What tech investors are looking for in China

After two years of difficult financing, as the US boomed across the Pacific, Chinese start-ups saw the interest of venture capitalists heat up again.

“The capital winter has passed and trading competition is fierce,” said Liao Ming of Prospect Avenue Capital. “To make a deal now, you need to provide more than just cash.”

According to data from data provider ITjuzi, the number of venture capital transactions in China in the first quarter increased by 56% year-on-year, and was active for the fourth consecutive quarter, as start-ups invested 354 billion yuan ($55 billion).

An active public market and large amounts of foreign capital have helped. Tencent, the most active investor, cashed in some gains because the value of its listed investment portfolio tripled last year. Venture capital companies such as Jiyuan Capital, Qiming Venture Capital, and Matrix China have raised large amounts of new capital.

In some respects, investments in China and the United States are similar; both markets are large enough to facilitate the creation of large technology conglomerates, and Chinese investors say that the valuation of start-ups is now compared to their US counterparts.

But investing in China also has its own quirks. Every new idea often spawns a large number of imitators, even competitive attempts from the country’s technology giants. Different cultures and government regulations add to the challenges.

Cultural differences extend to the types of effective business models. In the United States, companies that sell software as a service (SAAS) to large companies are highly valued, and the industry has not yet developed in China. Shaun Lim of Hopu Investments said it can be difficult for software companies to register subscription customers.

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

Other factors hindering the adoption of SAAS include the history of free pirated software and cheap labor to handle certain functions that the software can automate.

China Venture Capital Chart for the past six years

Consumer technology has historically attracted the most venture capital funds and generated the greatest returns, leading today’s popular industries into prosperity and depression. Although the idea of ​​plagiarism can be seen everywhere, the degree may be different in China.

During China’s infamous “War of a Thousand People” in the early 2010s, the research firm stated that 1,880 start-ups copied Groupon’s group buying business model. The wave of online ride-hailing has spawned 214 competitors, at least 20 companies have set foot in the shared bicycle field, and 208 companies have launched the business of renting portable mobile power supplies to charge electronic devices.

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

For Fu Jixun of Jiyuan Capital, it was his confidence in founder Yang Lei that helped him push Harrow Bikes into the shared bicycle field when the orange, yellow and blue rainbow shared bicycles have blocked the streets of major Chinese cities.

“I am sure [Yang] You can run it in a more efficient way,” Foo said. “The first mover keeps you ahead. ..[but] Compared with your peers, how efficient is your running? Over time, this advantage will definitely show up. “Five years later, Harrow Bike’s sales last year approached $1 billion and its losses were narrowing. Many of its competitors have failed.

In the same fiercely competitive field of portable power banks, Liu Wanlin, who focused on Carlyle’s technology investment in China, decided to invest when there was a winner in the first wave of startups entering the industry. Even so, when she weighed the investment in Energy Monster, she was still worried that China’s large technology companies would enter.

“Before we make a decision, you really have to understand all the top players and any potential competition from the big tech giants,” she said. Even after the US$240 billion food delivery company Meituan entered, Energy Monster still maintained its leading position. “Everything has to do with execution,” Liu said.

To help assess which teams are capable, Nathan Zhong of M31 Capital sometimes visits startup companies’ offices unannounced in the evening before investing. During a recent outing, he found that the office of a data analytics startup was empty.

“Their product iteration is not very fast-the CEO’s determination to continue fighting is waning,” he said. “Getting off work early means this.” M31 decided not to invest.

Patrick Zhong leads M31 Capital's Monday meeting every Monday

At the weekly meeting of M31 Capital, Patrick Zhong stated that unorthodox evening visits are a way to judge whether a potential investment target is appropriate © Ryan McMorrow

The unorthodox night visit is part of what Patrick Zhong, the founder of M31, called “feeling the temperature of potential investment targets.” “Chinese people are very smart; if you fall asleep on the steering wheel, your competitors will quickly catch up.”

Government policies can also be a source of uncertainty. In January of this year, the People’s Bank of China proudly announced that it had eliminated every P2P online lending institution in the country — from the peak of 6,000 — and ended a campaign to eradicate the wave of venture capital.

“You must always pay attention:’Is this company on the right side of China’s long-term government policy?'” said Gary Rieschel, who founded Qiming Ventures 15 years ago. “Chinese entrepreneurs have to deal with a lot of ambiguous issues,” he added.

Venture capitalists said that in the entire investment process, the difference is small. Start-ups usually hire financial advisors or FA (colloquially called) to contact investors. It is difficult to find a frank CEO letter of recommendation. Investing in a fledgling company that may one day need a new leader may not end well. Rieschel said that in China, it is very difficult for senior managers to “replace their trust in the original founder.” “This is a low-trust environment.”

Although the SAAS business has not yet taken off in China, Zhong of M31 Capital believes that software is the future and that it is valuable to review the trends that are taking place in the United States. At a recent weekly meeting, his team spent an hour studying how the database company MongoDB could re-accelerate growth as use cases expand and valuations.

“In the next 20 years, China will follow the example of the United States and use software to improve corporate efficiency,” Zhong said. “We are not saying that it will be exactly the same as the United States, but it is a reference point.”

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About the Author: Agnes Zang