Special Report: Early Stage Invesment in Chinese Tech Companies

Filed in archive Venture Capital on September 9, 2006

CVN is pleased to introduce guest contributor, Jesse Parker, Co-Founder and Managing General Partner of Dragonvest Partners, a Shanghai-based early stage venture capital firm specializing in fabless semiconductor, broadband and wireless and medical device investments. Located in Beijing and Shanghai, Dragonvest portfolio companies are developing and marketing products both for the Chinese domestic market and the global market. This blog wants to provide more indepth reporting and analysis and so we welcome this ongoing series on "Early Stage Technology Investing with Chinese Characteristics." This is the first of an 8 part series for CVN.

China is not unique but it is certainly different. The Chinese business community has reached the starting line - the WTO deadline at the end of 2006 will serve as the starting signal for entrepreneurs. We can not expect this new race to follow the well worn track of previous marathons. The tools necessary for victory are the same; the velocity and recipe are uniquely Chinese.

What's new about these broad and obvious statements? Americans have been drooling over China's market potential for more than 100 years. Missionaries, government missions and wayward entrepreneurs have been attempting to crack the market from every conceivable angle: God's wrath, government's military might and lucrative contracts have all failed to generate sustainable economic expansion.

No matter how uninformed one might be about Chinese history, culture or language, it is undeniable that China has "stood up." After years of colonial subjugation and decades of internal civil war and errant political campaigns, the undeniable fact is that China is a unified, strong, increasingly progressive potential world power. No government or corporate lobby can alter this fact.

In the summer of 1981 at the Changsha Railway Institute (located in Hunan's provincial capital of Changsha) I learned some very hard lessons about living and working in China. Good intentions and knowledge are not enough! Two thousand years of chinese culture is important. It infuses every corner of life in China. It is not easily diluted or ignored or forgotten. This is a simple lesson. Why is it so easily ignored by investors?

Investing in China over the past 25 years has passed through too many stages to review here. What is clear at the end of 2006 is that company building in the tradition of silicon valley is just beginning in China's east coast cities. I don't mean to suggest that the dozens of technology IPOs of the past ten years do not qualify as well build companies. They are however not representative of indigenous innovation.

Chinese technology innovation has begun. It can be found in early stage technology companies across China's numerous technology parks. These companies are not led by MIT and Harvard MBAs. They are not spin-outs from Lucent or IBM laboratories in the US.

Instead, these companies are raw startups. They are led by entrepreneurs with a vision for the company's future. They have been created from whole cloth with just a few thousand dollars of startup capital. Their hallmark is stretching their limited resources as far as possible.

The greatest strength of this new generation of entrepreneurs is their unyielding commitment to success at all costs. By placing frugality at the center of their startup activities they are able to avoid the death spiral of excessive burn rates early in their lives.

Many of these companies are also able to generate revenue almost immediately upon being established. They utilize their knowledge of the local business climate to build their company and establish a market presence.

This is not sufficient for many early stage technology companies. Despite successfully building a company to critical mass, many of these firms do not have the ability to attract international capital and partnerships. Although many international VCs are searching for companies at this stage, most companies are not properly prepared to receive international capital. They lack the proper corporate structure, the proper accounting and auditing procedures, the proper intellectual property protection or a fully developed team. They still need help building their company.

There is a funding gap in the Chinese technology sector. Many early stage technology companies are not ready for international Series A round capital but can not expand beyond their successful startup phase without it. They are caught in an intermediate stage.

Here's where the "investing with Chinese characteristics" comes to the forefront.

What these companies require is a formula which mixes their success-to-date with proven early stage company building tools. They need to mix their knowledge of the local market with a proven business modeling tool. They need to mix their ability to manage a low but highly efficient burn rate with the necessity of increasing the burn rate to attract the best possible team members. They need to mix their local corporate structure and management processes with internationally accepted company structures and transparent reporting.

Just as the best Chinese JiaoZi (dumplings) are made from the secret family recipe, so this early stage company building effort requires a blend of east and west, a mixture of patience and aggressiveness, the right amount of capital and most importantly a deep understanding of the value of "investing with Chinese characteristics."