIF has already made over 60 investments over the last six years and now manages over $2 billion in three funds. Yan and his team made their reputation with their investment in companies such as Shanda Interactive Entertainment Ltd, the nation's largest online games company, and Acorn International, a Chinese TV direct sales platform.

"One main reason is the low-efficiency of the nation's banking sector, which is traditionally unable to meet the financial demands of private businesses, especially the SMEs," explains Yan. "And the nation's continual push to restructure its State-owned sector will offer great opportunities for venture capitalists and private equity investors.

"But the nation's entrepreneurs as a whole will be the largest winner," says Yan. "The more we earned from their successes, the more we will have to help fund the next Baidu, Shanda and Focus Media."

(China Daily 09/15/2008 page2)