AVCJ Awards 2020: Special Achievement: Lip-Bu Tan

In 2002, a year after closing his latest Asia and US-focused venture capital fund at $1 billion, Lip-Bu Tan decided to return $250 million to LPs. Pacven Walden Ventures V, which had $1.5 billion in demand against a target of $750 million, was ultimately cut back to $593 million. Tan’s reasoning was that the bloated fund had made Walden International too bureaucratic and taken the fun out of early-stage investment.

“It was one of those moments when you stop enjoying being an investor because the organization is too big. We had 20 partners in an organization of 120 people. I was spending more time managing them than building companies,” he explains. “I decided to go back to funds of $300-400 million – there aren’t as many people to manage and you get carried interest faster. It was a good move because Fund V looks like it will be 4x. It wouldn’t be that if we’d stayed at $1 billion.”

After more than three decades in venture capital – during which he has seen 115 portfolio companies go public and pioneered the investment structure that has channeled billions of dollars into Chinese tech start-ups – Tan’s passion for early-stage deals is undiminished. His nine most recent investments were all seed commitments to university professors who had ideas but needed help devising business models. University of California Berkley has delivered 11 start-ups to date and Stanford three, creating a pipeline of proprietary opportunities.

“You back so many professors that they point you in the direction of people who are doing interesting things and I brainstorm ideas with them,” he says. “In the past, I looked at entrepreneurs who had set up companies and financed their growth. Now I create companies from scratch. There’s a lot of calculated risk, but I’ve seen and learned a lot over 30 years. And then you are always learning – about enterprise software, quantum computing, machine learning, and data analytics.”

SMIC and all that

In some respects, this accumulated knowledge has come full circle. Tan likes to talk about the “five waves” driving technology innovation: 5G, autonomous driving, hyperscale infrastructure, industry 4.0, and artificial intelligence (AI) and machine learning. The unifying piece of hardware is the semiconductor. It is one of the VC stories of 2020, especially in China, where the government wants to ease reliance on exports amid fears of international regulatory action.

There were nearly 100 semiconductor investments last year – up from 30 in 2017 – most of them relatively early-stage bets on AI-enabled chip designers and manufacturers. Meanwhile, more than 10 VC-backed semiconductor players went public in China – as many as in the five previous years combined – led by Semiconductor Manufacturing International Corporation (SMIC) with a RMB53.2 billion ($7.6 billion) offering. It is a company to which Tan is inextricably linked.

Walden was there in 2000 when Rujing Zhang, SMIC’s founder, sketched out his ambition to build a wafer foundry in mainland China. It was a founding shareholder in the company and remains an investor, having made partial exits following IPOs in Hong Kong and the US in 2004 and more recently in Shanghai. SMIC has become one of the world’s leading foundry operators but it took the company more than a decade to establish itself as a consistent profit generator.

Tan recalls that people thought he was crazy to transition from a generalist to a specialist VC and then pick semiconductors – “a sunset industry” – as his specialization. And then SMIC, where he served as a board member for 18 years, was no cakewalk. “We changed CEO and chairman several times. There was infighting within the management, between shareholders,” he says. “I had to help settle these disputes and look at what was best for the company and the industry.”

SMIC didn’t turn into a homerun for Walden, but the GP has backed 120 semiconductor companies out of 500 start-ups globally. They include equipment manufacturer Advanced Micro-Fabrication Equipment (AMEC) in Asia, chip designer Montage Technology in China, AI processor manufacturer Habana Labs in Israel, and machine learning specialist SambaNova in the US. Intel bought Habana Labs for $2 billion in 2019, while Tan claims to be sitting on a 150x paper gain on SambaNova.

Tan attributes some of Walden’s more recent semiconductor successes to Cadence Design Systems, a producer of software and hardware used in chip design, where he has served as CEO since 2008, presiding over a 55-fold increase in the share price. “Every major semiconductor and systems company needed Cadence’s help, so I got an insider view on the requirements, from Amazon to Microsoft to Intel to Samsung,” he says. “This gave me unique insights as to what to invest in.”

These investments are global, with an emphasis on finding the best developers regardless of geography. While the China portfolio includes several semiconductor start-ups – one of them, chip designer Galaxycore, is prepping for a domestic IPO – it is light on AI. Walden’s preference has been to back US companies in the space with a China expansion angle. In China, it backs businesses that target the local market, among them online-to-offline services giant Meituan-Dianping.

Tackling China

The firm, which was established in 1987, got initial traction in Asia through a partnership with the Taiwan government, which wanted to support local small and medium-sized enterprises (SMEs). This formed the template for other country funds around the region, from Singapore to Malaysia to the Philippines. Development finance institutions such as the Asian Development Bank and International Finance Corporation (IFC) were regular investors alongside a scattering of US endowments.

A first pan-regional fund came seven years later, around the time Walden launched its debut dedicated China fund. The China vehicle was supported by the country’s Ministry of Finance as the local strategic backer as well as UOB, Temasek Holdings and Tat Lee Bank out of Singapore and Commonfund Capital and the Harvard and Michigan endowments from the US, plus IFC.

Among Walden’s early China investments were Wuxi Little Swan and Shenzhen Mindray Bio-medical, now two of the leading manufacturers of consumer appliances and medical equipment, respectively. A turning point came in 1999 with internet services. Beijing had already nixed a series of foreign joint ventures in the telecom space, decreeing that such assets were off-limits to overseas investors. However, it did stipulate that the internet would be subject to less rigorous oversight.

Tan led the creation of the workaround, known as the variable interest entity (VIE) or “Sina model” for the internet portal deal in which it was first used. Typically, the assets to which foreign investors cannot have direct exposure are placed into an onshore vehicle controlled by one or more Chinese nationals. This vehicle operates in parallel to the standard wholly foreign-owned enterprise (WFOE) controlled by offshore investors and is contractually tied to it.

“We had to make government officials feel comfortable that the structure would work,” he recalls. “They were very nervous about foreign investment in media assets because the government wanted to have control. Online media was new to them, so we had to explain how it was safe. It took a long time, maybe a couple of years, educating them and sharing examples of how it worked in the US, before they were comfortable negotiating. Even then, there was a bit of trial and error.”

In the case of Sina, Walden led a $7 million round of investment in Beijing Stone Rich Sight Information Technology, which was set up by Sina’s former CEO. This was then merged with a US-based company called Sinanet under a VIE structure and the resulting entity was called Sina.com. Walden then brought in Goldman Sachs and others for Sina’s first institutional round, worth $38 million, and the company listed on NASDAQ in 2000.

By the time Sina went public, the NASDAQ Composite Index had peaked, and the internet bubble duly burst, leading to a huge amount of value destruction over the next couple of years. For China – still a nascent international venture capital market at the time – it proved to be a blip. Silicon Valley Bank started organizing Asia tours for North American VC firms in the early 2000s and many established China affiliates. The VIE remained the structure of choice for internet deals.

Decoupling question

Tan arguably has a unique perspective on US-China tensions, having helped initiate the flow of capital from North America into Chinese start-ups and now witnessing a potential decoupling of two interdependent technology ecosystems. Semiconductors is just one area in which Beijing wants to become leader rather than follower in technological innovation and the setting of global standards.

“Self-sufficiency is important for China; they are doing what is best for them. At the same time, I’m a strong believer in the global economy, and hopefully, US-China relations will be smoother under the Biden administration,” he says. “China is not exceptional in wanting to address local requirements, but can it be self-sufficient? In some areas, like online food delivery, they are already more sophisticated than the US. In others, such as EDA [electronic design automation], it will take longer.”

Importantly, in an early-stage investment context, China compares favorably to the US when it comes to university talent, according to Tan. The expectation is that Tsinghua University and Peking University could emulate Berkley and Stanford as sources of start-up deal flow. In the VC world, however, success is not guaranteed.

“I always tell my friends I don’t have a crystal ball – 50% of it is luck, and I prefer to be lucky than smart,” Tan explains. “Even if you pick the right industry and company, some investments you think are smart will turn out to be challenging. But going in at the ground floor and creating a business from scratch, that’s a lot of fun.”

Pictured: Lip-Bu Tan of Walden International

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• Topics
• Greater China
• Early-stage
• Technology
• North America
• Walden International
• Lip-Bu Tan
• AVCJ Awards
• TMT
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