Cross-border VC: Changes in the wind

Dash and Dot, a pair of robots designed by US-based Wonder Workshop, can sing, run, dance, and play games. But their real purpose is to be more than just a toy: the pair come with the software tools to let children create their own programs to govern the robots' behavior. Now the system, already sold in more than 30 countries, will soon become available in China, thanks to a distribution deal signed earlier this year between Wonder Workshop and JD.com.

The agreement with JD.com was a coup for Wonder Workshop's VC backers, which include China and Taiwan-based Innovation Works and US and China-focused WI Harper Group. Both GPs encouraged the company to enter China, and they believe they have played a crucial in helping the founders navigate the often slippery road to success in the country's hardware market.

"It's an extremely steep learning curve," says Chris Evdemon, a Silicon Valley-based partner at Innovation Works. "One or two bad choices and you're basically done, because a lot of these hardware start-ups are a lot more capital intensive than other purely software-centric sectors of start-up activity."

As China's consumer market continues to develop, the appetite for US start-ups to reach out to an increasingly affluent middle class will only increase. This cross-border interest represents an opportunity for VC investors as well, particularly those that can provide investee companies with an edge in addressing the completely unfamiliar Chinese market. With the growing sophistication of local Chinese companies opening up additional opportunities for cross-border exploitation, funds that can manage to keep a foot on both sides of the divide are expected to thrive.

Reality check

One of the main responsibilities for a VC investor is to manage the expectations of founders that are planning a China push. Without dampening their enthusiasm, the GP must still educate the company's management team about the difficulties that lie ahead, and the changes they will need to make in order to reach a totally new set of consumers.

"You're very much starting from scratch; even though the technology or the product might be pretty mature in the US, it doesn't mean that the Chinese branch does not need to be tweaked pretty heavily from the ground up," says Xiao Wang, CEO of cross-border focused tech incubator InnoSpring. "And China is very competitive, the good talent is hard to come by."

For WI Harper, which invests in both the US and China, one of the most important factors in enabling a cross-border strategy is to impress upon the investee the help that the GP can provide. Portfolio companies must recognize that their backer's experience is a valuable asset to them, and they also need to see how results differ for those peers that do not have such assistance.

"I think a lot of the companies we invest in, if they didn't have us as an Asian investor, with a deep track record in the region, they wouldn't even consider coming to Asia," says Edward Liu, a partner at WI Harper. "On the other hand, for some of these US start-ups that do not have Asian investors, I think they don't understand the market as well as they think they do."

Wang saw first-hand the damage that can result from a US technology developer failing to appreciate the needs of the Chinese market when China Broadband Capital, one of InnoSpring's LPs, was in talks with both LinkedIn and Facebook for helping with their China expansion. China Broadband ultimately decided to partner with LinkedIn, cutting off talks with Facebook; Wang attributes the decision to Facebook's unwillingness to concede the level of independence that the local partner wanted.

"A few years later Mark Zuckerberg's realized this, and he's trying to be a lot friendlier," says Wang. "It's something that every founder adapts to; some are quicker, some are slower. The understanding of why it's necessary to do that is probably the hardest thing."

Transplanting a US business model into China has only gotten more difficult in recent years, as competing copycat businesses have sprung up offering the same services with a local twist. Examples abound, ranging from Didi Chuxing, an Uber equivalent with a private valuation of more than $25 billion, to Tantan, a Chinese version of dating app Tinder, which recently raised a $32 million Series C round.

While most VC players believe US firms continue to have an edge over their Chinese competitors in terms of innovation, they also recognize the gap is closing. With Chinese consumers more likely to find the local alternatives an acceptable substitute, outside companies must find advantages that they can press home beyond the technological - such as the greater resources that a successful multinational can bring to bear.

"In a lot of ways I think Chinese consumer mobile products have leapfrogged their counterparts outside of the country, so it's difficult to think of cases where a foreign company has a distinct advantage," Innovation Works' Evdemon says. "Uber might be an exception to the rule. We cannot cast a strong vote on the final outcome of what they're doing, but at least Uber's approaching China the right way, which is all-in. The way we see it is very binary: you either go all-in or you better stay out."

Healthy collaboration

While the technology sectors are marked by fierce competition, healthcare presents a different story. This market is often characterized by collaboration with local partners who can guide the foreign developer through China's maze of healthcare regulations and position its products for the local market.

For example, when Minnesota-based Medtronic wanted to take its pacemaker technology into China, it was concerned that consumers would prove slow to adopt its high-end offering. Help came in the form of Lifetech, a Shenzhen-based medical implant manufacturer and investee of healthcare-focused GP Ally Bridge. The Chinese firm proposed to license Medtronic's technology and promote it to customers as a local brand alongside the original product, providing a second tier alternative to price-conscious consumers and insulating Medtronic from skepticism about a premium product from a foreign manufacturer.

"They assembled it in China, branded it as a Chinese product and sold it to China, at a much lower price point than Medtronic's own crown jewel pacemaker, like a Mercedes," remembers Frank Yu, founder and CEO of Ally Bridge. "So Medtronic continued to sell its Mercedes brand, and then this local company Lifetech sells the Toyota Camry brand."

Yu sees the deal as an example of his firm's value as a bridge-builder; he helped connect the leadership of the two companies and set up the partnership, drawing on his relationship with both Lifetech and Medtronic, which had participated with Ally Bridge in another investment.

Investors in healthcare tend to see this collaborative approach as a product of the lengthier development cycles typically found in the sector. Both the heavy regulation of the healthcare in China and the US, and the nature of medical research, mean that development cannot move as quickly as in other technology fields; drug designs are harder to copy, meaning there is less chance of one's intellectual property being stolen, and working with Chinese partners is less of a risk for US companies.

"Everybody has different strengths, and the regulatory systems also have different strengths and weaknesses, so it's great to see collaborative work coming from the US and China, whether it's between two companies or internal collaboration," says Nisa Leung, managing partner at Qiming Venture Partners, which is planning to launch a healthcare fund that will help US and China-based start-ups expand in both markets. She points out that a VC firm can also facilitate cross-border collaboration within a portfolio company, by influencing a Chinese company to hire US-trained talent, or vice-versa.

Application and ambition

Cross-border investors continue to be optimistic about US companies finding growth opportunities in China. One of the areas that some GPs identify as a target is supporting software development. This segment has seen little attention in China relative to the more photogenic consumer tech space that it underlies, but it is of critical importance, and domestic hardware companies will likely continue to rely on US developers for support.

"China is very rich in terms of data sets that need machine learning optimization technologies or deep learning technologies," says Evdemon. "China is also extremely hungry to modernize and automate its manufacturing sector, so industrial-facing and commercial-facing robotics will have a tremendously large market application in China."

The biggest driving factor in US-China cross-border investment, however, is likely to be the hunger of US companies that see their peers' growth take off as they enter China. Whether or not their expectations of similar results are realistic, entrepreneurs' dreams are likely to prove irresistible, bringing their VC backers along for the ride.

"The market has been educated by the success of companies like Uber," says InnoSpring's Wang. "If you look at their growth curve, the only hockey-stick growth is in their Chinese market expansion, and the rest of the market is really flat. That has helped them a lot in telling their story and raising a lot more capital, and obviously from a strategic level a lot of people want to have that success."

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• Topics
• Greater China
• North America
• Technology
• Venture
• Healthcare
• Early-stage
• TMT
• USA
• China
• Ally Bridge
• WI Harper Group
• Innovation Works
• Qiming Venture Partners
• GGV Capital