Chinese VC’s search for ways to profit from foreign startups
Glory Capital sits in a building overlooking the gleaming glass-and-steel high-rises in Shanghai’s northeast district of Yangpu, home to 14 higher education institutions including top ranked Fudan University and Tongji University.
Founded by Eric Yang and Jerry Bai in 2015, it’s not a typical Chinese venture capital (VC) firm: The partners launched one fund with RMB 250 million ($36 million) for investing in Chinese startups, and a second fund of around $10 million earmarked for Israeli startups that Eric and Jerry are betting have a real shot in China’s hyper competitive tech market.
They boast a small stake in some Israel-based high flyers, some of which have raised tens of millions of dollars from VC funds, such as Innoviz, a developer of LiDAR remote sensing solution for autonomous vehicles, and Intuition Robotics, maker of social companion artificial intelligence for older adults.
Fraught with risk
Cross-border venture investing is fraught with risk and most Chinese players are inexperienced in running due diligence on a foreign company, yet more of them are attempting to do so.
“We connect our Israeli portfolio companies to the likes of Xiaomi and Huawei, two of China’s hardware titans, helping them commercialize their products here in China,” says Yang.
But Glory Capital is still the exception among Chinese VC’s in the strategic value it delivers to portfolio companies.
Common wisdom has it that a VC fund needs to triple return to achieve a “venture rate of return” and be considered a good investment. Yet this is a notoriously hard, elusive goal to achieve. Numbers published by UpWest Labs, a Silicon Valley accelerator and VC fund, show that 2% of VC funds in the US capture 95% of return on investment, and only 5% of top-ranked funds can pay back to investors what they expect—triple the amount originally invested.
When evaluating foreign opportunities, Chinese VC managers soon hit upon a roadblock. They must ask themselves, what is their added value in attempting to pick winners among founder teams in remote markets. This is especially challenging because they are stacked against local VC’s that are better positioned to identify the best teams and move in on them quickly.
In the first half of this decade most Chinese firms concluded that the preferred method for tapping into Israeli innovation was to take the backseat role of financial investors—limited partner (LP’s). Lenovo, a Chinese computer giant, invested $10 million in 2015 as an LP into Canaan Partners Israel, a VC firm.
Shengjing Group, a large fund of funds, has since 2012 invested $100 million in venture capital firms Jerusalem Venture Partners, Vintage Investment Partners, Viola Group and Canaan Partners Israel.
Another fund, Shanghai-based Boliu, which has pooled money from high net-worth individuals for both domestic Chinese and cross-border activity, cast its net widely. Boliu’s fund-of-funds arm is an LP in two VC funds in Israel, one in New York and one in California, in the hope that these funds will help scout locally for star startups.
Boliu is one of the early investors in iQiyi, a Beijing-based online video streaming platform with 500 million users, but to date has only co-invested with its general-partner funds in American startups.
The best startups in Israel, those believed most likely to create a “home-run” exit for investors, typically prefer to raise money from the top quartile of US funds, whose returns are among the top 25% or even 10% in the industry.
The realization in recent months by Chinese investors that most Israeli funds do not make it to the top performers’ list is driving many of them to focus their war chests and efforts on startups rather than VC’s. This gives rise to new complications.
Sourcing deals directly
Peter Yang and Jerry Bai of Glory Capital are leveraging their advantage as a Chinese VC with access to China’s consumer society and capital markets. They believe that when taking a stake as “strategic investors” directly in a deep-tech foreign startup, then helping it build up a customer base in China and create value there, they pave the way to a hugely profitable exit.
Yet in doing so they face a compounded struggle: First is access to good deals, which lies at the heart of the VC business.
“Every two months we spend one to two weeks in Israel with our portfolio companies, sourcing for new deals, and meeting with these new prospects,” says Yang. “We find that without a permanent local presence in Tel Aviv it’s hard for us to source deals competitively and build our brand in the local ecosystem.”
Chinese investors struggle the second time when implementing their plan to spur on customer acquisition for their portfolio companies. Often, they find that one way to make this easier is by collaborating with accelerators that serve as a landing pad for the sought-after foreign innovators.
Plug and Play, an innovation platform and an early-stage investor from Silicon Valley with a well-established presence in Beijing, Shanghai and Hangzhou, has invited a handful of startups from the US, Europe and Southeast Asia to a six-month cross-border acceleration program dedicated to helping them gain market entry into China. The program includes meaningful interaction with Chinese VC’s, corporations, and multinationals that may lead to investments.
The extent to which foreign-born startups grow to create home-run exits in China depends on the ability of Chinese investors to transform their home market into a real alternative to Silicon Valley and Wall Street.