The Goldilocks Test: Why China Is Just Right
China, with its bustling economy and continuing growth is managing to create their own version of Silicon Valley. Add in the financial support of the Chinese government and their desire to take risks, it’s only a matter of time before China’s Silicon Valley will bypass the U.S. tech-hub.
China's venture capital economy is booming, and there is no denying the money pouring in. In 2015, government-backed venture funds swelled to $231 billion, tripling the amount under management in a single year. To put that into perspective, that's five times the amount raised by venture firms worldwide.
So what is it like to be a foreign venture capitalist looking at startups in China? I spoke with three active venture capitalists with funds focused on China to find out.
Surging venture capital.
“Chinese entrepreneurs have greater access to venture capital than anyone in the world, and the risk-appetite in China now rivals the United States,” says Phillip Kingston, Trimantium Capital’s managing director.
Related: China's Effect on the U.S. VC Game
For Phillip Kingston’s fund which focuses on fin-tech and health-tech startups that have the potential to scale globally, it isn’t enough to be a source of capital for startups in China. With the nation’s own government pouring over $338 billion into China’s startup economy since 2015, venture capital firms such as Trimantium Capital see a nation that is more sophisticated in its venture capital strategy than anywhere on earth.
“Not only are ideas getting bolder and more original, but highly sophisticated domestic funds are being established at a dizzying pace. Globally there’s unrivaled scale in China by sovereign entities, high net-worth families and smart diversified Chinese listed corporations, and I expect this to continue right through 2016 and beyond,” says Kingston.
With capital so readily available, it’s little wonder that China would have its own Silicon Valley. In a 2016 report, the Chinese city of Shenzhen emerged as the nation’s priciest real estate market, with the average home prices elevating the city over Beijing and Shanghai. Dubbed “China’s Silicon Valley,” this is where about 10 percent of all new startups are born, finding a home alongside the nation’s tech giants including Tencent.
“There is still a ton of action concentrated in the large ecosystems such as Beijing, Shanghai, Shenzhen, Guangzhou, Hangzhou and maybe Chengdu, Wuhan,” says Rui Ma, 500 Startups Partner in China.
“However there is a ‘power law’ at work here and Beijing really dominates in terms of number of deals as well as active investors. Beijing is to Shanghai as Silicon Valley is to New York City in terms of the level of activity - anywhere between 2 to 4 times depending on what report you read,” says Ma.
The biggest draw for investors in China, however, is likely to be the exit.
“Chinese venture capital firms have several accepted ways of exiting,” says Ma.
“For early stage investors (usually Pre-Series A), they tend to exit to series A or B investors. That usually doesn't happen in the US, but is very common in China. Because there are now so many listed companies (on NEEQ and on bigger main boards) who raised money through an IPO or follow on offerings, and because they trade at very high P/E or revenue multiples (at least compared to the U.S.), acquisitions are also now common exits.”
But in spite of the perks of an exit, playing in China’s startup scene doesn’t come without its risks. High prices for startups due to the oversupply of capital relative to deal-flow is dangerous, says Ma, and the general slowdown of the economy is also a huge source of worry that affects all investors and players in the economy.”
Confidence and tag-teaming in cross-border deals.
For U.S. investors and entrepreneurs looking to conquer China’s Silicon Valley, the good news is that there are more cross-border deals. There is even a trend now for Chinese companies to acquire U.S. startups (as happened for example, in the case of Grindr).
“The quality of deal flow in China is on par with the United States and Israel,” says Kingston. “Few Chinese companies focus beyond the Chinese-speaking world. The most likely transition will be more globally focused Chinese companies wanting to sell to Chinese outside of China, which means that there are more cross-border deals seeking investors like us.”
There are also U.S. investors who are aggressively building relationships in Asia with partners who understand international markets -- from banking to bitcoin.
"Software, and more specifically bitcoin and blockchain technology are permeating every corner of the world -- this is not a silo phenomenon but rather a global technology with global reach, so it’s important for us to build as many investment and entrepreneurial bridges to Australia and Asia as possible," says Cameron Winklevoss, co-founder of Winklevoss Capital & Gemini.
With the feverish confidence of Chinese venture capitalists and entrepreneurs giving Silicon Valley a run for its money, it’s become clear that the nation is no longer the country that merely manufactured your iPhone. Big name firms, like 500 Startups, Sequoia Capital and Trimantium Capital are investing in China and the world is realizing why -- that for the first time -- China might soon overtake our own Silicon Valley.