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									                     China VC Market

                            York Chen
                       iD TechVentures Ltd.
                    January, 25th, 2010; Beijing
                 Nanyang Technopreneurship Center

                 China VC Market

•   China Economy and VC Market, 2009
•   Offshore Deal Structure
•   Emerging Onshore Structure
•   Venture Financing in China
•   China VC Going Forward
    - Other Observations on China VC, 2009
    - How accurate about China data
    - VC Charity: Yanxing China
       China Economy, 2009
• China GDP growth in 2009 reached 8.7%. Bottomed out
  from Q1‟s 6.1% and grew up steadily: Q2 7.9%, Q3 8.9%
  and Q4 10.7%
• Amid depressed global economy, China turned around a
  typical V-shaped recovery. Key factors: government‟s
  prompt RMB4T stimulus package, moderately loose
  monetary policy (RMB9.5T lending, doubling of 08‟s), a
  big domestic market to boost local consumption and
  relatively healthy financial sector..
• GDP amount reached USD4.9 trillion, could overtake
  Japan to become the second largest economy in the
• Overtook Germany as the world‟s largest exporter in
China Economy Outlook, 2010
• GDP growth will be between 8 to 9%.
• Growth will not be a big challenge. Key effort
  will be on control and adjustment from short-
  term expansionary urgent measures in 2009 to a
  healthy and stable development system.
• Concerns going forward:
  – Excessive credit growth leading to inflation
  – Danger of real estate bubble bursting
  – Production over-capacity due to massive investment
    in heavy industries (such as those addressed by
    NDRC earlier in steel, cement, plate glass, coal-
    chemical, polycrystalline silicon and windpower
  – A weak global outlook
        China VC‟s 23 Years Evolution
    “China NewTech Ventures”, ‟86, is the first VC firm in China. But,
     meaningful VC operation was initiated by foreign players in ‟93.

Four Generations                  Four VC Stages
造反有理                              The Wild West
Rebellion is righteous            产业的洪荒时代 (‟88 – ‟92)

实事求是                              Practicing to be Perfect
Be Practical & Realistic          在实践中优化环境 (‟93 – ‟98)

与时俱进                              Following Global Dotcom Fever
Progressing with the Times        与世同步的达康冷热 (‟99 - „03)

和谐社会                              Soft-landing for a Healthier Market
Toward Harmonious Society         过热到软着陆的有序市场 (‟04- )
       Ten Years Come a Full Cycle
• In short 10 years, China VC goes thru a full cycle
  from dot com fever and bubble-bust, warming up,
  over-heating, soft-landing, then to on-going cold
   –   ’99 - ‟00:        Dot com fever & bubble
   –   ‟00 - ‟03: Bubble burst & VC winter
   –   ‟04 - ‟07: Warming, hot and over-heating
   –   ‟08 – „09 Soft-landing, cooling and getting cold
   –   ‟10        Recovering
• The ten year‟s cycle also illustrates how China VC
  grow, adjust and mature.
               VC Investment Dropped

Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
     VC Investment by Currency

                                                 Amount invested: US$2.4B

        No. of Deals: 425

Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
            VC Investment by Industry
                                               Amount invested: US$2.39B


         3 of Deals: 425
                                                     3               1

                2                                           2
Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
         VC Investment by Stage

Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
                                VC Exits
          by Industry : 106
                                                    by Exit Option: 106

Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
              VC Fundraising Declines

Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
  VC Fundraising: RMB vs. USD

                                                 by Funding Amt: USD5.1B

    by Fund Number : 90

Source: VC Data for First 11 Months, 2009, Zero2IPO, Dec., 2009
Offshore Deal Structure

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   China‟s Foreign VC Operation
 - Funding & Divestment Stay Offshore (两头在外)
                   Value Add &
                   Portfolio Mgmt

Deal Flow Screen                    Divestment &
& Investment                        Return to LPs

                   Fund Raising
                   & Set up Fund
             Foreign VC Investment
          Kept Equity Activities Offshore
         VC Mgmt
                                          VC Mgmt Co. LP Fund
     (Rep. Office)


Portfolio‟s onshore entity                         Portfolio‟s offshore
WFOE: Wholly Foreign Own Enterprise
                                On      Off
                                Shore   Shore

 (York chart, „02, quoted in HBS cases #805-090 and #805-091)
               Special PRC Vehicle for
           Projects Off-limit to Foreign Co.
            VC Mgmt Co.
                                         VC Mgmt Co. LP Fund
             (Rep. Office)

             Management                                    Invest


A SPV Co.                                                  Holding
                                 On      Off
(For Licensing & Rev. Booking)   Shore   Shore

    (York chart, „02, quoted in HBS cases #805-090 and #805-091)
Emerging Onshore Structure

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 Go Onshore?
Go Onshore?
             The Shifting Tides
• Through three major circulars (SAFE circulars #75 and
  #106, MOC #10) and other administrative measures since
  2005, Chinese government tried to discourage local deals
  to restructure into offshore holding for USD funding and
  overseas listing. As a result, offshore restructuring
  becomes much time consuming and challenge.
• At the same time, the local VC/PE environment is
  improving. The local IPO, legal framework and LP funding
  sources are getting better.
• High growth traditional sectors as a sector for VC
  investment, and most of them are onshore projects.
• As a result, some quality deals prefer to stay onshore. So,
  foreign GPs start to explore RMB onshore investment.
      Broad IT Investment (%) Dropping
                           (Data Comparing „05 & „09)
 Other          2.5%
Traditional                     60.3%

 Year           Inv $      Broad IT %
 05:            1.06B               60%
 06:            1.70                62
 07:            3.2                 43
 08:            4.2                 36
 09:            2.4                 30

           Source: Zero2IPO annual VC reports, ‟05 and „08
           VC in Traditional Sector
          - A Unique Characteristics in China
• Crowded, overheating and competitive TMT sectors putting
  constraints on return potential. High risks not necessary come with
  high return.
• Not like in the mature economies, high return opportunity in China
  might not necessarily be powered by high-tech. Many traditional
  sectors, backed by high growing economy, still present high growth
  and high margin potential. As a result, posting high return
  opportunities for investments.
• Source of high growth deals:
   – Low hanging fruits: many good quality and long operating
     projects are still kept private due to backward stock markets in
   – Emerging consumer projects due to urbanization and growing
     middle class
           Model A (Sino-Foreign JV Fund)


                                         3a                           USD
                JV Fund                                               Fund

                                            2                         1

               Project      Project                                 Project
               Project      Project
                (JV)         (JV)
                                        Onshore Offshore (Offshore Holding)
Route 1: invest into China projects‟ offshore holding entities, mostly in Cayman
Route 2: direct cross-border investment and turn a China entity into a JV
Route 3a: to sponsor a locally registered RMB JV fund with foreign participation.
                  Model B (Pure RMB Fund)



              RMB Fund                                              USD Fund

                                             2                        1

                                    Project                           Project

                                       Onshore Offshore            (Offshore Holding)
Route 1: invest into China projects‟ offshore holding entities, mostly in Cayman
Route 2: direct cross-border investment and turn a China entity into a JV
Route 3b: to sponsor and initiate a locally registered pure RMB fund
Model C (Pure Offshore Contributed Fund)


               RMB                                                   USD Fund
              JV Fund

                       3                    2                         1

              Project              Project                            Project
               (JV)                 (JV)
                                       Onshore Offshore (Offshore Holding)
Route 1: invest into China projects‟ offshore holding entities, mostly in Cayman
Route 2: direct cross-border investment and turn a China entity into a JV
Route 3a: to set up a locally registered RMB fund with all funding from offshore
               Model A vs. Model B
   Model A and B are most popular models, with significant
   implications (pro and con) to foreign GPs and LPs. Model
   C is rather niche and only very few funds being set up.
• Model A:
   – Expose to more red-tapes and regulatory uncertainty.
   – Not to restricted sectors (no Sina-structure for onshore deals)
   – Less conflicts of interests as foreign LPs have indirect interests in
     RMB funds.
   – GP needs to take care more complicated investment process.
• Model B:
   – Much less government approval required.
   – Less restriction on investment sectors.
   – Foreign LPs have big concerns on unavoidable conflict of interests
     of two not-related funds.
   – Best for GPs.
Venture Financing in China

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            At different stage, enterprises require different investors, which
                    Involve differently and bring different value adds


                                   横轴:创业行军的时间延伸 (time)

查立手绘图 ”创业公司的成长轨迹“,乾龙创投 查立 “在死亡谷蹦极”
      People, People and People
• Evaluation to the team is the most critical part of
  due diligence. Key founding entrepreneurs and the
  team is the most important factor if a project could
  be successful.
• “First tier team with second tier business model” vs.
  “second tier team with first tier business model”.
  A start-up is “shooting at a moving target” as the
  environment and competition is such dynamic.
  Only a good team could eventually work things out.
• VC prefers to back up a successful founding team,
  no matter what they are doing.
• People judgement is a KSF for a venture capitalist.
  An art, not a science.
       Business Model Decides the
           Funding Progress
• Three logical steps of founding a project: see a business
  opportunity (What), how to catch the opportunity (How),
  then why should I be the one to do it (Why Me).
• It‟s the “Business Model” to decide if a project will get a
  VC attention to proceed further. It‟s also highly relevant
  to a project‟s success.
• Timing (天时) and locality (地利) of a business model
  counts. Case: MVAS.
• Adjustment of a business model will also decide a
  project‟s strategic direction and also resource
  deployment. Case: Baidu changed from a back-end
  technology provider to a front-end searching services.
• Business model is also about revenue model. Needs to
  consider how‟s revenue generation mechanism.
  Valuation to an Early Stage Project
• Without ways of getting other funding supply (loan, ..),
  start-ups turn to equity financing as the major sourcing of
  capital to fuel corp. development.
• High tech start-ups, not like mature traditional companies,
  lack of past financial track record as a base for future
• A project‟s current perceived valuation is based on the
  projection to its future revenue, profitability, growth and
  perception from stock market. All these projection for
  potential “high return” are full of uncertainty.
• Since conventional valuation models, such as discount
  cash flow, … could not be applicable, so major evaluation
  system for early stage projects:
   – Bench marking with other similar transactions.
   – Derived and discounted from a future multiple projection.
       Challenges to Early Stage Projects
   (also the areas entrepreneurs should answer to VCs)
• Need to conservatively evaluate the time and capital
  required to reach product development, mass market,
  revenue and profit.
• Portfolio development could easily slip away from projection
  in financial performance, next fund raising and equity events.
• Failure of start-ups mostly coming from:
   – Business model not go through market validation
   – Major changes on legal, regulatory and industrial policy
   – Competitors‟ innovation on technology or business model
   – External challenges from financial and fund raising
   VC‟s Perspective on Value Adds
• Come in where founders are lack or short of, such as
  strategy planning, financing and alliance.
• Observe founders‟ entrepreneurship. Only to add up, not
  to replace.
• Different type of VCs bring in different kinds of value adds.
• What being brought in will be varied and evolved as a
  start-up grows.
• “20-80” concept applies. “Return on Effort” counts: spend
  more effort on those projects could contribute most to the
• A two way street: also depends on how founders
  appreciate and facilitate VC‟s involvement.
China VC Going Forward

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  RMB Onshore vs. USD Offshore
• RMB fund raising surpassed that of USD, for the first time,
  in 2009. RMB onshore fund raising will continue to be
  active in 2010.
• But, RMB funding‟s extraordinary performance in 2009
  should be seen only as a one time surge, and might not
  be sustainable. Key considerations:
   – Most domestic fundings are from first time players lured mainly by
     GEM board hype. The equity fund gold rush needs to be validated
     with good return.
   – Onshore LP funding supply needs a few years to be improved in
     views of right LP mindset, diversified LP sources, bigger funding,
     and more supportive regulatory and tax regimes.
   – And, for past 1.5 years, offshore LP fundings were on-hold. But,
     that‟s a temporary measures. From 2010, they will resume the
     new commitment, and China to be the first country to get new
                  RMB LPs in China
            - Limited and Not Yet Mature
• Conventional LP practice prevailing in the West is not yet
  popular in China, such as:
   –   Long term view for up to 10+2 years
   –   Not to involve in GP operation
   –   Commitment to capital calls
   –   Economic interests for GP: Fee and carried
• Local LP community has not yet a mature cluster. Limited
  LP source, and funding size is usually small. No
  insurance, pension, endowment, family offices, FoF, ….
• Many government agencies (ministries, banks, provinces,
  municipalities, hi-tech parks...) set up “Guidance Funds”
  (引导基金) to provide LP funding. But, most of them come
  with “strings attached”.
     RMB Funds with Chinese Characters
Local RMB funds are quite different to prevailing offshore USD funds,
mainly due to the needs to facilitate local LPs “short term drive” and no
commitment to capital calls.
                USD Offshore Fund        RMB Onshore Fund

Fund Life       Around 10 years          Around 5 years

Fund Size       A few hundred US$M       Around & less than US$50M

Capital Call    Several, for few years   2 or 3 times, for several months

Fund            Every 2 to 4 years       In less than one year

LP          Basically hands off          Try to involve (interfere)
         Short-mid Term Challenges
        for RMB Onshore Investment
• Tougher fund raising. China still lacks a sound LP
  mindset and practice. Short of diversified and Western
  style LP sources. And, foreign LPs are not ready to do
  direct cross-boarder investment into a RMB fund.
• Limited onshore divestment routes. Only IPO site in
  Shenzhen with higher listing criteria. Almost no M&A
  market yet.
• Yet-to-improve legal, regulatory and administrative
  framework to facilitate RMB fund set up and
• Extra red-tapes on operation of RMB funds, which are
  invested with foreign funding.
• Need more time to observe a smooth repatriation of
  foreign LPs‟ divestment in local deals.
Convergence of Foreign and Local GPs
Foreign GPs will go onshore, moving from A, to B, and
eventually onto C. At the same time, local GPs will try to
access foreign funding and eventually also managing
offshore funds.

 C          B                 A         A.   Offshore USD Fund:
                                             Parked offshore (Cayman Island)
 RMB       RMB                 USD
          JV Fund              Fund
                                        B. Onshore RMB JV Fund::
  Fund     Fund                              Invested by both foreign and local
                                             LPs, registered in China and
                                             denominated in RMB.
                                        C. Onshore Pure RMB Fund:
                                             Invested only by local RMB LPs.
          Project   Project
Project                       Project
           (JV)      (JV)
 RMB Onshore Fund: a Long March
• It‟s a trend of no return. In the long run, China‟s VC/PE
  industry will do RMB fund raising (from local and foreign
  LPs), locally registered, invest into local entities, and
  divested thru local and foreign IPO or M&A.
• It might take years for RMB onshore investment to become
  the mainstream, or to surpass offshore investment. But,
  foreign GPs and LPs should monitor and proactively react
  to the shifting trend. Eventually, doing RMB onshore
  investment is not an option, but a survival issue.
• However, local RMB investment is still come with lots of
  challenges. So, need to proceed cautiously and control the
  pace carefully.
China: a Risky Market for Foreign Players   危
China is a tough market                     机会
for foreign players.
Business initiative needs
“摸着石头过河” (a
Chinese proverb: cross
the river by groping the
stone under foot). Should
follow the trend and work
with reliable local
partners to avoid
operational/legal risks.
What’s expressed in this PPT highlights
York’s personal observations. It serves for
academic discussion only, and not
representing iDT VC’s view point.

    +86-13911735538 (SMS Preferred)

           VC Charity Yanxing China (雁行中国) MV:
Attachment I

               Other Observations
               on China VC, 2009

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                Mail to:
  VC Operation During Depressed Period
• Spend more time and resources on portfolio management. Helping
  on strategic planning and operational efficiency to overcome the
• Reserve funding to back-up existing portfolio, instead of investing
  into new companies.
• Take reserve and cautious approach toward new investment:
    – Prolong decision making time, spend more time for evaluation. Not rush
      into investment.
    – Be much conservative on start-up‟s future projection.
    – No matter at which stage, a VC looks serious on how will the company‟s
      next fund raising. Make sure the company will move on to next
      milestone with successful following up funding.
    – Lower down valuation, with better terms and build in down-side
• Spend effort to build up closer relationship with LPs to avoid default
  on future capital calls.
• Strengthen the team building.
   VC Cold Fronts: ’08 vs. ’00
                             2000                       2008
  Background        1. Dotcom hype globally    1. Overseas financial
                    2. Local VCs chasing 2nd        crisis
                    board launch               2. China VC over-heating
                    3. Global economy keeps    3. Global economic crisis
Hot, cool to cold   Instantly dotcom crash     Gradually (soft landing)
                    (hard landing)
Sectors Impacted    Mainly internet related    All sectors

 VCs Impacted       Mainly local VCs           Mainly foreign VCs

Tough Years Ahead   Three Years                ?
             Financial Crisis‟ Impact to
                 China VC Industry

Global financial crisis leads             VC Industry‟s Four Major Scope
to a depressed IPO market.
IPO and M&A routes are                                                   Value Add &
                                                                         Portfolio Mgmt
almost completely closed
down. To VC players, the
negative impact is not only            Deal Flow Screen
                                       & Investment                                                 Divestment &
on the divestment, but also                                                                         Fin Return to LPs

to other three major scopes
of a VC operation: fund                                                 Fund Raising
                                                                        & Set up Fund
raising, investment and
portfolio management.                Source: York Chen “Examining China VC maturity by three cycling theory”, Dec., 19, 2002

Chinese column by York: “全球金融危机对中国创投业的影响才刚开始”, 21世纪经济报道
          Opening Slide for Sequoia CEO Day
                   (Oct. 7th, 2008, Sand Hill Rd.)

                                                             This and next slides are from
                                                                 Sequoia Presentation

               Only the Quickest Will Survive
                     - Strong Message from Sequoia

Source: Sequoia Presentation , Oct., 7th „08
          Naked Swimmers
“It‟s only when the tide goes out that you learn who has
been swimming without a bathing suit.” - Warren Buffet
“只有退潮的时候,才能看清楚究竟谁在裸泳。” - 巴菲特

During the “VC Bull” market („04 to „07), many
un-experienced entrepreneurs and venture
capitalists joined the fun party. It would be a
tough challenges for them to go through the
bear market ahead.
            Cases Concerning Entrepreneurs‟
                Integrity being Exposed
•   Asia Media
    CEO Cui Jianping embezzled                           Value Chains of the VC Industry
    RMB107M to guarantee his personal                       (Three Major Player Groups)
    company. The company was delisted
    from Tokyo Exchange.
•   ITAT
    Fabricated financial data and made up                  LP
                                                                      LP Fund
    store activities to attract VC investment.   Angel
    It sucked over USD120M VC/PE funding.                       FoF

•   Gushan                                                             GP

    Hiring three empty oil trucks to drive in
    and out of factory to illustrate busy
    business transaction. No loading of oil.       Credit and Integrity are the
•   PPG                                            foundation for relationship
    It‟s alleged that CEO Li Liang is at run       between LP and GP, as well as
    and pocketed with USD20M.                      GP and Entrepreneur.
         GEM Board in Shenzhen
 - A Critical Step in Improving Local Divestment

• First batch of 28 companies
  went on trading on Oct. 30th,
  2009. A ten-years‟ long
  waiting for local stock market
  to facilitate VC-backed
  companies‟ to go IPO earlier.
• GEM board in Shenzhen is an
  important move, but just a
  small step in the long march
  for improving local divestment
  environment. Much to wait
  and see.
Attachment II

  How Accurate the VC Data in China

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                Mail to:
     How Accurate the VC Data in China?
 • As in many other Chinese statistics and data, for sure there are
   bubble in VC data. Just a matter of degree.
 • Key reason of the bubble:
    - “bigger is better” mindset. Intentionally or un-intentionally,
       entrepreneurs, investors, market data collectors and reporters
       tend to report bigger data.
    - Funding by stage, performance-attached remittance, contracted
       amount had eventually not invested in.
    - Sometimes, it‟s not easy to differentiate
       PE and VC.                                     北京四大虚:
    - How much to book in VC data for some            老板的肾,
       super projects, such as SMIC‟s series B
       for USD630M?                                   领导的稿,
 • Too much bubble in VC data will be of harmful 小姐的眼泪,
   to the VC industry                                 统计局的表。

(Chinese PPT: “停车暂借问:中国创投过热现象的沉思“ 0504
Case     How Much FocusMedia Raised?
Study         - What being reported in the press
 • Series A (including seed capital, before April, 2003)
    - “The investment is at the level of tens of millions. ” - “21st Century
      Economy Herald”, June, 2003
    - “After got several tens of millions investment from Softbank,
      Jason Jiang feels that he is ready for take off.” – “Economic
      Observer”, 2003
 • Series B (dated Sept., 2004)
    - “From the starting capital of 25M, to Softbank‟s 40M, to latest
      round of several tens of millions by CDH,…, it seems that Focus
      Media has being the darling of VC.” – “Internet Weekly”, August
      4th, 2004
 • Series C (dated Nov., 2004)
    – On Nov. 16th, Focus Media held a press conference in Great Hall
      of People to announce receiving 30M investment from Goldman
      Sachs, KTB and 3i. – company website, Nov., 16th, 2004
 How Much FocusMedia Really Raised?
The IPO prospectus:
- Series A: 6.3M, including founders, SoftBank, …..
- Series B: 12M
- Series C: 34.9M

• Only Series C amount is not too far away.
• For Series A and B, two “several tens of millions”
  investment implies to have total of some 70M or 80M.
  But, in reality the total amount is short of 20M.
• Judging by a project‟s stage and capital requirement, we
  could easily detect how much “bubble” in the reported
   Attachment III

         VC Charity:

  Colleges students
in Botanical Garden
        Apr. 4th, „09
                 Yanxing China 雁行中国
       The Charity Project Originated from Peking Univ.
• Originated from CCER, PKU, in 2003 to provide financial support to
  students from rural and western regions.
• Since 2005, being backed up by VC and entrepreneurs community.
• Expanding to Tsinghua, Renmin and BJ Normal U., with some 700

Yanxing Beida III Launch
2006, 4, 1                 Met Xiaoyans
       雁序成行的力量: 从小雁、大雁到头雁
        - 创投与创业朋友的非典型大学生公益项目
In addition to financial support, focus more on
building up a platform for them to communicate, to
interact, to learn and to grow smoother.

 A typical day: training in morning,
and outing in afternoon; 2007, 8, 23
Welcome Your
Participation as
 Sponsor and

                                                  Year-end party
Yanxing China MV & “Song of Yanxing”              Dec. 21st, „08
What’s expressed in this PPT highlights
York’s personal observations. It serves for
academic discussion only, and not
representing iDT VC’s view point.

    +86-13911735538 (SMS Preferred)

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