China’s corporates embrace VC

For the past 15 years, corporate venturing in China has been the exclusive preserve of foreign investors. The fundraising numbers said as much. Activity may have trebled from $611 million in 2006 to $2.2 billion in 2010 - evidence of the corporate sector boosting its exposure to fast-growing emerging markets - but it was still a fraction of total private capital committed to China.

The landscape changed dramatically last year. Corporate VC fundraising came in at $4 billion more than 2010, and not far off the total for the previous five years combined. Welcome to the world of domestic corporate venturing. While government-linked interests feature prominently - two state-run vehicles raised $2.7 billion between them last year - the presence of local tech firms, which were little more than independent start-ups themselves 15 years ago, is striking.

Tencent, founded in 1998 with venture capital backing and now China's largest internet company, rolled out the Tencent Collaboration Fund in January 2011. The vehicle targets social and mobile gaming, e-commerce and new media. It is equipped with RMB5 billion ($792 million) from Tencent's balance sheet and outside investors are expected to match this sum.

Alibaba Group has set up a RMB300 million fund under its online auction site, Taobao, and created AliVenture, a corporate VC arm with a team of 16-20 investment professionals. Internet search giant Baidu has no dedicated fund or investment arm, but its corporate development department is very active. Recent investments include a majority stake in travel search engine Qunar and a minority interest in Anjuke, an online real estate platform.

As part of their mandate or just as general guidance, these operations are tasked with identifying investments that bring strategic value to their parent companies. The Taobao fund, for example, will only support developers who produce digital applications that fit into the Taobao marketing platform.

"Many large companies, particularly the BATs - Baidu, Alibaba and Tencent - are utilizing venture capital models as a way to accelerate growth, enter into new businesses and keep abreast of the latest developments," says Fritz Demopoulos, an internet and media entrepreneur who co-founded Qunar.

"In some ways, an equity stake in a promising early-stage company gives them an option to secure an acquisition or strategic partnership at a later point in the early-stage company's development."

Domestic powerhouses

With the likes of video site Youku and social network Renren tipped to enter the fray, drawing on the capital raised through their IPOs, questions are being asked of existing VC players, both independents and foreign corporate venture units. Are the stars of the last generation of Chinese tech start-ups, with their deep local knowledge and networks, going to eat up the deal-flow of their one-time backers?

In some respects, the trend should come as no surprise. Many of the entrepreneurs who built these companies have spent time in Silicon Valley and are familiar with the evolution of corporate venturing in the US. They have seen how the likes of Intel, Cisco and Microsoft - not to mention LG and Softbank in Korea and Japan, respectively - have used acquisitions and investment to further their core businesses.

It is only natural that once a start-up reaches a certain critical mass, and rapid growth is replaced by consolidation of market share, M&A becomes an attractive means of expansion.

There are signs this might be the next step in certain parts of the e-commerce industry. It goes without saying that industry is seeing huge growth. According to Boston Consulting Group, total transaction value came to RMB476 billion ($75.5 million) in 2010, up from just RMB128 billion two years previously. The market is expected to be worth RMB2 trillion by 2015 - larger than the US market - as e-commerce penetration in China nearly doubles to 44%.

However, harnessing this growth means that the incumbent internet giants must broaden their product portfolios - and corporate VC can play a role. Alipay and Tenpay, run by Alibaba and Tencent, respectively, lead the online payment market but John Wu, former CTO of Alibaba Group and now chairman of VC firm F&H Fund Management Group, questions whether they can fight of new rivals.

"Alibaba wants to increase the Alipay customer-base," Wu tells AVCJ, "but if one of its competitors has set up a big fund to invest into 30 or 40 companies, it can really make a difference to the ecosystem and pressure Alibaba's core business. This is the reason why they need to have a venture capital arm."

The technology space is fast-moving and leading players that failed to stay relevant have found themselves left behind. Ten years ago Sina was the giant in China's internet space but now it is a second-tier operator, well behind the likes of Baidu, Alibaba and Tencent.

Corporate investors the world over tend to have the edge on their financial counterparts in two areas: capital and strategic interest. In China, a third category could be added: regulation, bearing in mind the government's policy to support the development of domestic companies with global clout.

Not only do Chinese corporate investors have more capital, they are also able to deploy it in local currency. "China changes in every six months, and the increasing demand for renminbi-denominated funds in recent years has shown that entrepreneurs prefer local money," says Andrew Gaule, founder of consultancy Corven Networks, which advises Western corporate venture investors in China.

In terms of strategic interest, the Chinese advantage is less clear cut. While overseas corporate VC players are typically patient and focus on building for the long term, Chinese conglomerates are said to be weighed down by short-term considerations in their investments.

One of the reasons is that the local technology sector is still in its nascent stages. Rather than concentrate on time-consuming, advanced innovations, some local companies emphasize expanding channels and applications for their existing technologies. To put it crudely - and perhaps unfairly - they prioritize scale over skill. This is understandable given internet entrepreneurs success' in China is largely built on rolling out their businesses nationwide.

Taobao's RMB300 million fund is a case in point, focusing on solely on applications for the company's digital platform instead of next-generation products. Similarly, the Tencent Collaboration Fund has target investment period of just 2-3 years.

"For multinationals like Intel, Microsoft and Google, their global corporate VC activities are more for technology and product innovations, intended to complement its in-house development," says York Chen, managing partner of iD TechVentures. "In China, local Corporate VCs could identify and invest into homegrown technological innovations, instead of chasing leading-edge technology for global competition."

These divergent strategies might go some way towards explaining why many foreign corporate development teams - who have an edge in technology innovation - continue to thrive in China.

Intel Capital, which aims to build an ecosystem that complements its parent company's core chip business, has so far invested over $650 million across more than 100 companies. IDG Capital Partners, a VC unit set up by International Data Group and Accel Partners, has accumulated 200 portfolio companies. The likes of Nokia, Cisco and Microsoft are also active.

Richard Hsu, managing director at Intel Capital China, notes that having an international brand name synonymous with technology, remains a great calling card. "From my personal experiences, the Intel name is still a great asset for start-ups as we focus not only on financial returns, but also strategic returns," he says.

Point, counterpoint

While domestic corporate venture players' strategic imperative is a work in progress, they are still able to approach tech start-ups from a position of strength, based on their well-established human resources, skill sets and sector knowledge. Chen of iD TechVentures argues that this is an advantage when investing in niche markets where start-ups may struggle to win over traditional investors.

"When Tencent invests in start-ups, it can always refer to the expertise and human capital led by its founder Pony Ma, which is a bonus for companies that are still at their initial stage," he says.

Nevertheless, it remains to be seen how many companies Tencent can feasibly approach. The big technology companies still account for a small portion of the market that is dominated by independent VC players.

A major reason why entrepreneurs might prefer to do business with an independent operator is autonomy. Provided business growth and returns remain on track, financially-driven VC firms are known for being more open-minded regarding development. In contrast, tensions may arise if what is in the best interests of a portfolio company runs contrary to wider business plans of a corporate venture unit.

"When I talk to entrepreneurs, they always have mixed thoughts. It is true that if Tencent and Alibaba are behind them, they will probably get a good deal of resources, but these giants can also come in and affect business strategy," says F&H's Wu. "Some companies may go with traditional VC firms instead of those that take away their independence."

Wu adds that independent VC firms aren't lacking investment opportunities. Rather, they don't have enough capital to commit to early-stage deals, particularly in the TMT space.

In this environment, corporate venture units are likely to be welcomed as co-investors alongside independents. Entrepreneurs also see the value of stakeholders who offer different strategic and financial perspectives and expertise. Baidu's investment in Anjuke is a good example. Last March, the search engine led a $50 million funding round for the company alongside Matrix Partners and some other VC investors.

"In the case of Anjuke, the company obviously wants to strike a balance between venture capital and corporate venture capital as it accesses funds," says Demopoulos. "While the venture capital firms are experts in finance, Baidu contributes operating resources such as demand generation or traffic, technology and human capital."

Alibaba is said to be taking a similar approach, working with several venture capital funds to provide loans to small vendors that sell their products through the Alibaba platforms. F&H Fund Management Group tells AVCJ that it also collaborating with a corporate VC arm in some upcoming investments, though it declines to disclose further details.

Working in partnership

The journey from start-up to IPO is a long one and success relies on investors collaborating with one another just as much as with entrepreneurs.

"Corporate VC is just another avenue to help the company, it is actually complimentary and not competing with the traditional VC players," says Intel's Hsu. "We work with VC firms all the time at different stages because there are still many early-stage companies that we find them too early for us to invest."

Looking at the VC industry as a multi-stage process, corporate venture players are also a much-needed source of liquidity for independents. For example, Tencent's $60 million investment in social networking provider Comsenz in 2010, reportedly facilitated the exit of VC backers including Sequoia Capital, Morningside Ventures and Google.

In this way, the abundant resources of corporate VCs' can contribute to the broadening of the venture capital industry as a whole. The IPO market will remain the exit route of choice for VC investors but if the domestic corporate venture presence continues to grow, it broadens the trade sale channel. With a lower liquidity risk, more investors might be willing to participate, which means more money for entrepreneurs.

"Historically, the only exit opportunity for venture investors and founders has been the public markets," says Demopoulos "Now, besides the IPO option, there are more and more trade sale opportunities, most evidenced by the BAT option."

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• Topics
• Venture
• Greater China
• Technology
• Early-stage
• China
• Venture
• Alibaba Group
• Intel Capital
• iD TechVentures
• Baidu
• Tencent
• Fundraising