Tech & government: 20 years of early days

Political enthusiasm for start-ups and venture capital investment in Asia's new economic powerhouses threatens to cloud projections about how the region's digital technology ecosystems will actually evolve.

Appetite for exposure to this space has undoubtedly been strong, with start-up funding across Asia Pacific reaching $7.8 billion last year, according to AVCJ Research, versus $742 million only 10 years prior. Investors are betting on the combination of long-term fundamentals - GDP growth, rising household incomes, greater smart phone penetration - and technology-enabled disruption. Confidence is buoyed by the fact that China and India are proven breeding grounds for successful start-ups.

Governments can stimulate these endeavors or stymie them - often through policy that is well-intended but poorly devised, communicated or executed. Perhaps nowhere is this more apparent than in China, where a flood of money from Beijing has led to local-level reverberations that highlight a number of uncertainties about the broader ecosystem's future.

"Whenever the government has a policy push on start-ups or innovation, you see local authorities setting up incubators and a lot of government guidance funds making policy-driven investments," James Lu, a China-based partner at US law firm Cooley. "It's good for the macro environment to have that at the top of the agenda, but a lot of these government-sourced funds are not disciplined compared to VCs. They are very short-term oriented, trying to sell their incubator programs as fast as possible."

A fine line

Recent activity includes the launch of a $30 billion state-backed venture fund, following the establishment of a similar $6.5 billion vehicle last year. It has also been reported that government-supported VC funds in China have raised a cumulative RMB1.5 trillion ($231 billion).

There are two major problems. First, this type of government assistance may not be what start-ups want or need. Second, the proliferation of these funds has prompted concerns of a valuation bubble, characterized by a disproportionate amount of unqualified start-ups are rising through the ranks of investor favor due to a mix of uninformed support and well-funded but dubious marketing streams.

Additionally, the nature of the capital means that China's digital economy could be shaped for years to come by political whims rather than by market forces. "The government is going to play an interesting role, if you think about censorship, security and content," says one industry participant. "All of those things in one way or another will affect the prospects of a start-up doing business there, so policy statements are making an impact on business models and future growth prospects."

The natural reaction to such interferences is to call for government to get out of the way. But in still-malleable frontiers such as the peer-to-peer lending segment of Singapore's fast-growing fintech space, stringent government controls can represent an attraction for VCs.

"People often ask for more de-regulation, but the flipside is that sometimes new industries should be regulated so we know the boundaries of what we can invest in or not, and what is the right timeframe of investing or not," says Stefan Jung, managing partner at Venturra Capital. "It's great as an investor if you have guidelines on what is actually the playing field."

Singapore is a regional leader in striking a balance between government involvement and private innovation in the technology sector. The city-state has supercharged its VC industry through a string of matching funds, whereby the National Research Foundation makes commitments to funds on the condition that an equal amount of capital is sourced from the private sector. The manager has sole responsibility for investment decision-making.

The advantage of such approaches is that they give professional direction to government involvement and add to the lines of communication between policymakers and industry. This strategy appears to have had a direct impact on the local start-up ecosystem. Total VC investment in the country has increased steadily from $61.1 million in 2010 when the matching system was implemented to $918.1 million in 2015.

VC investment has already reached a new high of $1.2 billion so far this year, but the number of deals is down by one third on 2015 as a whole, suggesting a shift in emphasis towards later-stage activity. While this is evidence of a maturing ecosystem, it also points to potential holes in the country's ambitious innovation agenda, which includes a multifaceted smart city program and a number of financial sweeteners from government-backed accelerators.

"From a VC perspective, the grants in Singapore have helped enormously," says Michael Lints, a venture partner at Golden Gate Ventures. "But there is a shift in focus where the grants are slowing down at the seed level. This is basically because companies are seeking more later-stage funds and the government is now opening grants for the corporates."

Encouraging the expansion of later-stage investment activity does not have to include a retraction of start-up support, however. As markets become more advanced, governments will be better situated to help early-stage entrepreneurial communities through education systems.

Indian education

India provides a good example of combining a government push for early-stage company creation with broader educational support by hosting a widespread program of campus-connected accelerators where research is exchanged for equity or simply a space to work. But unlike much of Asia, India has never contended with a pervasive culture of conservatism, roundly frowning on entrepreneurialism in favor of more traditional, secure career paths. As a result, such investments may not be the best use of funds when fostering a start-up ecosystem.

"I don't think the government needs to do necessarily anything on the accelerator front. The IITs [Indian Institutes of Technology], which are partly government funded all have their own incubators, so they're already contributing to the ecosystem," says Ben Mathias, managing director at Vertex Ventures India. "But some of the government-funded incubators are still useful to the extent that entrepreneurs need initial seed funding, particularly in newer, un-established sectors. Once they get beyond that point of idea-to-product, the VC ecosystem is very well established."

Government influence in company support at such an early stage is not always measureable, but India has charted some promising progress. In 2015, seed funding reached its highest level since the global financial crisis last year at $6.6 million, compared to only $1.4 million across the preceding five-year period.

This momentum has recently been boosted by Startup India, a funding campaign that also aims to add clarity to some complex issues such as tax exemptions. Having only been in effect for six months, however, it mirrors much of the immature and unproven nature of Asia's government policy environment in general.

"There could be more clarity on taxation, particularly for companies that are co-located and co-managed in India and, say, the US or Singapore," Mathias adds. "Nobody wants to be called up three years from now for unintentionally not paying their taxes just because they didn't understand the rules."

CASE STUDY: China - Zero Zero Robotics

When Mengqiu Wang returned to China after 13 years in the US, he didn't experience any returnee culture shock, but he did notice a distinct shifting in the government's cultural influence toward the technology sector. The entrepreneur went on to establish Zero Zero Robotics, a Beijing-based personal-use drone start-up, with no intention of seeking state support.

The China he came home to, however, was considerably different to the country he had left. This is perhaps most evident in the ease and speed with which the Stanford-educated engineer got his latest company off the ground. "Starting a company in China these days is perhaps even easier than the US in certain regards because there are a lot of professional agencies and services that let you pay a very small fee and get registered in a short period of time," he says.

This incubation support has expanded Zero Zero operations across bases in San Francisco, Shenzhen and Hangzhou in less than two years. It now claims some 3,500 square meters of permanently rent-free office space thanks to Chinese government incentives. "I've never heard of these kinds of conditions outside of China," Wang says. "It definitely goes well beyond what I expected when I came back."

This growth process recently included a $23 million Series A round to support development of the company's debut product, the "Hover Camera," and a steady stream of national TV appearances offering promotional opportunities typically reserved for far more developed companies. Much of the attention is tied to government efforts to encourage more of China's educated diaspora to return home, but it is also part of a broad-based initiative aimed at inspiring the existing local ecosystem.

Wang describes this fast-emerging environment as an efficient system where accelerators and VCs thrive in a survival-of-the-fittest market, regardless of whether or not they have government backing. Leave of absence concessions are offered to university students to allow them to pursue start-ups, and even college professors are given flexibility to grow venture businesses on the side.

Although this agenda aimed at bolstering the technology space has so far made effective use of the government's financial and communications heft, the inherent challenges of a cultural pivot in so large a nation remain as intractable as ever.

"The start-up mentality here is a bit of a craze, especially in Beijing," Wang adds. "But in terms of originality and true innovation, I think it will take a while to change because education is still test driven and results driven versus creativity driven. Creativity means catering to each individual, but in a class with one teacher for 60 students, it's hard to ask for that."

CASE STUDY: India - Blume Ventures

India's government started the year with promising signals about its willingness to engage the venture capital community, including the launch of a INR100 billion ($1.5 billion) venture capital fund-of-funds. This coincided with a Union Budget that offered incentives ranging from a streamlined registration processes for new companies to a tax holiday for three of the first five years of a start-up's life.

Improved sentiment around these measures has underpinned the establishment of a flurry of new incubators, the launch of the Startup India campaign and a move by the India Venture Capital Association (IVCA) to broaden its traditional PE-related mandate with the introduction of an arm focused on start-ups. Significantly, this new IVCA stream is expected to deliberate extensively on one of the unexpected complications of the government's VC initiative: determining what constitutes a start-up.

"Start-ups extend well beyond what is defined as one by a VC firm. So coming up with a policy to define it tightly will always be very challenging " says Karthik Reddy, co-founder and managing partner at Blume Ventures, which recently closed its second technology-focused VC fund at $60 million.

The concern is that unqualified legacy companies will exploit government start-up tax holiday incentives by finding mechanisms to create new companies that can handle the parent group's contracts in lieu. This has led to a slowdown in policy implementation as the government mulls the most effective measures for policing related regulations.

"That's an unfortunate part of business in India, but it's a hard reality that anytime you create a new policy, there are enough creative minds who will find loopholes to abuse this policy," Reddy says. "We are trying to boost start-ups by creating a wide enough umbrella that encompasses everybody, but it's a struggle."

Perhaps the greatest concern is that these cultural barriers are not merely gumming up tax break plans in the near term. Such headwinds are indicative of a fundamental difference in business attitudes between India and the country whose success story it most wants to replicate.

"The things that led to China accelerating its venture ecosystem and almost catching up with the US over a 15-year period - I don't think we have all those ingredients in India," Reddy adds, evoking China's "walled garden" approach to foreign investment protectionism, India's cumbersome regulations in areas such as e-commerce and cynicism among Indians about their ability to compete globally. "Nothing has been unshackled. People ask if we'll be able to do what China has managed to do, but I can't see it happening in less than 10 years."

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• Topics
• Greater China
• South Asia
• Southeast Asia
• GPs
• Regulation
• China
• India
• Singapore
• Venture
• seed
• Venturra Partners
• Golden Gate Ventures
• Blume Ventures