Why foreign startups shy away from China

What is the common thread tying together Skype, Spotify, Waze, Mobileye, Wix, Zoopla? They are all companies hatched in Israel and Europe. They have all grown much of their business in the US and then made a major exit there, either through an acquisition or IPO. For two decades the US has provided high-growth startups with what they need: access to deep-pocketed venture capitalists, proximity to top-notch universities, a culture of risk-taking and sheer market size.

This changed, however, in July 2017, when China’s State Council issued the New Generation AI Development Plan, a three-step roadmap to becoming a world leader in AI by 2030. In November 2017, China’s Ministry of Science and Technology appointed four of its biggest technology companies—Baidu, Alibaba Group, Tencent Holdings, and voice recognition company iFlyTek—to lead the development of AI innovation.

Earlier, in May 2015, Chinese Premier Li Keqiang and his cabinet issued the “Made in China 2025” plan that stipulated the increase of Chinese domestic content of core materials, which means more components produced locally in China in products that are made or designed in China.

Inward-looking, frantic, reckless

But China’s nascent VC ecosystem is still inward-looking, lacking many of the best practices and the transparency necessary to become a serious rival to Silicon Valley. It is characterized by frantic, and often reckless, activity: Indiscriminate investment by venture capital firms, which in many cases are run by general partners who have no track record of investing in risky hi-tech ventures; pursuit of fads with inadequate attention to due diligence; and investors who renege on commitments and expect quick returns. All this makes it still almost uninhabitable territory even for the boldest foreign entrepreneurs.

What, then, is the lure of China for foreign technology entrepreneurs? The prospect of a huge market of consumers with a voracious appetite for spending and for new technologies. Massive flows of capital chasing sexy innovation that has “AI” or robotics tagged next to its product description. Short scale-up cycles, rapid value creation and the promise of high startup valuations. Foreign founders with a China orientation read daily about huge financing rounds that give birth to dazzling billionaires.

The vast riches of China are out of reach for many Western innovators. They are deterred by the appearance of chaos, head-spinning speed and vicious churn that characterize China’s tech landscape. Those that have raised pre-seed or seed financing in Israel, for example, from the prolific local tech ecosystem are almost immediately directed to scale up in Silicon Valley. Israel is a negligible market, a massive incubator that is deeply intertwined with the Bay Area. The newly funded companies have one shot, a long shot, at success—should the founders squander it on the vagaries of China or follow the beaten track to the Valley where so much collective knowledge and experience have been accumulated in the past 25 years?

Slow progress

One company that has braved the odds is Sky Sapience, based in Yokne’am in northern Israel. Its homeland security product line—a tethered, hovering device for real-time intelligence and communication—is selling in Israel, Argentina, and Africa and the company has raised $13 million to date in Israel. In December 2017 the company’s founder, Gabriel Shachor, a former brigadier general in the Israeli army, was invited to attend the exclusive World Internet Conference in Wuzhen, Zhejiang province.

The visit resulted in deep cooperation with the Wuzhen local government, the establishment of a Wholly Foreign-Owned Enterprise (WFOE) in the city, an intent by it to raise $15 million and promote the company’s technology to clients such as China’s ministry of emergency management. For months nothing happened, up to now little has actually been achieved.

Many dynamic Israeli and European tech startups closely observe these developments and wait for Chinese institutional investors to extend a helping hand and guide them into their ecosystem. Some serious Chinese players will have to be more deeply committed to this cause to create the first visible success stories.