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Entrepreneurship and Venture Investment in China

Entrepreneurship and Venture Investment in China. York Chen 陈友忠 iD TechVentures Ltd. 智基创投 Jan., 15, 2008, Ann Arbor Global Private Equity and Emerging Markets Univ. of Michigan. Entrepreneurship and Venture Investment in China. China VC Market Overview, 2007

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Entrepreneurship and Venture Investment in China

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  1. Entrepreneurship and Venture Investment in China York Chen 陈友忠 iD TechVentures Ltd.智基创投 Jan., 15, 2008, Ann Arbor Global Private Equity and Emerging Markets Univ. of Michigan

  2. Entrepreneurship and Venture Investment in China • China VC Market Overview, 2007 • China at the Center of Global VC Market • The Hot Market and On Going Soft-landing • From High Tech to High Growth • From USD Offshore to RMB Onshore Investment • Deal Structure in China • Venture Opportunities in China

  3. VC Investment Annual Amount Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  4. VC Investment Industry Breakdown Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  5. VC Investment Geographical Distribution Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  6. VC Investment: RMB vs. USD Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  7. VC Investment Stage Distribution *Average amt. is based on deals with disclosed value. Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  8. VC Investment Stage Distribution(in Deal Number) Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  9. VC Investment Stage Distribution(in Amount Invested) Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  10. VC Deals Exit Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  11. VC Annual Fundraising Amount Source: China VC Annual Report, Jan-Nov Data, by Zero2IPO

  12. China at the Center of Global VC Market

  13. China at the Center of Global VC Market • China, for the first time, surged to the second spot in the global VC market. Top four in terms of 2006 investment amount (Dr. Martin Haemmig): • USA: US$25.75 B (VentureOne data) • China: US$1.78 B (Zero2IPO data) • UK: US$1.73 B (VentureOne data) • Israel: US$1.62 B (Israel VC Association data) • But, considering VC activity’s significance to its economy, China’s VC industry is still at an infant stage. Top four countries’ VC amount to its GDP (Dr. Mannie Liu): • Israel: about 0.5% • Europe: about 0.3 to 0.4% • USA: about 0.2% • China: about 0.067%

  14. Foreign VC Funding Flow in China LP Start-up LP Fund Angel FFF FoF GP Foreign Funding Suppliers Foreign VCs with Operation in China Chinese Start-ups With Offshore Entities

  15. VC: Much Internationalized Ind. At the moment, foreign VCs lead the way supplying more than 70% of VC funding in China. • Fund raising completely from foreign LP and FoFs • Fund managed by foreign GP companies with liaison offices in China • Fund outflow to offshore holding entities owned by Chinese entrepreneurs • Divestment through overseas IPO and M&A • Chinese portfolio are funded by offshore money. So, VC activity is less affected by China economic cycle and macro policy. • Among all industries, VC’s manpower comes with the highest educational and professional level, mostly foreign trained. Note: point 5 & 6 are views of Mr. Zhao Min(赵民), Chairman, Adfaith Management Consultant (正略钧策), July 12, 2006

  16. Foreign VC: Go Alone or Go Thru Local Teams? • VC is a localized operation in terms of local talents, local supporting infrastructure, local decision making, and should even local fund raising. • Out of the driving distance and crossing the Pacific is just too tough for American counterparts.  “Tourist VC” won’t work.  Sand Hill Road VCs will either enhance their own local operation or park their interests with a local team. • Two examples of shifting to partnership: • KPCB gave up own effort, to work through an enhanced TDF team joined by SAIF’s Joe.  Raised a China Fund, 360M, in April ‘07.  • Mayfield stopped its own effort in China by parking all interests in China with GSR Fund II.

  17. China Rooted VC Brands CDH 鼎辉 CDH VC 鼎辉创投 SAIF 赛富 Legend 联想 New Margin 联创 Infotech 英富泰克 DT 德同创投 SBCVC 软银中国 iDT VC 智基创投 Local VC: To Partner or Not to Partner? • Home grown VCs, many of them grownout of hi-tech/financial groups or government entities, are emerging as key players. • China GP teams are pondering should they outsource fund raising challenges to Sand Hill Road peers by giving up some economic interests and operational independence?  • A question to follow: will there be independently owned and managed China-rooted VCs in the long run? 

  18. “Great Leap” of Mega Funding • Ballooning of VC fund raising in China. US$4B VC fund raised each year for both ’06 and ’05. Added US$5.4B for ‘07. • Quite a few mega VC/PE funds raised in 1H ‘07, in less than two or even only 1.5 years from previous vintage ’05 funds. • Mega funds raised in 1H ‘07: • TDF II (120M) to “KPCB China Fund” 360M • Sequoia China Capital I (200M) to total 750M (Sequoia China Capital II 250M and Sequoia China Growth I 500M)‏ • SAIF II (643M) to SAIF III 1.1B • CDH PE II (310M) To CDH PE III 1.6B • IDG Accel I (290M) to IDG Accel II 550M

  19. A China Miracle: Chasing for Better Return Drives Funding to China • Sand Hill Road peers took one or two decades to reach mega funding size. For example, KPCB, founded in ‘72, had its Fund IX reached 550M in ‘99, then Fund XII of 600M in ’06. • It’s a “China Miracle” for local VC/PE to reach mega size in just a few years. And, all these funding are endorsed and invested by reputable and leading Western LPs and FoFs. Take SAIF III. It gathered one of the mostimpressive LPs including endowment funds of Harvard, Princeton, Cornell and Dartmouth, CalPERS and NY State pension funds, Dupont, Common Fund, Horsley Bridge, .. (*) • The VC/PE funds in China have really seen good financial returns in past few years. And, these foreign investors are confident about the future opportunity going forward in China. *: Source: Andy Yan Interviewed by Zero2IPO eWeekly, May, 2007

  20. Another China Miracle:The Booming Local Stock Market • The foundation of “China Miracle” with huge foreign funding is the long sustaining high growth of local economy, which is the same ground for current booming stock market and high P/E in China. • It looks scary for Shanghai Composite jumped from 1000 in 05 to 5100 in07, with average PE stays at 50X. But, for 10 years upto 03, it stayed at 1500 level, and even dropped down to 1000 in 05. No appreciation for more than 10 years whilethe local economy comes with impressive double digit growth. So, with a longer time horizon, the hot market might just reflect “under value” adjustment. • Accumulated fortune and personal saving (up to USD2.3 trillion) channeled into limited investment vehicle, such as real estates and stock market.

  21. The Hot Market and On Going Soft-landing

  22. China VC up to Mid-’06: Active and being Over-heating • After ten years subdued and “Check In, No Check Out” VC environment, China VC starts to kick off a virtuous circle from 2004. Successful and active divestment brought high return to VC investors. And, in return facilitated successful fund raising for more active venture activities in China. • With improving and potentially high returns in China, many mainstream VCs, LP funds and hightech MNCs are flocking into China. • Keywords of China VCs changed in 04 to 06: • “It’s here, and it’s for real”. • THEN: Why China, and why now? NOW: How? • “Cautiously Optimistic” • The market is characterized by strong supply of GP teams, LP funds and VC People

  23. More VC Players Joining the Market • One of the most significant development of China VC since ’04 has been the market getting world’s attention, and the flocking-in of Sand Hill Road VCs. • More veteran VC players from Taiwan, Singapore, Israel, Korea, Japan and Europe are also setting operations in China. • The hot environment and proven divestment track-record also invites many China focused first-time GP teams, LP funds as well as FoFs. • Foreign VCs into China is not only seeking local direct investment opportunity, but also out of the need to support their venture activities in their home countries. Many deal flows based in the Valley will likely have China presence. In some cases, even doing the due diligence for a foreign deal might need to visit China.

  24. Five Routes Sand Hills Rd VCs Take to Enter China • Model A (Setting up own China fund) • Sequoia China; KPCB China • Model B (Joint or Franchising Fund) • IDG Accel China Fund; DFJ DragonFund China • Model C (Global GP becomes a China LP) • As a LP to a China fund to have a platform to develop China opportunity. • Model D(Liaison offices with local professionals) • DCM, NEA, Bessemer, Atlas, Redpoint, BlueRun, GAP, Granite, Highland, …. • Model E (Sideline observers, ad-hoc investors) • Continue to explore the China strategy, or not yet buy-in the China story From original presentation “The Way We Were, China VC in 2005” Shanghai, Dec., 14th, 2005, CVCF

  25. Len Baker pioneered and defined the unique model. His Sutter Hill invested 8M each into Chengwei’s fund I and II in ‘99 and ‘04 respectively, and 5M into TDF in ‘05. The closeness and strategic relationship between the two parties, and economic terms for US parties, are varied. Qiming, without an Ignition name, is more than “Ignition China”. Two VC veterans from the Seattle relocated to Shanghai bridging the HQ and China “branch” under a much solid and substantial mechanism. DCM – Legend Capital 3i - CDH Sierra – Gobi Light Speed – DT Capital Sutter Hill – Chengwei, (TDF) Greylock; NEA – N. Light Worldview - Infotech Mayfield - GSR Ignition - Qiming Global GP Becomes a China LP

  26. Much Funding Chasing Quality Deals • Considering the fact that rather big portion of funding is focusing on local value add service segments (internet, web2.0, MVAS, broadband, ….), the issue of fund’s over-supply is sector specific. • And, many funds, especially first-time funds raised in 2005, have the pressure to “pour” out investment quickly. Investment pace is quicken than what it should be. • While funding supply multiplied, quality deal flows not increased at the same pace. Supply-demand mechanism at work. Valuation jacks up.Start-ups get much bigger funding than originally planned. • Illustrating cases: Blog China (Bokee) and BlogCN.

  27. LP Funds’ Larger Allocation for Asia- Case Study on Horsley Bridge International Funds Source: Mr. Gary Bridge presentation on Zero2IPO Conference Palo Alto, April 25, 2006

  28. Though with a short history in China, VC’s virtuous circle is in the forming. Successful VC-backed entrepreneurs are turning around and becoming: Serial entrepreneurs GP venture capitalists LP investors Angel investors Entrepreneur Turns VC GSRJames Ding (Asiainfo) SequoiaNeil Shen (Ctrip) DCMHurst Lin (Sina) BlueRidge Justin Tang (eLong) Northern Feng Deng; Yan Ke Light (Netscreen) CyberNaut Zhu Ming (WebEx) CBC Capital Edward Tian (CNC) TPG Sing Wang (Tom) MatrixBo Shao (EachNet) More Professionals Jumping On

  29. Like in other industries, old players are supplying talents to new comers. New GPs, by head-hunting, to jump-start operation in the rather competitive environment. VC is a people business. Deal flows usually go with the people into new funds. VC job opportunity opening up, and a war of retaining and recruiting good people. HR cost lifts up. For newly build-up VC teams, the “break-in” of team members will be a challenge to go through. Sequoia China: Zhang Fan (DFJ) Zhou Qui (Legend) Steven Ji (Walden) CDH Ventures: Wang Gongquan (IDG) Wang Shu (IDG) Huang Yan (Intel) Vivian Chen (Walden) Granite: Foo Jixun (DFJ) Jenny Lee (Jafco) Qiming: Duane Kuang (Intel) Ed Zhou (Cisco) KPCB: Joe Zhou (SAIF) Tina, David, Forrest (TDF) Reshuffling of VC Professionals

  30. Events in ‘06 Led to Softened and Reserved VC Environment • VCs’ investment during the over-heating period are coming to a “Reality Check”. A time to review and to see if anything need to be adjusted. • Government regulatory measures on cross-border transaction are putting negative implications on overseas VC investment in China. • MVAS, provides substantial revenue source to China internet companies, experiences depressed environment due to MII and operators’ discipline measures since June ‘06. And, government agencies’ crackdown on TV Shopping, music, game and UGC video. • The momentum for “China Concept” IPO has not been carried on from 05 to 06. Latest stock performance of those listed Chinese companies are also not encouraging.

  31. More Cautious Investment Pace After mid-’06, China VCs proactively do self adjustment in areas of: • Take more reserved and cautious steps toward new investment. Slow down investment pace. • Not to chase around deals. Tender term sheets carefully. • Deals’ valuation coming down. Investment terms shifting to be more favorable to VCs. • Avoid Web2.0. Cautious on MVAS, and other deals without sensible revenue projection.

  32. Diversifying Investment Focus • Pure Web2.0 projects were difficulty to get VC attention and funding. • MVAS will take time to recover. Maybe need to wait till 3G launch for a new start. • VCs are still keen and willing to bet on future killer app for internet and broadband applications. IPTV opportunity is still a few years away. • Many VCs start to pay attention to non-Internet, or even non-TMT, sectors. On top of IT hardware opportunities (IC design, Semicon, key component, module, …), VCs interests have extending to: • Medical devices and health care services, • Retailing, franchising and branding for consumer services and goods • Alternative energy and green tech • Manufacturing, logistics, Mining, …. • Outsourcing services

  33. “Soft-landing” for a Healthy Adjustment • On the macro, as long as China economy continues to open up and with healthy growth, VC activities here will continue to be active and promising. We continue to see foreign VCs and LPs interests toward China keeping high. • In 2000, we experienced a VC “Hard-landing”, reflecting passively to the dotcom corruption. Painfully taking huge casualties, and it took 3 years to recover. • Since mid-’06,we are taking the counter-measure actions into our own hands by proactively do the self-adjustment before the situation running out of control. The on-going soft-landing since mid 06 illustrates maturity of China VC industry.

  34. From High Tech to High Growth

  35. TMT Investment (%) Decreases 2007 VC Investment: USD3.18B 2005 VC Investment: USD1.06B Source: Zero2IPO Annual China VC Data

  36. High Growth: New Cluster for VC Inv. • Observation of China stock markets: • China stock markets in Shanghai and Shenzhen are mainly servicing government owned entities. Most of 1500 listed companies are of government conglomerates. • Stock market re-engineering has being on for only two years. Less than 200 listed are of private SME. • As a result, quite some good and long operating traditional companies are still kept private. These companies are usually being listed in the West. • Projecting China economy’s healthy growth into the future, these high growth companies are growing to become a promising cluster, and good target for VC/PE investment.

  37. From Expand to Sector High Tech (TMT)‏ HighGrowth Deal Structure Offshore USD Onshore RMB Entrepreneurs Returnees Locals Location Coastal East West & Inland IPO Red Chips A & H Shares Deal Generation Own Screening Thru Partnership Stage Early/Expansion Late/Pre-IPO Diversifying of VC/PE Operation

  38. From High Tech to High Growth • Crowded, overheating and competitive TMT sectors putting constraints on return potential. • And, not like in the mature economies, high return opportunity in China might not necessarily be powered by high tech. Still quite lots of traditional sectors not being well served. And each sector, no matter how narrowly defined, present high growth and high margin potential, and as a result high return opportunity for investment.  • Zero2IPO data also shows that TMT sectors dropped from some 70% for past several years to below 50% in 2007. • Successful IPOs since 06 of New Oriental, Home-Inns, Belle Shoes, Weiqian Lamen, …. Illustrate the high growth sector opportunities.

  39. Consumer Power in China(a flavor of high growth investment in China) • With fast growing GDPand urbanization, the middle-class is expanding quickly as a powerful consumer group. Products and services addressing their consumer needs gradually become an important target of VC/PE investment. • Cases in point: • Food: Mengniu, Shuanghui, Huiyuan, Youge • Restaurants: Weiqian, Chamate, Zhenggongfu, Xiaofeiyang, Little Swan, … • Education: New Oriental, ChinaEDU, 100e, … • Medical services: CiJi, AiKang,Jiamei, …. • Hotels: Home-Inns, Mandarin Court, 168/268, ….

  40. From USD Offshore to RMB Onshore Investment

  41. China’s Foreign VC Operation- Funding & Divest. Stay Offshore (二头在外) Portfolio Management Divestment & Financial Return to LPs Deal Flow Screen & Investment Fund Raising & Set up Fund

  42. The Changing Tides • The shifting tides are mainly due to the legal and regulatory changes happening in past three years.  Through SAFE circulars #75 and #106, MOC #10 and other administrative measures, Chinese government tried to discourage local deals to be restructuring into offshore holding for USD funding and overseas listing. • As a result, offshore restructuring becomes much time consuming and challenge, if not impossible. • At the same time, the local VC/PE environment is greatly improved.  The local IPO, legal framework and LP funding sources are getting better. • It might take years for RMB onshore investment to become the mainstream of VC/PE activities in China.  But, an emerging trend needs to be watched closely.

  43. RMB Inv Significance Only be Seen from 08 Onward By Number of Deals By Amount Invested (US$M) Sino-foreign JV Domestic, 175M, 16.5% 160M, 15% Foreign, 740M, 70% 2007 VC Investment: USD3.18B 2005 VC Investment: USD1.06B Source: Zero2IPO Annual China VC Data

  44. Foreign LPs & Funds in China Projects (Current Status) LP LP USD Fund RMB Fund 3a 1 2 3 Project Project Project Project Project Onshore Offshore (Offshore Holding) Route 1: invest into China projects’ offshore holding entities, mostly in Cayman Route 2: Direct cross border investment and turn a China entity into a JV Route 3a & 3: to sponsor and initiate a local registered RMB fund.

  45. (Route 2) Direct Investment into Chinese Co Using Existing Offshore LP Fund Offshore LP Fund LP Fund SPV SPV Local Shareholders Local Shareholders Local Shareholders Public Local Co., Ltd. Foreign Invested Co. Ltd. A Share Listed Onshore Source：Mr. D.C. Lee, SBI Crosby, Jan., 17th, 2007, Shenzhen

  46. A Foreign Fund Sponsors a RMB Fund (Route 3a) GP GP LP LP 1 Fund Mgmt Fund Mgmt LP 2 LP 3 USD Fund RMB Fund Onshore Offshore

  47. Overseas LPs’ Role • Conventional LP practice (long term, not interfering GP operation, management fee/carried arrangement) prevailing in the West is not yet popular in China. Local LP funding supply is still at shortage. • At the moment, government owned/affiliated funds could be a good source for RMB funding. Many government agencies (ministries, banks, provinces, municipalities, hi-tech parks...) set up matching funds (引导基金) to support RMB fund formation. • With the improving of legal, forex and tax issues, overseas LPs and FoFs,in the mid-long terms, will continue to play a key role in supplying funding into China’s VC/PE industry.

  48. Get Government LP Funding?- A Debatable Issue • Pro: • To enlarge the fund size for economies of scale. And, bigger fund size to be eligible for registering as “non-institution” entity (minimum USD10M) • Government endorsement for fund set-up as well as better tax terms, SAFE approval, project’s R&D subsidy, IPO opportunity, deal flow sourcing, … • Avoid perception of a foreign fund without local root. • Con: • Local LP likes toinvolve in fund management. Put negative impact to a GP’s independence and decision making process. • The fund and its GP will need to register in a particular city, and with constraints on investment’s location, sectors, … • Not easy to bring more than one government LP to invest into a fund.

  49. Government Funding as LP • Model I (LP & GP) On top of LP funding, government entities will also be shareholder to GP, which turns to be a JV. Involved formally and directly in VC management and decision making. • Model II (Involve in Decision Making) Government entities won’t join GP set up and operation. But, will join Investment Committee and usually have a veto right • Model III (More as a Conventional LP) Not involved in decision making and not put limitation on where to invest. But, will ask the GP and the fund to be registered in the local.

  50. Foreign LPs & Funds in China Projects (Future Scenario) LP LP 4 3b USD Fund USD Fund RMBLocal Fund RMBLocal Fund RMBJV Fund RMBJV Fund 3a 2 1 3 Project Project Project Project Onshore Offshore (Offshore holding) Route 3b: foreign LP’s direct investment into local RMB funds Route 4: local LP’s investment into foreign funds or FoFs

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