What tech investors are looking for in China

After two years of struggling to raise money, Chinese start-ups are seeing renewed interest from venture capitalists as the US boom crosses the Pacific Ocean.

“Winter in the capital is over and competition for trade is fierce,” said Minryao of Prospect Avenue Capital. “To start trading now, you need to bring more than cash to the table.”

According to data provider ITjuzi, the number of venture transactions in China increased 56% year-on-year in the first quarter as start-ups attracted RMB 354 billion ($ 55 billion) investment.

A vibrant public market and a large amount of foreign currency helped. The most active investor, Tencent, has made some profits as the value of its listed investment portfolio tripled last year. VC companies such as GGV Capital, Qiming Venture Partners and Matrix Partners China have raised large amounts of new funding.

In some respects, investing in China and the United States is similar. Both markets are large enough to facilitate the creation of large technology groups, and Chinese investors say startups are currently rated compared to their US peers.

However, investing in China also has its own quirks. Each new idea often creates many imitators and even a competitive advance from the country’s tech giants. Different cultures and government regulations are added to the agenda.

Cultural differences extend to the types of business models that work. Unlike the United States, which has a very high reputation for companies selling software as a service (SAAS) to large companies, this sector is not yet developing in China. Shaun Lim of Hopu Investments said software companies can have a hard time registering customers for their subscriptions.

“People here don’t value intangible services so much. They are willing to pay more for what they can see and touch,” he said. Lim said one enterprise AI software company he helped increased sales by incorporating software applications into the servers he sold.

Other factors hindering the adoption of SAAS include the history of free pirated software and the cheap effort to handle some of the features that software can automate.

Chart of Chinese startup investment over the last 6 years

Consumer technology has historically withdrawn most VC funding, generated the most profits and led the hot sector of the day to boom and bust. Copycat ideas come up everywhere, but they can be different in scale in China.

During China’s infamous “Thousand Groupon War” in the early 2010s, research firms say 1,880 start-ups copied Groupon’s group-buying business model. The wave of ride hailing has nurtured 214 competitors, at least 20 companies have promoted bike sharing, and 208 has launched a business that rents out portable power banks to charge electronics.

In this fierce competition, investors say that execution and effort can overcome the fact that they are not pioneers in new areas.

For Jixun Foo of GGV Capital, it was to founder Yang Lei who helped Hellobike push into the bike-sharing space when the rainbow of orange, yellow and blue share bikes was already blocking the streets of China’s largest city. It was trustworthy.

“I was convinced of that [Yang] You can do this in a more operational and efficient way, “says Foo. “The starting lineup gives you a lead.[but] How efficiently are you running compared to your peers? That edge will definitely appear over time. Five years later, Hellobike reported last year that sales reached nearly $ 1 billion and losses were reduced. Many of our competitors have failed.

Focusing on technology investment in China’s Carlyle in a similarly competitive area of ​​portable power banks, Wanlin Liu said he would invest when a winner emerged from the first wave of start-ups entering the business. Decided. Still, when she was considering investing in Energy Monster, she was worried that Chinese big tech companies might be pushing in.

“Before we call, you really need to understand the potential competition from all the top players and the bigger tech giants,” she said. Energy Monster remains in control after the entry of the $ 240 billion shipping company Meituan. “It’s all about execution,” Liu said.

Nathan Zhong of M31 Capital may visit the startup office at night without notice before investing to assess which team has what they need. On a recent outing, he noticed that the data analytics startup office was empty.

“The iteration of their product wasn’t that fast — the CEO’s determination to keep fighting weakened,” he said. “Getting out of work early shows that.” M31 decided not to invest.

Patrick Zhong, who leads one of M31 Capital's Monday meetings

Patrick John states at M31 Capital’s weekly meeting that an unorthodox evening visit is a way to determine the suitability of potential investment goals © Ryan McMorrow

The unusual night visit is part of what M31 founder Patrick Zhong calls a potential investment “feel the temperature.” “Everyone in China is smart. If you hold the steering wheel and sleep, your competition will soon catch up.”

Government policy can also be a source of uncertainty. In January, China’s central bank proudly declared that all domestic peer-to-peer online lenders had closed their campaign to wipe out the VC betting wave from a peak of 6,000.

“Is this company on the right side of China’s long-term government policy?” Says Gary Rieschel, who founded Qiming Venture Partners 15 years ago. “Chinese entrepreneurs have to deal with a lot of ambiguity,” he added.

VCs say there are small differences throughout the investment process. Start-ups often hire financial advisers or FAs to contact investors, as colloquially called. Finding a candid CEO reference can be difficult. And investing in start-ups that may one day need new leaders may not end. “Regaining trust in the original founder” is very difficult for senior executives in China, according to Lee Shell. “It’s an unreliable environment.”

The SAAS business isn’t on track in China yet, but M31 Capital’s Zhong believes software is the future and finds it worthwhile to review ongoing trends in the United States. At a recent weekly meeting, his team spent an hour investigating how the use cases of database company MongoDB expanded and their reputation accelerated.

“In the next 20 years, China will follow the United States and use software to improve enterprise efficiency,” Zhong said. “I’m not saying it’s going to be exactly the same as the United States, but it’s a reference point.”

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