Starving firms compete for China's scanty venture capital
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It was a scene I had witnessed many times before. At the conclusion of a talk at Tsinghua University by a well-known Chinese venture capitalist, eager MBA students surged around him like waves crashing against craggy rocks.
They pitched ideas, and scrambled to seize a business card before they were gone. In the end, the venture capitalist parted his way through the sea of would-be entrepreneurs, and made his escape.
The Chinese saying, "Behind the red doors, meat and wine go to waste, while on the roadside lie the bones of the frozen" describes China's feast or famine financial markets.
On the one hand, China enjoys a feast of capital. Currency restrictions bottle up yuan capital in China. Foreign investors, eager to escape the sluggish recovery in the West, pour capital into China like wine into an already overflowing cup.
Paradoxically, amidst this glut of capital, entrepreneurs seeking early stage capital face a famine. Behind closed doors, I asked my investor friends to explain. One explanation is a shortage of financial talent. China's economy has been open only for a brief while.
The venture capital/private equity industry has grown rapidly, but rapid growth necessarily entails that newcomers outnumber old hands, making experienced financial professionals scarce.
These old hands often started as venture capitalists or entrepreneurs. The entrepreneurs who started the right firms and the venture capitalists who backed them achieved rock star status.
Flush with success, they left early stage investment to raise larger funds, run larger deals, and reap larger fees. Fund elephantiasis set in. Sequoia and CDH steadily crept up into the growth capital space.
Talent migrated away from the early stage space to pursue bigger game, but everyone else soon followed. After all, early stage investment is uncertain, and time-consuming.
To do well, venture capital firms need industry expertise, a sense for management, and the patience to guide entrepreneurs for several years to exit. Even with all these elements in place, nine out of 10 investments are still expected to fail.
Late stage investment is more forgiving. Mature deals have proven business models. Their profits are trending upward, and an initial public offering (IPO) is beckoning. The room for error is lower, and the capital that can be deployed per deal is higher.
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