AVCJ at 25: Finian Tan of Vickers Capital

In the early 2000s, Baidu nearly died. China's largest search engine is now valued at around $40 billion and has an estimated 80% market share, but as a two-year-old company backed by a spluttering of venture capital funding, life was anything but certain.

Baidu started out as a technology provider to the first generation of Chinese internet companies that went public in the US, Sina and Sohu. When users conducted web searches through these pioneering news portals, Baidu received a small on-screen credit and an even smaller fee. As internet traffic grew, the fees began to accumulate and the portals responded by renegotiating Baidu's contract. There was nothing the company could do: it had a world-class search algorithm but no independent channel through which to monetize the technology.

"We couldn't argue with these big gorillas and this meant our revenues would be capped forever," recalls Finian Tan, founder and chairman of Vickers Capital Group, who at the time was Baidu's principal VC investor through Draper Fisher JurvetsonePlanet (DFJ). "We had three options: sell the company, remain a small-scale technology provider, or launch our own portal, which would mean losing our two biggest customers because Sina and Sohu would cut ties with us as a competitor."

Robin Li, who co-founded Baidu with Eric Xu and now serves as CEO, came up with a high-risk alternative strategy: launch a portal under a different brand and rely on it gaining traction before the incumbent gorillas realized what was happening.

The gamble paid off as Baidu's clean and simple homepage - a concept far removed from the cluttered web pages of the time - took off like wildfire. Within four years, the company listed on NASDAQ, generating more than 100x money multiples for its early investors.

What also paid off was Tan's early faith in Li. Then, as now, venture capital investing was as much about backing the entrepreneur as the idea. Baidu was the first DFJ deal in China completed under Tan's stewardship, after the investment committee rejected several earlier proposals. With only $780 million committed across 90 venture capital transactions in the seven years leading up the Baidu deal, China wasn't a proven market and US-based investors were apprehensive.

"Robin and Eric seemed like they had the right attitude and they were familiar with international business rules and etiquette," says Tan. "Robin could answer every question I threw him about search technology and how it would develop. He's the only guy I've ever met whose life revolved around search. You seldom find a world-class internet guy in China; most of the time it's China-class guys."

Anatomy of a start-up

When DFJ arrived on the scene in 2000, Baidu had been up and running in Beijing for one year with 15 employees and about $1 million in funding from two angel investors, Integrity Partners and Peninsula Capital Partners. The algorithm for search engine page ranking that underpins its success was devised four years earlier - around the same time as Google - while Li was working at IDD Information Services in the US. The initial objective was to displace a Taiwan company as technology provider to the portals.

"There was no revenue, they just had a code and it was better than anything else we'd seen in the market," Tan says. "By the time we signed the term sheet they had one customer and they were about to close a deal with Sohu. The market was so small then. We had to do B2B and corporate data technology as well as B2C search to create something that could potentially be worth $1 billion."

DFJ led a Series B round of funding worth $10 million, putting in $7.5 million itself while IDG Ventures contributed $1 million and Integrity and Peninsula covered the rest. As the second-largest shareholder with a 25% stake - rising to 30% by the time of the IPO following a $25 million Series C round in 2004 - Tan was responsible for two seats on the board and two seats on the four-person executive committee.

The investment closed after the dotcom bubble burst and Tan recalls valuations being low. "Robin and Eric were not too expensive and I didn't haggle too much," he says.

Although Baidu was Tan's first investment in China for DFJ, it wasn't his first exposure to the country's tech sector. An engineer by training who then forged a career in oil trading, in 1997 Tan was recruited as a deputy secretary in Singapore's Ministry of Trade and Industry, with the remit to turn the city-state into a Silicon Valley for the East. He recommended the creation of a $1 billion to foster innovation, the Technopreneurship Investment Fund (TIF), and became its chairman.

TIF helped jump-start many venture capital firms, such as Granite Global Ventures, and its direct investments included a small position in Sina. The fund was acquired by Kleiner Perkins Caufield& Byers (KPCB) and Tan moved on to DFJ as founding partner for Asia, where he appointed three young executives. One of them, Zhang Fan, subsequently leveraged his involvement in deals like Baidu to secure a managing partnership at Sequoia Capital China, working alongside Neil Shen, who made his name with VC-backed Ctrip and Home Inns.

Home runs, strike-outs

DFJ's first fund, Draper Fisher JurvetsonePlanet Ventures, was a $650 million vehicle raised in 1999 that invested globally. Between 2000 and 2005, Tan was responsible for investments worth $41 million in Asia. Baidu was one of three significant home runs. The others were out-of-home advertising network Focus Media, where DFJ participated in a Series B round of funding about a year before the company went public on NASDAQ, and KongZhong, a mobile value-added services provider that also completed a US IPO.

DFJ invested about $800,000 in KongZhong in 2002, taking a 9% stake, and the company went public about 18 months later, generating a 36x money multiple for the VC firm. The IRR was even better than Baidu because the holding period was less than a quarter as long.

However, KongZhong later came unstuck after failing to liberate itself from the gorilla that controlled the purse strings - in this case China Mobile, which operated the payment gateway for value-added services like ringtones and drove a lot of players out. There was no Baidu solution and KongZhong had to diversify its offering, looking at broader digital entertainment services such as online gaming. It is the nature of the internet business - for investors as well as entrepreneurs - that one must evolve to stay commercially relevant.

"Generally, we look at three things: space - it has to be fast growing and sexy; competitive edge - if you don't have this everyone will copy you and as a first mover you are dead; and the entrepreneur - even if the first approach is wrong, a gifted entrepreneur has the ability to re-invent himself and rise again," Tan says. "In China you have to reinvent yourself with every fund because what was hot in fund I has now all been done and it's finished. For example, you couldn't start a social network today."

The industry dynamics have also evolved. Sina and Sohu, the original gorillas, are no longer such a threat; they have been replaced by Baidu, Alibaba Group and Tencent Holdings, China's preeminent search provider, e-commerce platform and entertainment portal, respectively, although each one is trying to broaden its product portfolio.

While the Sina and Sohu approach was to watch, copy and then kill off the competition, the new giants recognize that it is quicker and easier to buy their way into new markets. "It's creating a vibrant M&A environment that already exists in Silicon Valley," Tan observes. In 2011, Baidu made at least five lateral acquisitions, including the $306 million purchase of VC-backed travel booking site Qunar.

Widening the scope

Tan left DFJ to set up Vickers in 2005 and started investing more broadly, both in terms of sector and geography. In recent years the venture capital firm's portfolio has encompassed everything from the first independent real estate investment trust (REIT) to list in Singapore to a company that makes engines for electric hybrid cars to the Asia Food Channel.

Tan is particularly excited about US-based biotech firm Samumed, which he believes has the power to revolutionize approaches to oncology and degenerative conditions through drugs targeting the Wntsignaling pathway that regulates stem cell proliferation and differentiation. It has eight drugs entering clinical trials in the next 15 months.

"We have been reluctant to pull the trigger on life sciences because of the risk and the long-term nature of the investment, but all that changed with this biotech company," he says. "Everyone has been trying to develop drugs that target the Wnt pathway and they have done it. If they work as we hope, they will stop cancer, grow cartilage, bone, hair and cure many other diseases. This company is the most exciting company I've seen in my life and I have looked through something like 30,000 deals in my career."

Although life sciences tends to be more capital intensive than internet plays and requires larger ticket sizes, Vickers isn't about to leave its comfort zone. The previous fund was $60 million and the one currently being raised is targeting $150 million, with 60% of the corpus earmarked for China, 25% for Southeast Asia and 15% for the US and other regions.

Tan has no desire to upscale from venture capital to growth capital because the economics change: 90% of the companies in a VC portfolio can fail provided a couple deliver returns of 10x or more; the 3-4x returns that typically come from larger growth deals can't sustain this approach.

"Assets under management don't excite me," he says. "Can I be the largest asset manager in the world? No. Can I be the best performing fund? I have a chance. China is growing at 7% a year and they are seeing 100 years of opportunities compressed into 20 years. Indonesia is growing at 6%. It's a rising tide. If you are a smart team, follow the rules for creating a successful organization and treat the entrepreneurs as the real stars of the show, you should be among the best performers."

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