January 9, 2020
Y Combinator's (YC) FIRST “demo day” in Beijing last November hosted two dozen local startups vying for the attention of high-profile investors. It marked the entry into China of the most famous accelerator in Silicon Valley, which helped launch Airbnb and Dropbox. Days later, YC abruptly announced that it was leaving the country.
In a statement, YC said it was returning, under a new boss, to invest in startups from its Californian base. Your Chinese startups will be powered by MiraclePlus, the new fully localized incarnation of YC China. However, in the context of a deep Chinese-American gap, the retreat looks threatening. "In today's global environment, to fulfill our mission – China, China, China – we need to be able to dominate our own destiny," wrote MiraclePlus in a social media post, citing Lu Qi, his boss, whom YC had hired to set up his Chinese arm in 2018. (Lu declined to be interviewed for this article.)
At first glance, YC's fate appears to be at odds with the broader health of foreign venture capital (VC) in China, with its red-hot technology industry. Chinese Sand Hill Road heavyweight operations such as Lightspeed Venture Partners and Sequoia Capital – whose fifth growing Chinese fund raised $ 1.8 billion, double its last – are thriving. Chinese founders coveted the attention of foreign funds, seen as the best way to list on American stock exchanges and more insightful than the Chinese to support ideas that take longer to make money. Its dollar-denominated funds last ten years or more, while yuan investors generally want a five-year return. (Most foreign VCs now also raise funds for the yuan, which allows for exits on the continent's stock exchanges and investments in more industries.) Foreigners offer experience over checks, especially for startups looking to expand abroad.
For venture capitalists, China used to be easy, notes one based in Shanghai. “You were dealing directly with entrepreneurs, not with the state. Zhou Wei, who worked for Kleiner Perkins, says that life was especially lively in “copying to China” years after the first companies arrived around 2005. But it has remained quite attractive for longer. . In 2018, China overtook America as the top country for VC returns (as measured by the current return on investment), according to eFront, a data company. That year, seven of the ten largest VC transactions in the world involved Chinese startups. YC called China “an important piece that was missing from our puzzle” and dreamed of combining “the best of Silicon Valley and China”.
For many foreign companies, the glory days are over. They must compete with local rivals, a few thousand government-funded incubators distribute money and free digs for start-up entrepreneurs and the Internet giants in China, with their voracious appetite for trading. In an interview with the local media, Lu recalled his time at YC that many Chinese businessmen have undergone difficult interviews just to refuse foreign funds and go, with YC's imprimatur, to wealthier Chinese investors. William Bao Bean, Shanghai partner of SOSV, an American company, says the type of amount that companies like YC help raise is "a rounding error" in the most competitive VC market in the world – even in the middle of "capital" "winter", which has involved China for the past 18 months and caused activity in 2019 to fall to its lowest level in four years (see graph).
Poaching from more experienced Chinese partners has become more difficult, says Kuantai Yeh of Qiming Venture Partners, a large Chinese VC company. The flow of talent may have reversed. In 2017, Zhou and others left the struggling Chinese arm of Kleiner Perkins to form China Creation Ventures. The previous year, the New Enterprise Associates team set out to build Long Hill Capital. (New Enterprise now invests in Chinese startups in Silicon Valley.) And Chinese startups increasingly cater to idiosyncratic local tastes – good luck explaining the value of a "mobile karaoke social network" for California headquarters, says Zhou . It is no wonder that 19 of the 30 top performing private equity and private equity firms in 2018 were local, according to Forbes magazine.
The recent financing crisis has another side. Squeezing smaller domestic rivals, this could give rise to giant cash-rich funds, including foreign ones. It is not clear that they will seize the opportunity. China has become "kryptonite" in Silicon Valley, says Bean. Silicon Dragon, a valley-based VC news tracker, predicts that this year VC will flow in separate Chinese and American vessels. Startups supported by international investors are preparing for a cash crisis. A veteran venture capitalist at a company with foreign roots says that American investors are asking the investment committees of their VC companies: "Do we need to invest in China?" For some, the answer will increasingly be "no".
This article was published in the Business section of the print edition, under the title "Life is getting harder for foreign VCs in China"
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