For decades Silicon Valley has dominated the world's venture capital scene. But on April 12, the Wall Street Journal reported that China's is ascending in the global VC game. Is this a threat or an opportunity for entrepreneurs?
The answer is both.
Before getting into why I reached that conclusion, let's look at the evidence. According to the Journal, in 2007 America was the world's undisputed leader -- its VCs accounted for 75% of the startup investing which went mostly to U.S.-based firms.
China is coming up fast -- thanks to a surge in capital. In 2017, a record $154 billion worth of VC was invested -- a much smaller 44% came from U.S. firms while a whopping 40% came from Asian VCs -- up from 5% in 2007, according to the Journal.
As I have seen from my own startup investing experience, Asian venture capital can enable a select few startups to get much more capital at higher valuations. SoFi, the San Francisco-based fintech company in which I am a shareholder, raised $1 billion in 2015, according to Bloomberg. Tokyo-based Softbank -- which owns 39% of Renren, China's version of Facebook, led the round. And Renren invested $240 million in SoFi, noted Forbes.
By March 2017, when it raised another $500 million, led by Menlo Park, Calif.-based private equity firm, Silver Lake Partners, SoFi was valued at $4.3 billion. Capital from Asia was a blessing and curse -- it gave SoFi far more money but it also raised the bar for the amount of revenue growth that would be needed to get a higher valuation the next time it seeks to raise capital.
This brings up three important trends from Asia's rise in VC, the opportunities and threats that arise from each, and what entrepreneurs should do about them.
1. VC Is Cyclical -- And A Quick Rise Can Presage A Sudden Collapse
Venture investing is cyclical. I remember clearly the rapid rise of Japan as a global competitor in the 1980s -- striking fear into the hearts of the American media as the Japanese stock and real estate markets soared and Manhattan's Rockefeller Center was purchased by a Japanese firm.
Not too long thereafter, the Japanese stock and real estate markets collapsed thanks to too much unpaid debt.
It is possible that China -- which as the Journal points out -- has built up huge piles of capital looking for a place to invest -- could face a similar problem. Indeed China has recently bailed out -- to the tune of $9.7 billion in April 2018 -- Anbang Insurance -- which went bankrupt after a global real estate buying spree which according to the Wall Street Journal, included acquiring another Manhattan trophy -- the Waldorf Astoria Hotel.
Opportunity: While China is investing more in VC, there is an opportunity for companies around the world that receive their funding. Founders seeking this capital must be leaders in big industries that are growing fast. While the potential to raise more capital from Chinese VCs can help them grow, it will also put more pressure on founders to earn a higher valuation in the next round of funding -- or risk being replaced as CEO.
Threat: Entrepreneurs who have attracted investment from Chinese VCs could be in trouble if those VCs suddenly decide that they are no longer in a position to invest. Such founders should keep a close eye on factors that might reduce Chinese VCs' willingness to keep investing and have in mind other investors who could make up the difference should the worst happen.
2. Chinese and American VCs Have Different Goals
The second point is that Chinese VCs may have different goals than U.S. ones. Consider the fate of Singapore-based grocery delivery service, RedMart. As I wrote in my recently-published book, Startup Cities, RedMart (which I visited several times) was losing money in January 2016 and could not convince investors to put more money in.
Ultimately, the company was acquired by a subsidiary of Alibaba and when I visited in January 2018, RedMart was using unlimited capital from Alibaba to dominate the Southeast Asian market for groceries by slashing prices and trying to create an excellent delivery service in the region -- making a profit is not the point.
U.S.-based VCs take a different approach. To be sure, they are at times willing to fund rapid growth for startups that seek to gain market share by cutting price and operating at a loss.
But U.S.-based VCs are far more responsive to changes in the market for initial public offerings (IPOs).For example, in the summer of 2015, VCs began to realize that the IPO market was drying up and that they would not finance another round of price-cutting to gain share. The VCs told their portfolio companies to cut costs or raise price so they would be cash flow positive to survive the coming capital freeze.
Opportunity: Entrepreneurs who aspire to dominate Asian markets for popular services and emerging technologies should seek out Chinese investors who aspire to achieve market dominance.
Threat: Entrepreneurs competing against startups backed by Chinese capital may find themselves losing market share as these rivals cut price to win customers fast. Founders competing with such rivals should seek to raise more capital or focus on customers who are less price-sensitive. .
3. China Copies Successful U.S. Business Model Innovations And Protects Its Local Copiers
The final point is that the U.S. has been the undisputed leader in inventing ground-breaking business models -- such as social media, e-tailing, search-engine marketing, and cloud services. Asian companies have gotten very large by copying these innovations -- and many Asian governments have protected the local copiers from the incursion of the U.S. inventors of those businesses.
But as I pointed out in Startup Cities, Chinese companies are offering the world's largest compensation packages for artificial intelligence (AI) specialists. To wit, Beijing-based news aggregator, ByteDance, offered experienced AI developers up to $3 million in salary and bonus -- far lower than the $200,000 to $500,000 range offered by Silicon Valley giants -- but it remains to be seen whether these developers will produce the next big business model innovation.
Moreover, as the Journal reported U.S. investors pumped $4 billion into AI startups in 2017 -- while Chinese investors spent $2.5 billion last year -- still a big increase from the $100 million they invested a few years ago.
Opportunity: Asian entrepreneurs should seek to adapt the fastest-growing U.S. business ideas to the Chinese market. Founders who have already built successful companies will be in the best position to raise funding from Chinese VCs.
Threat: Should these Asian entrepreneurs attract such funding, the U.S. entrepreneurs who have developed these innovative business models may need to consider whether to hold off on trying to enter the Chinese market and stay attuned to threats to their leadership outside of China.
Entrepreneurs must pay attention to the rise of the Asian VC industry -- both to tap into the opportunities it creates and to guard against its threats.