China-US VC: Beyond borders

Alibaba Group's early success was based on its ability to match Chinese suppliers with Western distributors. The Chinese e-commerce giant spread from B2B into the B2C and C2C worlds, with Taobao and TMall cornering the market in domestic consumer demand. Wish, a San Francisco-based mobile shopping app, wants to connect sellers on Taobao and TMall with consumers in the US and Europe.

The company's target market is the so-called "Diaosi," a buzzword in the Chinese internet community used to refer to ordinary young people with poor social skills who spend most of their time online. Demand from China's estimated 400 million Diaosi has spurred growth for the likes of Alibaba and rival retailer JD.com. However, the purchasing potential of overseas Diaosi has yet to be realized.

"The Diaosi user base worldwide is may be three to four times the size of their peers in China. All that purchasing power is being unleashed in lower cities around the world," says Hans Tung, managing partner at GGV Capital, a Wish investor. "These users are unsatisfied because physical retail channels in their cities are inefficient and broadband PC internet penetration is still relatively low."

Wish wants to become a mobile shopping channel that offers a wider selection of goods at lower prices than Amazon and WalMart. It claims to have 31 million active users, up from 25 million two months ago, with about 10,000 merchants using its platform to sell goods.

Wish is an example of Sino-US convergence in action. The disruptive impact of mobile internet services - which take time and space as barriers to geographic expansion and reduce them to binary code - is changing consumer behavior. As a result, the target market for companies at the nexus of the technology and consumer spaces has become exponentially larger. What does this mean for the venture capital investors whose remit is to initiate and accelerate such trends?

Increasingly acquisitive

According to Thomson Reuters, Chinese outbound investment in the technology sector reached stands at $1.06 billion for 2014 so far, up from $324.5 million in 2013 as a whole. Of this $1.06 billion, $414.6 million has ended up with US-based companies. This compares to investment of $125.9 million in 2013.

Alibaba and Tencent Holdings are among the most aggressive players. Tencent has deployed $2 billion across 20 investments in the US since 2000, AVCJ Research's records show, while Alibaba has pumped almost $1 billion into six American start-ups. A number of newly listed tech firms - young enough that their VC backers are mostly still on board - are also embracing M&A opportunities. Online retailer LightInTheBox and mobile app developer Sungy Mobile both made acquisitions in the US last year.

"We are beginning to see how strategic partnerships and M&A are going to increase between China and the US," says John Ball, founder and managing partner of Steamboat Ventures. "In the last five years, M&A in the China media-tech space has been primarily focused on domestic transactions. But over the next 3-5 years there will be a dramatic increase in outbound M&A as companies become more comfortable and adventurous in expanding into foreign markets through acquisitions."

Steamboat was among the first VC firms to travel from to China from the US in search of cross-border opportunities, opening offices in Shanghai, Hong Kong and the US in 2000. Four years later the movement was kick-started when Silicon Valley Bank (SVB) took about 25 top-tier US VC firms on a tour of China. SVB itself launched a joint venture with Shanghai Pudong Development Bank and subsequently set up a local VC affiliate, SVB Capital China.

SVB Capital China now has renminbi- and US dollar-denominated fund-of-funds that back local managers - predominantly the affiliates of US VC firms - as well as making direct investments in Chinese start-ups. "Finally today we have the resources and capabilities in China to match what we have in the US," says Ming Yeh, who heads up SVB Capital China. "In many ways, we are in leading position to facilitate cross-border transaction opportunities."

Not long after the SVB trip, Sequoia Capital, Lightspeed Venture Partners and Repoint Ventures arrived in China. KPCB joined them in 2007 and Matrix Partners followed a year later.

At that time, China's tech sector was a relatively nascent stage, which provided a great opportunity for US firms to introduce technologies from overseas. According to PitchBook, investment by US-based VC firms in China soared to $14.44 billion across 106 deals in 2006, up from $3 billion in 2005. Many investee companies have since gone public, generating handsome returns for their investors.

The capital initially came from global funds but it wasn't long before these VC firms established dedicated China vehicles. Sequoia China was set up as early as 2005 and others have followed suit, with Lightspeed raising its first China fund as recently as 2011.

The reality is that as the China opportunity grows, a partial allocation from a global fund might be insufficient. Localization is also driven by China-based teams' desire for greater autonomy and their US employers' willingness to accommodate talent in order to retain it.

"VC success depends heavily on the team and partners, and it takes time to build the partnership," says James Mi, co-founder of Lightspeed China Partners. "It's difficult for US VCs to expand in China without strong China-based partners and talented people are hard to find."

However, in the face of increased competition from wholly domestic VC players as well as spin-outs from global firms, collaboration with the US mother ship offers differentiation. Offices in China and Silicon Valley exchange information on emerging trends and new technologies. And when Chinese portfolio companies want to expand overseas, global networks and resources can be put at their disposal.

"Most of VC firms have some US affiliation and these capabilities are important in helping portfolio companies reach counterparts in the US and expand globally," says Lye-Thiam Koh, principal at Northgate Capital. "But if the firms are investing in early-stage start-ups, I don't think the global reach angle is that significant. Companies have to grow bigger before making acquisitions."

With Silicon Valley still considered the center of global tech innovation, some US-based VC firms invest in China as part of a unified global strategy rather than establish a separate fund. In this way they can build relationships with local Chinese corporates and VC funds that are not only developing Chinese businesses but also taking US-based companies expand into China.

"We have a built a strong portfolio of companies in both China and the US as part of our global investing strategy," says Carmen Chang, partner and Asia ex-India managing director at NEA. "We believe that the strength of our US portfolio companies and our domain knowledge of the most advanced and critical technologies help our investments in China. Understanding the roadmap as it was forged in the US helps us understand possible new developments in China."

Strategic twist

However, it could be argued that Chinese companies have greater scope for geographic expansion than their US counterparts. While US tech firms have generally struggled to establish themselves in China - sometimes due to regulatory restrictions - Chinese players are able to leverage Chinese communities in new markets.

This may already be factored into companies' respective valuations. US-based messaging platform WhatsApp was sold to Facebook last year for $19 billion; Tecent-owned WeChat, which offers a similar service, is said to be worth around $100 billion. Alibaba and JD.com may also turn out to be worth more than Amazon.

"I completely agree that innovation in Silicon Valley is greater than anywhere else. Yet I don't compare China to the US because you can say that the US will continue to have more innovative companies for a long time," GGV's Tung adds. "What people are missing is that the Chinese internet experience over the last 10 years offers its own micro-innovations. Chinese mobile internet companies will be in a better position to become more global over the next 10 years."

With this in mind, Tung broke cross-border Sino-US deal flow into "three buckets." The first bucket comprises US-based companies expanding into China, such as social networking site LinkedIn. Few are expected to be successful due to a lack of understanding of the China market. The second bucket is for leading Chinese tech firms set to go global - entering Southeast Asia, India and Latin America - and the third is for US-based companies whose founders have experience of both markets.

Wish's founders, former Google and Yahoo employees Peter Szulczewski and Danny Zhang, are an example of a Sino-US combination.

"Increasingly these teams include immigrants from China who have lived in the US for over 10 years, they know the e-commerce marketplace model has worked well for Taobao and TMall in China, but they also have a global perspective because they have successfully adapted to best practices in Silicon Valley and New York," Tung explains. "These people should be able to adapt proven concepts in China for the global market, with potentially even collaboration from companies in the second bucket."

The occupants of the second bucket are already well established and they will continue to develop their businesses geographically through M&A. But the start-ups that come onto their radar occupy a space that is increasingly neither Chinese nor international - they are global almost from inception. In this context, venture capital firms, with their domain expertise and networks in multiple markets, are well positioned to offer early-stage guidance.

"Over the next 10 years, the distinction between a company based in the US or China will become secondary. The focus will be on building global brands and user bases that cut across multiple geographies and leverage skills and resources in those locations," says Steamboat' Ball.

SIDEBAR: China hits the accelerator

When 500 Startups chose Rui Ma as its first Beijing-based venture partner early last year, it was a sign that the US accelerator was getting a serious about China. Ma is one of three partners in Asia and one of 10 around the globe sourcing deals.

500 Startups has already launched seed funds targeting Southeast Asia and India, with the potential of follow-on investments from the US-based master fund. Although 500 Startups is one of the better well-known Silicon Valley seed-stage investors in China, its accelerator program has yet to gain traction in the country. Ma says the company faces two main obstacles.

"Firstly, most angel investors have cropped up in last three years and are still in the low thousands so investors don't really understand risks yet and terms are only just becoming standardized," she says. "Secondly, is the lack of sharing culture and a mentoring ecosystem; successes generally happen behind closed doors right now. There are starting to be more exits but it's still relatively concentrated."

Though US accelerators and pure seed-stage investors have a limited presence in China, the investment models they have established in Silicon Valley have been adopted locally.

Beijing-based Innovation Works, for example, was set up in 2009 by the former Google China head Kai-Fu Lee to combine early-stage investment with the operational services typically associated with most Silicon Valley accelerators. Meanwhile, Chinaccelerator is one or four Asian programs to be part of US-based TechStars' Global Accelerator Network (GAN).

US seed-stage investors' access to Chinese start-ups has so far been dependent on these kinds of networks and by hiring local talent - as in the case of 500 Startups. However, it is early days.

"There is no reason why more structured programs cannot be setup in China," says Chris Evdemon, a partner with Innovation Works. "The challenges will be adapting them to the realities of the Chinese early stage ecosystem and being honest in terms of the type of entrepreneur and project that you are targeting."

500 Startups' Ma stresses that is if any US seed stage investor is to build a significant presence in China, it must differentiate itself from local players.

"Local players in the seed space tend to focus solely on products addressing the domestic market whereas we are a lot more flexible," she says. "We have still need to educate our target audience as to our value-add but I'm glad to report that it's really starting to stick and people are really seeing us as value-added partners."

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• Topics
• Venture
• North America
• Greater China
• Early-stage
• Technology
• TMT
• Consumer
• Venture
• China
• USA
• GGV Capital
• New Enterprise Associates
• SVB
• 500 Startups
• Innovation Works