StartUp Capital Ventures
John Dean and Danny Lui began raising their first fund as StartUp Capital Ventures (SCV), a small venture capital firm in 2005. Along with the four other “Managing Members” of the firm, they intended to focus investments on early stage software companies with capital efficient business models. SCV looked for organizations with initial pre-money valuations of less than $5 million. The firm’s philosophy was to target companies that already had a product or service generating revenue and that could show a reasonable likelihood of reaching near-term profitability with SCV’s investment. During the fundraising process, Charlie Eubanks, an “anchor investor” for the fledgling firm, pressured the founders to devote 30 percent of SCV’s capital to investments in China. The country was a compelling place to invest in many ways. China’s GDP was growing at 10 percent per year, primarily driven by annual private sector growth of 20 percent. Tax burdens were light – there was no capital gains tax. In addition, seven times more engineers graduated from colleges in China every year than in the United States. Yet, Dean and Lui (who was originally from Hong Kong) were also cognizant of significant drawbacks to investing in the region. This case examines some of those challenges as they related to two questions the colleagues tried to answer: • Whether to enter that market at all – in addition to lingering vestiges of Communist rule, Chinese entrepreneurs had to contend with arcane governmental regulations and fickle policy pronouncements, a weak legal system that did not adequately protect intellectual property (IP) and a private sector that critics suggested was overrun with patronage and corruption. Despite these investment pitfalls, the VC market was “frothy,” particularly for foreign investors who did not fully understand the complexities of investing in this country. • Whether to invest in Zero2IPO, a Beijing-based market research firm – the start-up tracked Mainland China private equity and venture capital markets. It had three main revenue streams: an annual investment report (considered to be the industry standard), quarterly conferences for VC investors and commissions from providing services similar to that of a small investment bank (e.g. introductions between entrepreneurs and investors).