January 11, 2020
Y Combinator (YC) 's first "demonstration day" in Beijing last November hosted two dozen local startups vying for the attention of top investors. It marked the entry into China of Silicon Valley's most famous accelerator, 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 at its California base. Your Chinese startups will be powered by MiraclePlus, the new fully localized incarnation of YC China. However, in the context of a deep Sino-American crack, the retreat seems threatening. “In today's global environment, to fulfill our mission – China, China, China – we need to have the ability to master our own destiny,” MiraclePlus wrote in a social media post, quoting Lu Qi, its boss, whom YC hired to ride his Chinese arm in 2018. (Lu declined to be interviewed for this article.)
At first glance, YC's fate seems to be at odds with the broader health of foreign venture capital (VC) in China, with its red-hot technology industry. Sand Hill Road's Chinese 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 have coveted the attention of foreign funds, seen as the best way to list on the American stock exchanges and more insightful than the Chinese to support ideas that take longer to make money. Its dollar-denominated funds are ten years or older, while yuan investors generally want a five-year return. (Most foreign VCs now also raise funds for the yuan, which allows for outflows on the mainland stock exchanges and investments in more industries.) Foreigners offer expertise on checks, especially for startups wishing to expand overseas.
For venture capitalists, China used to be easy, notes a Shanghai-based company. “You were dealing directly with entrepreneurs, not the state. Zhou Wei, who worked for Kleiner Perkins, says life was especially lively in the "copy for China" years after the first companies arrived around 2005. But it remained quite attractive longer. . By 2018, China surpassed America as the leading country for VC returns (measured by current return on investment), according to eFront, a data company. That year, seven of the world's top ten VC transactions involved Chinese startups. YC called China "an important missing piece in 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 hand out free money and digs to fledgling entrepreneurs and the Internet giants in China with their voracious appetite for trading. In an interview with local media, Lu recalled from his time at YC that many Chinese businessmen underwent difficult interviews just to refuse foreign funds and to go, with YC's imprimatur, to richer Chinese investors. William Bao Bean, a Shanghai partner at SOSV, an American company, says the kind of amount companies like YC help raise is "a rounding error" in the world's most competitive VC market – even in the midst of a "capital". "winter", which has engulfed China in the past 18 months and caused activity in 2019 to fall to its lowest level in four years (see chart).
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 Kleiner Perkins' struggling Chinese arm to form China Creation Ventures. The year before, the New Enterprise Associates team set out to build Long Hill Capital. (New Enterprise now invests in Chinese Silicon Valley startups.) 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 . No wonder 19 of the 30 top-performing venture capital and private equity firms in 2018 were local, according to Forbes magazine.
The recent funding 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 the VC will flow to separate Chinese and American vessels. Startups supported by international investors are preparing for a cash crisis. A veteran venture capitalist at a foreign-based company says US investors are asking their VC companies' investment committees, "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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