Among the many lessons that Silicon Valley's entrepreneurs learned during the bursting of the dotcom bubble 10 years ago was that being a business failure in the U.S. isn't the end of the world. For sure, having a new venture go bust might not be something entrepreneurs want to boast too much about on their CVs or when pitching their latest idea to new investors, but the experience can add to their credibility.
That's still a lesson being learned in China, the world's latest venture capital (VC) hotbed. “The U.S. culture is much more tolerant of failures,” said George Wang, founder and chairman of the Beijing-based Chinese Professional Network (CPN), a provider of career resources and advice. “In China, when you fail, you sometimes lose face in front of your family and others.” Wang was recently in Philadelphia to join other VC experts at the 15th annual Wharton Asia Business Conference for a panel discussion titled, "Entrepreneurship and Venture Capital: Thriving in the Face of Adversity and Change."
Wang, however, reckons that China's fear of failure might be changing in an era when its entrepreneurs dream of starting their own businesses and becoming the country's next Alibaba, China's biggest e-commerce site, whose Hong Kong initial public offering in 2007 raised US$1.5 billion during the country’s pre-recession stock market boom. That's good news to people like Jovan Hsu, another panelist at the conference and founding partner of the Beijing-based Chinese Founders Fund, which provides angel investments for telecom, media and technology start-ups. “We say, 'We’d like to see you with some kind of experience in the past,’” Hsu said. “So if you fail, two or three times, we like it. It’s better than not having learned anything.”
Though Hsu and Wang's discussion took place beneath the shadow of the global financial crisis, the mood was relatively upbeat, with good reason. As recent economic data shows, the benefits of China's RMB 4 trillion ($585 billion) stimulus package are kicking in and its economic growth is back on track. The country's entrepreneurs and their investors are heaving a collective sigh of relief.
“In China, there really hasn’t been that much of a recession,” added Jacob Hsu, CEO of Symbio, a global product development outsourcer with U.S. headquarters in Silicon Valley and offices in Finland, Sweden and Taiwan as well as in mainland China, where it runs a Chinese start-up incubator program. “What has taken a hit is VC and angel investing." Though Hsu reckons that earliest-stage angel investing was suffering less than other parts, he noted that, across the board, “risk tolerance has diminished.”
However, what hasn't diminished is a general enthusiasm as far as Asia is concerned. A survey of 725 venture capitalists around the world last year by Deloitte Touche Tomatsu found that though VCs are decreasing their overall investments in order to focus more on their portfolios' best companies and increasing their allocation to later-stage investments, over half of the respondents said they expect to increase their funding levels in Asia between 2009 and 2011. China, in particular, was cited as the world's most promising country for their investments.
Yet if venture capitalism is going to steam ahead in China, as many observers are predicting, it’s more important than ever to understand both the subtle and unsubtle differences between the country's start-up environment and other parts of the world, noted the panel, which was moderated by Michael Kelsen, a Wharton lecturer in entrepreneurship and co-founder and principal of Philadelphia’s Miro Capital Partners.
Right from the early days of venture capitalism in China in the 1990s, it was clear that its approach would be different than, say, that of the U.S. In the early 1990s, 90% of VC-backed firms were state-owned enterprises (SOEs), according to a research paper from RAND. That percentage diminished rapidly, however, as China’s market-oriented reform deepened and international venture capital funds faced fewer discriminatory policies.
Something that has remained a constant throughout this evolution, however, is what it takes to make a VC investment succeed in the country. “In a wild emerging market like China, investing is more like gambling,” said CPN's Wang. “The difference is whether you’re a professional gambler or a gambler just for fun. The majority [are investing] just for fun.” For such people, he said, “money is never, never, never, the issue.” For professionals, on the other hand, the challenge lies in identifying the best ideas and people, and doing so as early in the investment process as possible.
Indeed, the common denominator for all VC success stories involves something that can’t be recorded on a balance sheet: Human capital excellence. “Invest in the people, invest in the entrepreneurs early and support them, almost like an incubator,” Hsu of Symbio said. “Know the entrepreneur, know the market. A lot [of the work requires] helping entrepreneurs set up the right partnerships to be successful.”
It’s more about personal connections than institutional connections, he added. “If you come to Beijing, there are [about] 10 people who could connect you to everyone else in terms of investors.” He recommended that anyone from the West wanting to get involved in Chinese start-ups to slow the pace down and not make a "pitch" too soon after arriving in China. “Spend six months and get to know the place and the people,” he advised.
People and Places
The catchphrase in this respect is "local expertise." As the panelists agreed, understanding China's business environment is more critical to VC success than, say, whether a firm is Chinese- or foreign-owned or whether it adheres to Chinese or Western governance practices. “Advantage comes for someone who knows China quite well, knows how Chinese entrepreneurs think and are educated," Wang explained. "You cannot judge them in many ways from the Western perspective.”
For sure, there are important China-specific nuances that can make or break a new business plan. A case in point: E-commerce. Just as in the West, e-commerce is about selling goods and services over the Internet, but a typical Chinese consumer prefers to place an order with a call center, rather than online. According to Wang, an entrepreneur who is familiar with Chinese shoppers would understand this intuitively, while a newcomer to China might not. However, the pace of change is so rapid that venture capitalists need to refresh and update their local knowledge regularly. “If you’re out of China for more than three years, you’re viewed as outdated or out of the game,” he said.
In the past, what deep-pocketed foreign venture capitalists lacked in terms of local knowledge, they aimed to make up for by importing all lawyers, accounting firms and other transaction specialists that Western investors take as a given but aren't relied on as much by locals in emerging markets such as China.
Of course, deep-pocketed foreign players can avail themselves of an infrastructure to help make up for at least some personal experience — something that didn’t used to be the case in China, and isn’t in many other emerging markets, observed a forth panelist, Alex Grove, who did "inter-stage" venture capital work in China for Morgan Stanley before starting an education consulting firm last year.
As he recalled, “If we were going to invest in a coal mine, we’d hire KPMG or whoever to go in and look at their accounts. We would get Western law firms such as Linklaters. These guys were all set up and ready to go…. The infrastructure is definitely there,” Grove said. “I would guess that a lot of the smaller guys, especially the local VC players in China, are probably not as reliant as a big firm like Morgan Stanley would be [on such service providers].”
Hsu of The Chinese Founders Fund agreed that a lot of his fellow Chinese venture capitalists, especially those involved in early-stage investing, implement their deals differently than the big investment banks. “For start-ups, I’m talking about the earlier stage, the drawing-board stage, a lot of VCs just do their own thing. Of course, they also have lawyers, accountants, CPAs and professionals helping them, but they also have in-house and sometimes they count on that more.”
In fact, the embryonic nature of the Chinese marketplace was a major impetus for the group of investors wanting to join forces at Hsu’s Founders Fund. “We have a model where we link up with angel investors, each with different specialties, [who are] proven, successful investors in China,” he said. So entrepreneurs making a presentation to the fund will likely come face to face with someone with experience in their field, which can be useful when assessing new ideas or sniffing out a business plan's flaws. Bankers tend to prefer the start-ups that link entrepreneurs with investors, which have similar industry knowledge and interests, he said.
Therein lies another difference between the VC environments in China and the U.S. Kelsen noted that in the U.S., it is unusual for entrepreneurs in search of VC to “come through the front door” and immediately meet investors. Instead, he said, the first step is to hire a lawyer or another type of adviser with connections to investors.
But in China, Hsu of The Chinese Founders Fund said, “everything goes through connections.” That's why his multi-investor company has an advantage in linking up with a range of people, who often already know the peers or former bosses of entrepreneurs seeking capital.
Even for veteran expats in China like Grove, the country requires a continuous climb up the learning curve. He recalled how his Western education was held in high regard and his fluent Mandarin appreciated. But since setting up his own firm last year to help Asians join U.S. MBA programs, he's been met with a fair amount of skepticism, particularly when it comes to his academic credentials, which include some of the schools he now seeks to place clients in. Phony diplomas, after all, can be printed quite easily. “I’ve worked in China my whole career,” Grove said. “It’s forced me to look at things a different way. It’s forced [me to have] a more agile, resourceful, flexible, creative or whatever you call it mindset.”
Kelsen added that Grove’s start-up experience shows that beyond the good fortune of having a global financial crisis helping rather than hindering businesses like his, “if you want to be successful, you have to ignore the macroeconomic conditions.”
Asked what lessons American venture capitalists could learn from startups in China, the panelists returned to their focus on individuals. “It’s like a dating process,” Wang said, prompting laughter. “Think about it like if you want to pick up a girlfriend in China. Question one is, ‘Why do I need a Chinese girlfriend?’ But that’s just the first step -- superficial.” The second step, he said, is getting past preconceived ideas. He noted that someone who insists on having girlfriends with long hair will be disappointed. “Everyone’s an individual … you have to get to know each one of them." In business, too, keeping an open mind is much better than having set ideas about what makes a worthy investment. “Don’t be duped by the superficial thing," he said. "Go into the heart of the people and ask: What are your values?”
“The number one lesson is don’t invest in a business model or business plan,” said Symbio's Hsu. "Make a bet on the entrepreneur and support him like hell. Most of the successes you’re going to hear about in China will have entrepreneurs behind them who will be doing something very different from what they initially thought they would be."