China VC Market York Chen iD TechVentures Ltd. January, 25th, 2010; Beijing Nanyang Technopreneurship Center (Non-confidential)
China VC Market China Economy and VC Market, 2009 Offshore Deal Structure Emerging Onshore Structure Venture Financing in China China VC Going Forward Attachment - Other Observations on China VC, 2009 - How accurate about China data - VC Charity: Yanxing China
China Economy, 2009 • China GDP growth in 2009 reached 8.7%. Bottomed out from Q1’s 6.1% and grew up steadily: Q2 7.9%, Q3 8.9% and Q4 10.7% • Amid depressed global economy, China turned around a typical V-shaped recovery. Key factors: government’s prompt RMB4T stimulus package, moderately loose monetary policy (RMB9.5T lending, doubling of 08’s), a big domestic market to boost local consumption and relatively healthy financial sector.. • GDP amount reached USD4.9 trillion, could overtake Japan to become the second largest economy in the world. • Overtook Germany as the world’s largest exporter in 2009.
China Economy Outlook, 2010 • GDP growth will be between 8 to 9%. • Growth will not be a big challenge. Key effort will be on control and adjustment from short-term expansionary urgent measures in 2009 to a healthy and stable development system. • Concerns going forward: • Excessive credit growth leading to inflation • Danger of real estate bubble bursting • Production over-capacity due to massive investment in heavy industries (such as those addressed by NDRC earlier in steel, cement, plate glass, coal-chemical, polycrystalline silicon and windpower equipment). • A weak global outlook
Four Generations 造反有理 Rebellion is righteous 实事求是 Be Practical & Realistic 与时俱进 Progressing with the Times 和谐社会 Toward Harmonious Society Four VC Stages The Wild West 产业的洪荒时代 (’88 – ’92) Practicing to be Perfect 在实践中优化环境 (’93 – ’98) Following Global Dotcom Fever 与世同步的达康冷热 (’99 - ‘03) Soft-landing for a Healthier Market 过热到软着陆的有序市场 (’04- ) China VC’s 23 Years Evolution“China NewTech Ventures”, ’86, is the first VC firm in China. But, meaningful VC operation was initiated by foreign players in ’93.
Ten Years Come a Full Cycle • In short 10 years, China VC goes thru a full cycle from dot com fever and bubble-bust, warming up, over-heating, soft-landing, then to on-going cold front： • ’99 - ’00: Dot com fever & bubble • ’00 - ’03: Bubble burst & VC winter • ’04 - ’07: Warming, hot and over-heating • ’08 – ‘09 Soft-landing, cooling and getting cold • ’10 Recovering • The ten year’s cycle also illustrates how China VC grow, adjust and mature.
VC Investment Dropped Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
VC Investment by Currency Amount invested: US$2.4B No. of Deals: 425 Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
VC Investment by Industry Amount invested: US$2.39B US$M 1 No. of Deals: 425 3 1 3 2 2 Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
VC Investment by Stage Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
VC Exits by Industry:106 by Exit Option:106 Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
VC Fundraising Declines Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
VC Fundraising: RMB vs. USD by Funding Amt:USD5.1B by Fund Number:90 Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
Offshore Deal Structure For PPT softcopy and exchange views on China VC Mail to: firstname.lastname@example.org
China’s Foreign VC Operation- Funding & Divestment Stay Offshore (两头在外) Value Add & Portfolio Mgmt Deal Flow Screen & Investment Divestment & Return to LPs Fund Raising & Set up Fund
Foreign VC Investment Kept Equity Activities Offshore VC Mgmt （Rep. Office） LP Fund VC Mgmt Co. Investment Management Portfolio’s onshore entity Portfolio’s offshore Holding WFOE: Wholly Foreign Own Enterprise On Off Shore Shore (York chart, ‘02, quoted in HBS cases #805-090 and #805-091)
Special PRC Vehicle for Projects Off-limit to Foreign Co. VC Mgmt Co. (Rep. Office) LP Fund VC Mgmt Co. Investment Management Invest WFOE Offshore Holding A SPV Co. On Off Shore Shore (For Licensing & Rev. Booking) (York chart, ‘02, quoted in HBS cases #805-090 and #805-091)
Emerging Onshore Structure For PPT softcopy and exchange views on China VC Mail to: email@example.com
Go Onshore? Go Onshore?
The Shifting Tides • Through three major circulars (SAFE circulars #75 and #106, MOC #10) and other administrative measures since 2005, Chinese government tried to discourage local deals to restructure into offshore holding for USD funding and overseas listing. As a result, offshore restructuring becomes much time consuming and challenge. • At the same time, the local VC/PE environment is improving. The local IPO, legal framework and LP funding sources are getting better. • High growth traditional sectors as a sector for VC investment, and most of them are onshore projects. • As a result, some quality deals prefer to stay onshore. So, foreign GPs start to explore RMB onshore investment.
Broad IT Investment (%) Dropping(Data Comparing ‘05 & ‘09) (2005) Year Inv $ Broad IT % 05: 1.06B 60% 06: 1.70 62 07: 3.2 43 08: 4.2 36 09: 2.4 30 (2009) Source: Zero2IPO annual VC reports, ’05 and ‘08
VC in Traditional Sector- A Unique Characteristics in China Crowded, overheating and competitive TMT sectors putting constraints on return potential. High risks not necessary come with high return. Not like in the mature economies, high return opportunity in China might not necessarily be powered by high-tech. Many traditional sectors, backed by high growing economy, still present high growth and high margin potential. As a result,posting high return opportunities for investments. Source of high growth deals: Low hanging fruits: many good quality and long operating projects are still kept private due to backward stock markets in China. Emerging consumer projects due to urbanization and growing middle class
Model A (Sino-Foreign JV Fund) LP LP USD Fund RMB JV Fund 3a 1 2 3 Project Project (JV) Project (JV) 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: to sponsor a locally registered RMB JV fund with foreign participation.
Model B (Pure RMB Fund) LP LP 3b USD Fund RMB Fund 1 2 3 Project Project Project (JV) 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 3b: to sponsor and initiate a locally registered pure RMB fund
Model C (Pure Offshore Contributed Fund) LP USD Fund RMB JV Fund 3a 1 3 2 Project Project (JV) Project (JV) 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: to set up a locally registered RMB fund with all funding from offshore
Model A vs. Model B Model A and B are most popular models, with significant implications (pro and con) to foreign GPs and LPs. Model C is rather niche and only very few funds being set up. • Model A: • Expose to more red-tapes and regulatory uncertainty. • Not to restricted sectors (no Sina-structure for onshore deals) • Less conflicts of interests as foreign LPs have indirect interests in RMB funds. • GP needs to take care more complicated investment process. • Model B: • Much less government approval required. • Less restriction on investment sectors. • Foreign LPs have big concerns on unavoidable conflict of interests of two not-related funds. • Best for GPs.
Venture Financing in China For PPT softcopy and exchange views on China VC Mail to: firstname.lastname@example.org
At different stage, enterprises require different investors, which Involve differently and bring different value adds 纵轴：收入的增加 (revenue) 横轴：创业行军的时间延伸(time) 查立手绘图 ”创业公司的成长轨迹“，乾龙创投 查立 “在死亡谷蹦极” http://column.chinaventure.com.cn/u/chali1/archives/2008/1116.shtml
People, People and People • Evaluation to the team is the most critical part of due diligence. Key founding entrepreneurs and the team is the most important factor if a project could be successful. • “First tier team with second tier business model” vs. “second tier team with first tier business model”. A start-up is “shooting at a moving target” as the environment and competition is such dynamic. Only a good team could eventually work things out. • VC prefers to back up a successful founding team, no matter what they are doing. • People judgement is a KSF for a venture capitalist. An art, not a science.
Business Model Decides the Funding Progress • Three logical steps of founding a project: see a business opportunity (What), how to catch the opportunity (How), then why should I be the one to do it (Why Me). • It’s the “Business Model” to decide if a project will get a VC attention to proceed further. It’s also highly relevant to a project’s success. • Timing (天时) and locality (地利) of a business model counts. Case: MVAS. • Adjustment of a business model will also decide a project’s strategic direction and also resource deployment. Case: Baidu changed from a back-end technology provider to a front-end searching services. • Business model is also about revenue model. Needs to consider how’s revenue generation mechanism.
Valuation to an Early Stage Project • Without ways of getting other funding supply (loan, ..), start-ups turn to equity financing as the major sourcing of capital to fuel corp. development. • High tech start-ups, not like mature traditional companies, lack of past financial track record as a base for future projection. • A project’s current perceived valuation is based on the projection to its future revenue, profitability, growth and perception from stock market. All these projection for potential “high return” are full of uncertainty. • Since conventional valuation models, such as discount cash flow, … could not be applicable, so major evaluation system for early stage projects: • Bench marking with other similar transactions. • Derived and discounted from a future multiple projection.
Challenges to Early Stage Projects (also the areas entrepreneurs should answer to VCs) • Need to conservatively evaluate the time and capital required to reach product development, mass market, revenue and profit. • Portfolio development could easily slip away from projection in financial performance, next fund raising and equity events. • Failure of start-ups mostly coming from: • Business model not go through market validation • Major changes on legal, regulatory and industrial policy • Competitors’ innovation on technology or business model • External challenges from financial and fund raising market.
VC’s Perspective on Value Adds • Come in where founders are lack or short of, such as strategy planning, financing and alliance. • Observe founders’ entrepreneurship. Only to add up, not to replace. • Different type of VCs bring in different kinds of value adds. • What being brought in will be varied and evolved as a start-up grows. • “20-80” concept applies. “Return on Effort” counts: spend more effort on those projects could contribute most to the fund. • A two way street: also depends on how founders appreciate and facilitate VC’s involvement.
China VC Going Forward For PPT softcopy and exchange views on China VC Mail to: email@example.com
RMB Onshore vs. USD Offshore • RMB fund raising surpassed that of USD, for the first time, in 2009. RMB onshore fund raising will continue to be active in 2010. • But, RMB funding’s extraordinary performance in 2009 should be seen only as a one time surge, and might not be sustainable. Key considerations: • Most domestic fundings are from first time players lured mainly by GEM board hype. The equity fund gold rush needs to be validated with good return. • Onshore LP funding supply needs a few years to be improved in views of right LP mindset, diversified LP sources, bigger funding, and more supportive regulatory and tax regimes. • And, for past 1.5 years, offshore LP fundings were on-hold. But, that’s a temporary measures. From 2010, they will resume the new commitment, and China to be the first country to get new investment.
RMB LPs in China - Limited and Not Yet Mature • Conventional LP practice prevailing in the West is not yet popular in China, such as: • Long term view for up to 10+2 years • Not to involve in GP operation • Commitment to capital calls • Economic interests for GP: Fee and carried • Local LP community has not yet a mature cluster. Limited LP source, and funding size is usually small. No insurance, pension, endowment, family offices, FoF, …. • Many government agencies (ministries, banks, provinces, municipalities, hi-tech parks...) set up “Guidance Funds” (引导基金) to provide LP funding. But, most of them come with “strings attached”.
RMB Funds with Chinese Characters Local RMB funds are quite different to prevailing offshore USD funds, mainly due to the needs to facilitate local LPs “short term drive” and no commitment to capital calls.
Short-mid Term Challenges for RMB Onshore Investment Tougher fund raising. China still lacks a sound LP mindset and practice. Short of diversified and Western style LP sources. And, foreign LPs are not ready to do direct cross-boarder investment into a RMB fund. Limited onshore divestment routes. Only IPO site in Shenzhen with higher listing criteria. Almost no M&A market yet. Yet-to-improve legal, regulatory and administrative framework to facilitate RMB fund set up and management. Extra red-tapes on operation of RMB funds, which are invested with foreign funding. Need more time to observe a smooth repatriation of foreign LPs’ divestment in local deals.
Convergence of Foreign and Local GPs Foreign GPs will go onshore, moving from A, to B, and eventually onto C. At the same time, local GPs will try to access foreign funding and eventually also managing offshore funds. • Offshore USD Fund: Parked offshore (Cayman Island) B. Onshore RMB JV Fund:： Invested by both foreign and local LPs, registered in China and denominated in RMB. C. Onshore Pure RMB Fund: Invested only by local RMB LPs. C B A
RMB Onshore Fund: a Long March It’s a trend of no return. In the long run, China’s VC/PE industrywill do RMB fund raising (from local and foreign LPs), locally registered, invest into local entities, and divested thru local and foreign IPO or M&A. It might take years for RMB onshore investment to become the mainstream, or to surpass offshore investment. But, foreign GPs and LPs should monitor and proactively react to the shifting trend. Eventually, doing RMB onshore investment is not an option, but a survival issue. However, local RMB investment is still come with lots of challenges. So, need to proceed cautiously and control the pace carefully.
危 机会 China: a Risky Market for Foreign Players China is a tough market for foreign players. Business initiative needs “摸着石头过河”(a Chinese proverb: cross the river by groping the stone under foot). Should follow the trend and work with reliable local partners to avoid operational/legal risks. 摸着石头过河
What’s expressed in this PPT highlights York’s personal observations. It serves for academic discussion only, and not representing iDT VC’s view point. firstname.lastname@example.org www.idtvc.com +86-13911735538 (SMS Preferred) VC Charity Yanxing China (雁行中国) MV: http://v.youku.com/v_show/id_XNTQ5OTE5MTY=.html
Other Observations on China VC, 2009 Attachment I For PPT softcopy and exchange views on China VC Mail to: email@example.com
VC Operation During Depressed Period • Spend more time and resources on portfolio management. Helping on strategic planning and operational efficiency to overcome the crisis. • Reserve funding to back-up existing portfolio, instead of investing into new companies. • Take reserve and cautious approach toward new investment: • Prolong decision making time, spend more time for evaluation. Not rush into investment. • Be much conservative on start-up’s future projection. • No matter at which stage, a VC looks serious on how will the company’s next fund raising. Make sure the company will move on to next milestone with successful following up funding. • Lower down valuation, with better terms and build in down-side protection. • Spend effort to build up closer relationship with LPs to avoid default on future capital calls. • Strengthen the team building.
Financial Crisis’ Impact to China VC Industry Global financial crisis leads to a depressed IPO market. IPO and M&A routes are almost completely closed down. To VC players, the negative impact is not only on the divestment, but also to other three major scopes of a VC operation: fund raising, investment and portfolio management. Chinese column by York: “全球金融危机对中国创投业的影响才刚开始” http://it.hexun.com/2008-08-16/108167805.html, 21世纪经济报道
Opening Slide for Sequoia CEO Day(Oct. 7th, 2008, Sand Hill Rd.) This and next slides are from Sequoia Presentation Slides: http://www.slideshare.net/eldon/sequoia-capital-on-startups- and-the-economic-downturn-presentation
Only the Quickest Will Survive- Strong Message from Sequoia Source: Sequoia Presentation , Oct., 7th ‘08
Naked Swimmers “It’s only when the tide goes out that you learn who has been swimming without a bathing suit.” - Warren Buffet “只有退潮的时候，才能看清楚究竟谁在裸泳。” - 巴菲特 During the “VC Bull” market (‘04 to ‘07), many un-experienced entrepreneurs and venture capitalists joined the fun party. It would be a tough challenges for them to go through the bear market ahead.
Cases Concerning Entrepreneurs’ Integrity being Exposed • Asia Media CEO Cui Jianping embezzled RMB107M to guarantee his personal company. The company was delisted from Tokyo Exchange. • ITAT Fabricated financial data and made up store activities to attract VC investment. It sucked over USD120M VC/PE funding. • Gushan Hiring three empty oil trucks to drive in and out of factory to illustrate busy business transaction. No loading of oil. • PPG It’s alleged that CEO Li Liang is at run and pocketed with USD20M. Credit and Integrity are the foundation for relationship between LP and GP, as well as GP and Entrepreneur. Source: http://news.chinaventure.com.cn/2/20080913/18981.shtml (Chinese) http://www.cyzone.cn/forum/45147.aspx http://news.chinaventure.com.cn/3/20080926/19231.shtml http://finance.sina.com.cn/roll/20081122/03235540248.shtml