Changing Markets: What's Next for China

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An uncertain economy, coupled with financial accounting scandals, has shaken China’s once thriving venture capital investment market. During the first 6 months of the year, venture capital IPO exits in China sank 42% to just 32 cases, according to Dow Jones VentureSource. The value of VC investments in Chinese companies dipped 43% — to $1.9 billion — compared to the same period last year.

Still, with an economy that’s growing at 7.6% annually, it’s just a matter of time before venture firms regain confidence, and investments in China improve. That’s the view of panelists who addressed the China 2.0 conference, which was held this September and sponsored by the Stanford Program on Regions of Innovation and Entrepreneurship at Stanford GSB. Here are excerpts from their talk:

Economic Conditions in China

Two years ago, with valuations super-high, China was in the midst of an investment “party,” according to Hany Nada, founding partner of GGV Capital, a Menlo Park venture capital firm that invests in Chinese firms. However, with the average valuations in certain market segments now down significantly, some of those earlier investors “are feeling a lot of pain today, a big hangover.” Investments in the capital-intensive electronic commerce or clean tech sector are particularly troubled. “The average valuation of that sector is down north of 90%,” says Nada. “So if you were at a $1 billion valuation a year and half ago and you’re trying to raise money today, you’d be lucky to get a $100 million valuation. That’s the reality in certain parts of the market.”

The Transformation of the Tech Start-up

China’s enormous market potential has sparked some Chinese tech startups to duplicate successful U.S. online trailblazers rather than innovate themselves, said Fang Fang, CEO of JP Morgan China. “They just move the business model to China, turn that into Chinese, and they immediately have 200 million customers. That is why we see a lot of me-too technologies in China.”

However, Fang added, tech ventures that target individual customers are where the money has been made during the past decade. Startups “that destroyed most of the venture capital money were the ones that targeted the enterprise sector — the enterprise software space, the semiconductor design business. Why? Because the sales process and the certification process are just enormous in China,” he explained.

“If you have a unique technology and you want to make it big, find an angle to apply your technology to the consumers. Don’t sell to the enterprises,” Fang said.

What’s Hot in the VC World

The next wave of Chinese internet firms will not simply mimic successful U.S. businesses, said Nada, pointing to YY Inc., a startup that developed a technology enabling masses of people to communicate to each other over the internet in real-time through voice chat. Described as a “virtual stadium,” YY filed with the U.S. Securities and Exchange Commission in mid-October for an initial public offering of $100 million. With 310 million registered users, the service has gone beyond gaming to offer online language classes, poetry readings, and even karaoke performances. “There’s not a single international company that can handle tens of millions of users concurrently using voice chat,” said Nada, whose firm is an investor. “Those models don’t exist in the U.S. and that technology only exists in China, and there are many U.S. companies now that are trying to copy YY here.”

Xu Xiaoping, founding director of ZhenFund, an early stage seed fund that invests mainly in China, said startups specializing in online education are also positioned to become “the next big thing,” following the lead of the United States, where universities, including Stanford, have begun offering courses on the internet. “Online education is quickly growing, so we see this area may be hopeful to catch up,” he said.