Q&A: Soul Capital’s Herry Han

Q: You formed Soul Capital last year through a spinout from Lightspeed China Partners. Wasn’t this a difficult time to launch a new firm?

A: China’s venture capital landscape is undergoing significant change. The country’s economy is entering a new phase and geopolitical issues have caused a challenge between nations. As investors based in China, we clearly see that local innovation will diverge from that in the US over the next two decades. Consequently, we believe it is a necessary and good time to launch an independent China VC platform to capture opportunities that will emerge in the coming decades. Since IDG Capital entered the country in 1993, US dollar-denominated investors have gradually fostered the local venture capital ecosystem. Now, though, we believe this cycle is coming to a new era. A new one is beginning characterised by a divergence in investment directions and exit channels, the rapid development of domestic capital markets, and yes, the emergence of Chinese VC brands. We want to build a local brand with world-class management and investment standards. Just like the US VC brands that entered China over the past 30 years, there is a longer-term opportunity to expand globally.

Q: For some China-focused managers, global expansion has meant shifting focus to Southeast Asia or rebranding as pan-regional. Did you consider such courses of action?

A: No. China is encountering some of the most profound changes of the past four decades. These changes have impacted individuals and their perspectives, leading to short-term decision-making. A lot of investors recognised that Southeast Asia is a large market and that web3 is the next big opportunity, but it has since become clear that neither is as significant as previously thought. During the COVID lockdown, many investors were uncertain about their next steps; there was much discussion of internal circulation and whether China would still connect with the world. After the lockdown was lifted, many of us started travelling again. Our conclusion was that China and the world need each other, and internal circulation probably would be insufficient. We see the most value in being rooted in China and helping portfolio companies grow globally. China will continue to reform, open up, and encourage innovation. This is clear today; it wasn't that clear last year.

Q: Is it becoming any easier to raise a US dollar fund for China?

A: The geopolitical issue is significant and it may well remain for the long term. A lot of US-based LPs can hardly continue investing in China because of the tensions, but the US is a diverse market and some investors still recognise the US and China are the two biggest PE and VC markets globally and it doesn’t make sense to skip China. They started due diligence and are pushing forward. But it is a relatively smaller group than before. While capital coming from the likes of Silicon Valley and New York has traditionally held most of the prime assets, today we see capital from other parts of the world playing a more important role. For example, a European LP told us that it finally has the opportunity to access those quality assets because US investors are loosening their grip. At the same time, managers with US dollar funds used not to think much of renminbi, but now renminbi and US dollars are entering a period of coexistence.

Q: Yet most of the large deals in China appear to be executed by renminbi-denominated funds…

A: US dollar funds mostly draw on capital from the US. They face certain restrictions on investing in certain key assets involving semiconductors, artificial intelligence, and data because of the geopolitical tensions and technology competition between US and China. Additionally, Chinese companies have not performed well in the US in recent years, so that exit channel is unclear. These factors have led to a freeze in new investments by many US dollar funds. With reduced capital available from market-oriented funds, companies are more willing to accept renminbi. This will not be the case in the long term. US dollar and renminbi funds will co-exist; the exit issue will be solved; and more US dollars will come in from other regions.

Q: Will renminbi funds replace US dollar funds as the dominant force in the market?

A: Ultimately, they will co-exist, but with renminbi funds playing an increasingly critical role. Over the past two decades, the market has heavily favoured US dollars – this is known for being long money from patient investors who are willing to take risks and don’t require guaranteed returns. Whenever entrepreneurs can take US dollars, they do. But geopolitical tensions mean a larger slice of the cake is going to renminbi funds.

Q: Where are the main opportunities for US dollar funds in China?

A: While certain sectors are restricted, there are plenty of exciting opportunities in other areas. I believe electrification is the biggest one in 30 years. The entire human race is shifting to new energy, which will create openings for investment in everything from upstream infrastructure to downstream module suppliers. It’s very much hardware-oriented, so not so sensitive and accessible to US dollar investors.

Q: You mentioned that innovation in China is different from the US. Could you elaborate on that?

A: It might be tempting to classify Chinese innovation as “towards the real,” while the US is “towards the virtual.” But this is not entirely accurate. Chinese innovation serves China's real-economy development, which is entering a new stage. Previously, the economy largely relied on real estate, but now science and technology is becoming the key driver. At the same time, China is graduating from low value-added production to high value-added, high gross profit, high-tech production. Venture capital investors need to back this trend, although the next generation of successful companies will rely on government support as well. In the US, VCs tend to focus more on software, algorithms, and web3 to make breakthroughs. There is already an abundance of high-tech production, so they have more scope to prioritise virtual aspects to enhance the user experience. This is also reflected in the capital markets, where the US tends to be dominated by enterprise services, infrastructure, databases, and software. China-listed companies are more about domestic substitution, high-end manufacturing, electrification, chips, and new energy.

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• Topics
• Greater China
• GPs
• Fundraising
• Early-stage
• Technology
• China
• Soul Capital
• TMT
• Renminbi
• Fundraising