AVCJ at 25: Lip-Bu Tan of Walden International

Lip-Bu Tan has won his place in the annals of Chinese venture capital as father of the VIE. This structure goes by two names: formally, it is the variable interest entity; informally, it is the "Sina model," named after the internet portal for which it was originally devised. Though arguably overused and abused since its inception in 1999, the VIE opened the door for much of the $9.2 billion that has flowed into China's IT sector over the past 13 years.

"We came up with a structure that worked," Tan recalls. "It was a case of convincing the Chinese government that it was a viable. Fortunately, I'd already made several investments in China and had demonstrated to them that I have experience investing in China, so they were supportive. Then everyone started copying the model."

The VIE was necessary to work around a ban on direct ownership of internet assets by overseas investors. This dated back to efforts made by foreign telecom operators to enter China in the mid-1990s through indirect ownership of joint ventures with local players. Beijing cancelled the agreements, saying assets such as networks and carriers were completely off limits.

However, it stipulated that areas such as the internet and related services would be subject to less rigorous oversight, provided a suitable structure could be found. The VIE was acceptable because the onshore asset is owned by Chinese nationals and the foreign investor controls a parallel entity; legal agreements secure this entity's economic interest in the onshore asset.

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 May 2000.

The bubble bursts

Two months earlier, the NASDAQ Composite Index peaked above 5,000 points and by the time Sina went public the index had already slipped to 3,300 before staging a rally. The value destruction that followed over the next two years claimed some notable scalps and wiped out a number of fundraising efforts by Asia-focused VCs as investors backed out.

From the start of 1998 to the end of 2000, just over 300 Asia-focused venture funds raised $6.7 billion, with Japan, South Korea and Taiwan accounting for 23%, 16% and 20%, respectively, of the capital. In the following three years, 290 funds attracted commitments of $4.7 billion. Taiwan saw the most substantial decline: VC investment fell from $4.3 billion in the first three-year period to $1.9 billion in the second.

"Of course our portfolio was affected by the dotcom bubble bursting - growth slowed and it took longer for companies to become profitable and generate cash," says Tan. "But many continued to do well. For example, Mindtree, an Indian IT outsourcing company, remained profitable despite the bubble bursting."

He adds that the fallout was eased by two factors. First, there was a breadth to Walden's investments in terms of sector and geography, itself a reflection of the opportunities available in nascent economies.

In China, early deals included Wuxi Little Swan, now one of the country's largest consumer appliance manufacturers, and Shenzhen Mindray Bio-medical, a medical equipment maker, in 1995 and 1997, respectively. Walden entered Malaysia two years later by backing employment search site Jobstreet.com and helped take the company into Indonesia.

Inevitably, there was a plethora of Taiwan companies that together chart the progress of the domestic tech sector: electronic components manufacturer Umec, internet telephony company Mediaring, LCD display manufacturer Mytech and semiconductor producers like fourth-generation wireless specialist Beceem Communications.

"We have always been very focused on technology," says Tan. "Initially it was technology in terms of manufacturing and design and then it was software, mobile and internet. The one thing we have always done is semiconductors, especially on application-driven design."
Second, there was relatively little competition in the years running up to 2001, which helped in terms of valuations.

Walden was founded in 1987 and the initial LPs were development finance institutions, government and quasi-government agencies and local banks. It took seven years, around when the VC firm launched its third main fund and first China-dedicated fund, for North American investors to get interested. The LP roster for the China vehicle reads like a GP in transition: International Finance Corp. (IFC) and Tat Lee Bank, but also Commonfund Capital and the University of Minnesota Foundation.

North American venture capital firms, however, had yet to establish Asian affiliates. "There weren't too many guys from Silicon Valley at that point," Tan says. "They came in after the Silicon Valley Bank trip to China and India a few of years after the tech bubble."

The arrival of these firms plus the emergence of domestic competition has brought critical mass, while the archetypal portfolio company has climbed the value chain from electronics-oriented original equipment manufacturer to a sophisticated brand owner carrying a lot of intellectual property. (It is worth noting that the VIE structure itself is evolving due to the changing competitive environment.)

However, there are negative connotations too, which to some extent challenge the Walden approach. "Our philosophy has always been to back good entrepreneurs, be disciplined with valuations and pick a 10-year horizon for the company, which is ideally what you need to build up from zero to $500 million in revenue," says Tan. "In the early days entrepreneurs valued long-term relationships but now they want to raise a lot of money very quickly at a high multiple."

Mindtree and Lashou are helpful case studies. The former was a Walden portfolio company more than 12 years, guided from Series A round to IPO and finally exited earlier this year for a 12x money multiple. The latter, one of many group buying sites set up in China from around 2010, accumulated $166 million through three rounds of funding in 12 months, but its plans for a swift IPO have yet to come to fruition.

"As long as the market continues to push up Chinese valuations, then good luck," Tan says, unconvinced by the prospects. His strategy for Walden is to add value through greater specialization, as evidenced by the firm's deepening involvement in the semiconductor supply chain.

It is a bet that Asia's venture capital community, still a shadow of the US market in terms of scale and sophistication, has a long way to run.

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• Topics
• Venture
• Greater China
• Southeast Asia
• Early-stage
• Technology
• People
• TMT
• Walden International
• Venture
• Taiwan (China)
• China
• Southeast Asia
• Lip-Bu Tan