In the past couple months WebWednesday Beijing, a monthly gathering of Internet, tech, and digital marketing professionals has invited speakers from the China venture capital & start-up investment world share to with us their thoughts. Harry Man is a Partner at Matrix Partners, a venture capital firm in Beijing with a home base in Boston. Stanley Tang is Vice President at China Renaissance, a financial advisory investment bank for startups seeking funding.
The majority of the speakers’ thoughts and tips were fairly mainstream venture capital selection criteria, such as looking at the ‘Team first’, then the Market, then the Model. However, there was a common point made by both speakers specifically about venture capital dynamics in China.
1) Harry Man mentioned that the ‘Copy-to-China’ model is good. Creativity in China is not on technology, but more on the business model.
2) Stanley Tang said that their firm highly prefers to work with those business plans that have benchmark businesses overseas.
What does this tell us about the startup investment industry in China?
Quite simply, we’re seeing that venture capitals, start-up financial advisors, and investment banks are very active in funding copycats because the model has been tested and proven in other markets, thus lowering investment risk. This also means that the sentiment, attention, and majority of investment dollars are supporting the copycat industry in China. Both speakers mentioned that there is still a lot of opportunity for creative localization and adaptation of tried & true overseas business models. These professional investors also noted that they do prefer local Chinese entrepreneurs, as the nuances of Chinese localization are best identified and executed by a native of that culture.
Here I must add a caveat: It may be that the speakers we listened to were coming from smaller VC and investment firms, so their investment strategies cannot take on higher levels of risk, and therefore have crafted this ‘prefer copycat’ guideline as an additional risk-mitigating rule to help them in their selection criteria.
But if two speakers are saying the same thing, then it is likely that this is common practice and strategy among many China investment firms.
Given this clear preference for investing in copycat start-ups, what does this mean for original innovation in China?
Here I want to add another caveat: We could be looking at a paradox – chicken & egg – scenario. Venture capital’s preference for copycat start-ups maybe a direct result of the entrepreneurial ideas coming out of China. VCs are investing in predominantly copycats perhaps because the other actual original ideas are just not very good. Maybe the best that would-be entrepreneurs in China can come up with right now is copycat models. Indeed, both speakers mentioned that they do a lot of handholding with their selected investment start-ups, as most are first time entrepreneurs.
Regardless of which side of the paradox you believe to be truer, one thing is for certain: one reinforces the other. A VC culture of investing in copycats drives many entrepreneurs to think, plan and look for opportunities only as a copycat. Conversely, if there are not enough good, fresh, original ideas coming out of China’s entrepreneurs, naturally this will influence VCs to allocate their funds to primarily copycat models.
If China has this downward spiral paradox, how then can it break out, and get the chance to build an investment ecosystem that at least allows China the opportunity to create something completely unique?
In the developed economies, and especially in the North American context, Angel investors help to fill that gap between early stage startup and venture capital financing. Angels play a pivotal role in championing a much wider variety of entrepreneurial permutations – the widest rim of the funnel – which inevitably gives rise to a greater probability of different and unique innovations being funded by venture capital. In China the Angel circuit is almost non-existent, a natural consequence of an economy and investment environment that has leapt almost overnight from a society of have-nots to a society with a small group of have-plentys with no investing experience.
To fill this gap, venture capitalists are revising their tactics and role in China, taking on more duties that normally an angel investor would do; the VC often provides training, HR, and direct development strategy. But venture capitalists can only do so much.
Lee Kai Fu, the former head of Google in China, identified this systemic problem with China’s innovation capacity very early on and decided to do something about it. Late in 2009 he announced the creation of a new company called Innovation Works. This company would be a hybrid angel-investor/startup-incubator. While adding a very minimum seed capital into the ventures they recruit, Innovation Works’ main value-add is its ability to augment the founding entrepreneurial team by supplying expertise in areas the founders have not: finance, marketing, user experience, design, strategy, engineering, etc. All the combined expertise makes for better product and business quality, and better chances of market success. Lee Kai Fu’s prestige and Innovation Works’ reputation means their endorsed startups have a clear path to eager venture capitalists ready to ensure enough funding so the startup can reach its full potential. What Innovation Works gains in return is a significant share of these top-grade startups, effectively giving Innovation Works a portfolio of higher-performance, lower-risk startups. Innovation Works may eventually end up with a better IRR and higher startup success rate than even the top VCs.
Innovation Works is a new kind of creature for China, and perhaps is the structural component China needs that will allow entrepreneurs to pump fresh ideas and opportunities into the startup soil bed here. There are other natural incubators in China, namely the academic institutions like Tsinghua, Peking U, and Fudan. But whether universities can weaponize incubation as well as a privatized entity like Innovation Works remains to be seen. The other saving grace may be in China’s DNA of copy-cating. Now that Innovation Works has shown one viable model to solve this innovation gap, will others copy and iterate? Maybe an entire industry of incubators is just what the doctor ordered. It could give entrepreneurs enough time and incentive to start thinking beyond copycatting and give China some real new creativity. It would also give VCs breathing room so they could start funding unique ideas beyond just copycats.
Incubators can also innovate themselves. Innovation Works is just one model, best suited specifically for the tech industry. The challenge is how incubators can be applied creatively to other industries with dynamics different than purely product-based startups? How can incubators be brought to benefit grassroots cultural entities? Can incubators be catalysts for human capital development? Similar to the tech startup environment, can incubators help open-source, viral, or the creative industries find monetization models faster, cheaper, with less risk, and with more accuracy?
One final thought: I agree with Harry Man when he says that creativity in China is not in new technology but in new business models. Its not that China cannot produce new technologies, it can. But it is so obvious that the size of China’s markets, the economies of its scale, and the ability now to crowd-source at a hyper extent, means China’s greatest and easiest opportunities for innovation and creativity will come from new business model development. There will be models that can only be tested and proven in a market size only China can currently provide. Models that America’s numbers cannot validate. There will be models that emerge from China with individual margins too small to be worthwhile in America, but extended with China’s long-tail, these models may suddenly become viable. And there may be models based on cultural norms found only in Eastern cultures, norms that may alter the paradigms of doing business, norms that the West could not behaviourally or naturally conceive of.
Incubators could be a key player in innovation and creation for China. At the very least, they could offer China the opportunity to switch course, away from the diminishing returns of copycat startups.