What technology investors are looking for in China

After two years of struggling to make money, it is seeing new Chinese companies sparking interest from venture capitalists as the U.S. boom crosses the Pacific.

“The capital is over in the winter, the competition for agreements is fierce,” said Ming Liao of Prospect Avenue Capital. “You have to bring something more than money to the table now to get into the deals.”

The number of risk agreements in China rose 56 percent in the first quarter from a year earlier, the fourth consecutive quarter of activity growth, as start-ups raised Rmb354bn ($ 55 billion) in investment, according to data provider ITjuzi.

Good public markets and floods of foreign currency have contributed. Tencent, the most active investor, has made some gains, tripling the value of its listed investment portfolio last year. VC companies like GGV Capital, Qiming Venture Partners and Matrix Partners China raised large new funds.

In some ways investing in China and the US is similar; both markets are large enough to encourage the creation of large technology groups, and Chinese investors say the initial valuations are comparable to their American counterparts.

But investing in China also has its quirks. Each new idea germinates many copiers as well as competitive attempts at the country’s technology giants. Different cultures and government regulations add to the challenges.

Cultural differences extend to the types of business models that operate. Unlike in the US, which has seen high value ratings for companies selling software as a service (SAAS) to large companies, this sector has not yet been developed in China. Shau ​​Lim of Hopu Investments said software companies could struggle to register subscription clients.

“People here don’t place so much value on intangible services. They are willing to pay for something they can see and touch, ”he said. Lime said a sponsored AI company had increased sales by embedding its software applications on servers that it sold.

Other factors that have prevented the adoption of SAAS are the history of cheap pirated software and cheap labor to manage some of the functions that software can automate.

Consumer technology has historically achieved the most VC funding and produced the highest returns, with the hot sector of the day rising and crashing. Although copying ideas happen everywhere, there can be another magnitude in China.

In the early 2010s in China’s notorious “Thousand Groupon War,” research firms said 1,880 start-ups copied Groupon’s group acquisition business model. It boosted 214 competitors, encouraged at least 20 companies to share bikes, and launched 208 businesses that rent portable banks to charge electronic devices.

With such fierce competition, investors have said that executions and jobs may not be the first engine in a new field.

For GGV Capital’s Jixun Foo, his faith in founder Yang Lei helped Hellobike help him enter the space to share bikes as the orange, yellow and blue bike shared a rainbow while covering the streets of China’s largest cities.

“I was convinced of that [Yang] this can run more efficiently in an operational way, ”Foo said.“ The first motivator gives you leadership…[but] how effective are you with your classmates? That edge will definitely show up over time. ”Five years later, Hellobik reported nearly $ 1 billion in sales last year, reducing losses. Many of its competitors have failed.

In the competitive space of portable power banks, Wanlin Liu, who relies on Carlyle’s technology investments in China, decided to make the investment when one of the winners of the first wave of early business ventures came out. Even then, as Energy Monster’s investment grew, it became concerned that it was being pushed by Chinese Big Tech companies.

“Before you make the call, you need to understand the most important players and any competition from the big tech giants,” he said. Energy Monster has maintained its leadership even after delivering a $ 240 billion company to Meituan. “Execution is the issue,” Liu said.

To help you assess what teams need, M31 Capital’s Nathan Zhong makes unannounced visits to start-up offices before investing at night. In a recent outing, he found the initial analytical data office empty.

“The repetitions of their products weren’t very fast – the CEO was weakening his decision to continue the fight,” he said. “Leaving work early meant that.” M31 decided not to invest.

The unorthodox afternoon visits are part of what Patrick Zhong, founder of M31, calls “feeling the temperature” of potential investment goals. “Everyone in China is smart; If you sleep behind the wheel, your competition will catch on quickly. ‘

Government policy can also be a source of uncertainty. In January, China’s central bank proudly announced that it had crushed every peer lender in the country – starting at a peak of 6,000 – ending the campaign that wiped out the wave of VC betting.

“You always have to know,‘ Is this company on the right side of China’s long-term government policy? ’” Said Gary Rieschel, who founded Qiming Venture Partners 15 years ago. “Chinese entrepreneurs face a great deal of ambiguity,” he added.

VC said there are smaller differences during the investment process. Start-ups often bring together financial advisors or FAs, as they are colloquially called, to reach out to investors. Difficult references to CEO candidates can be found. And investing in a new company that someday needs a new leader may not end well. Rieschel said it is very difficult for high-ranking officials in China to “replace the trust they had in that original founder”. “It’s an environment of low trust.”

Even though SAAS businesses have yet to take off in China, M31 Capital’s Zhong believes that software is the future and that it is valuable to review current trends in the US. At a recent weekly meeting, his team spent an hour examining how growth has accelerated in the MongoDB database company as it expanded its use cases and analyzed its valuation.

“Over the next 20 years, China will continue to use software to improve the efficiency of companies in the U.S.,” Zhong said. “We’re not saying it’s going to be the same path in the US, but it’s a benchmark.”