Capital winter is forcing China’s startup scene to get mature
Jun 7, 2019
It was a dreary winter evening in early 2018, in the peak of China’s tech frenzy, when the founder of an early-stage artificial intelligence startup was rehearsing his pitch to investors in his Shanghai headquarters. The founder, whose startup develops personal robots for the home, had no qualms pitching a future sales pipeline of $10 million. With no current revenues, his pitch was a stretch at best, as was his fantastic company valuation of nearly $100 million.
When I questioned it, the founder’s reply was “if I do not swing as hard as I can, someone else will beat me to the punch and they will end up getting the money.” That was the zeitgeist just over a year ago—but what a difference a year makes.
In the course of less than two years, from late 2016 to the fall of 2018, Tech China swung from one extreme to another, in a roller coaster that harks back to the dot com era of the late 1990’s when many early US Internet companies inflated to massive valuations only to implode a short while later.
But this “capital winter” is helping the field grow: China’s tech industry is coming of age. A confluence of forces, the latest of which is partial decoupling of the US tech ecosystem from China’s, are pushing entrepreneurs to a more rational, disciplined approach to founding and investing in startups.
The reshuffle is forcing all stakeholders to find new models for success. Startup founders are toning down their hype, and pitching defensible value propositions that emphasize the market and economic feasibility. General partners in venture capital firms are told by their limited partners that they need a track record of at least six to seven years and competitive rates of return on investment to stand any chance of raising capital for a new fund. And workers—the most critical resource for a tech company—are refusing to be taken for granted.
In short, China’s tech scene is coming to look at lot more like Silicon Valley in the post-dot com era. And Silicon Valley business know-how is increasingly valued as Chinese tech players learn their way around a world where investors demand transparency and expect to see fact-based plans. Realistic planning is becoming the norm among founders, forcing discipline on Chinese VCs as well.
Cross-border VC activity between the US and China—and in particular US investor participation financing rounds for China-based companies—peaked in 2018 despite the trade war. The figures tell a striking story of Chinese companies’ rising appetite for US capital and the additional value it brings. US investors provided capital for over 64% of the cross-border investment deal volume in 2018, with 355 deals between US-based investors and China-based companies. This is a sharp reversal from 2016, when 63% of cross-border deal volume came from China-based investors financing US-based companies.
The U.S.-China Investment Project, a research initiative led by Rhodium Group and the National Committee on U.S.-China Relations, reports that in 2018 U.S.-owned VCs participated in more than 330 unique Chinese venture funding rounds, investing a record $19 billion, double the pace of 2017.
American VC brands including Sequoia and Redpoint invest heavily in China, and Chinese entrepreneurs increasingly turn to them for “smart” capital for their global customer access and as conduits to America’s deep, liquid capital markets.
Another sign of openness is the growing appetite of American tech companies for investments in Chinese ones, investing $1 billion since the beginning of 2018, according to Dealogic, a data provider. In April Intel announced backing for Shanghai-based Cloudpick, which uses deep learning and computer vision for ecommerce solutions, and Zhuhai (China) based Eeasy Technology, a maker of AI systems for media,.
Nvidia, an American maker of chips often used in AI computing, has invested in WeRide.ai, a Guangzhou-based autonomous vehicle firm. Amazon is reportedly in talks to acquire Chinese self-driving truck startup TuSimple, which also boasts NVidia as an investor.
None of these deals was blocked by Chinese regulators. The foreign investment law passed by Beijing in March puts foreign companies on a more level playing field with their local competitors.
In first- and second-tier cities and regions, incubation and acceleration programs are putting foreign entrepreneurs in front of companies and investors in China. Organizers believe that foreign know-how and mindset, particularly from Silicon Valley and Israel, is instrumental in upgrading China’s innovation ecosystem.
In Hangzhou, niHub, an innovation platform owned by a Swiss national, Lucas Rondez, is using scouts in Israel to select a short-list of startups to be flown to Hangzhou and introduced to companies and VC funds in this vibrant tech hub. “The Chinese want Israeli technology. We are testing the model to help Israeli startups embed and gain commercial traction in Hangzhou, then scale up from here to the rest of China,” says Rondez.
The city government of Nanjing is allocating considerable resources to its flagship annual tech and innovation event in late June, Nanjing TechWeek. Nanjing intends to bring Chinese and foreign smart mobility and robotics startups to the city and match them with Ford and other multinationals; and with Chinese firms such iFlyTek, a maker of voice recognition software, and Nio, a driverless car firm. “Nanjing has invited high-flying Israeli tech companies such as Mellanox, a supplier of networking products used in AI computing, and Temi, a personal home robot run by AI,” says Oscar Prat van Thiel, director of Nanjing TechWeek, “with the goal of boosting the city’s stature as a tech hub.”
The desire to attract foreign innovators to China is bringing together some of the largest global players: Chinese cloud computing giant Alibaba Cloud, US-based shared workspace operator WeWork, and enterprise consultancy firm Softbank Telecom China announced a strategic partnership May 25 to launch a service platform to help foreign companies scale in China.
Volatility in Tech China is not letting up just yet. Yet tenacious foreign startup founders who are able to navigate the sea change may find that their Western professional toolset may just come in handy in China in the near future.