Established companies favored, but average deal size is rising.
June 26, 2006
June 26, 2006
The flow of U.S. venture capital to China is rising, but is it peaking? Are venture capitalists getting sloppy in their quest for big exits?
One thing is certain: the Middle Kingdom is being taken more seriously these days, and with good reason.
The latest taste of the figures shows the flow of venture capital between 2004 and the first quarter of 2006 topped $2.81 billion, according to Dow Jones VentureOne, which has begun to track China and will take a closer look in a report slated for release later this summer.
Overall, the country attracted $1.5 billion in 2005, up from $1 billion in 2004. This year appears to be on track, with preliminary numbers showing China snared more than $300 million in new investment in the first quarter of 2006—not bad for what is historically the lowest quarter of the year—and about twice the level of investment in the year-ago quarter.
These numbers are in line with similar figures released by Zero2IPO, a Shanghai-based firm that monitors both foreign and domestic venture capital. But unless second and subsequent quarters vastly exceed the $300 million mark, venture capital in China for 2006 won’t soar—it will fall.
If history is any indicator, that’s unlikely: first quarters in China are frequently tepid for VC, but subsequent quarters usually make up the difference. Moreover, the trend in China VC is resilient, even during a downturn.
For instance, according to Zero2IPO, which has been watching China longer than Dow Jones, in 2005, 233 mainland and mainland-related enterprises had been invested by venture firms with a total of $1.05 billion through 2005.
That was down 16.7 percent from the 2004 in terms of investment, when VCs pumped $1.3 billion into China, up 29 percent over 2003. But the bad news was offset by a $4-billion fund raised by mainland and foreign investment firms, making it a record for venture fund-raising in the Middle Kingdom.
The View from Shanghai
Ron Cao, who was recently made a general partner at Lightspeed Venture Partners, has been based in Shanghai for the past decade, where he previously worked as an “in-country” venture capitalist for KLM Capital Group. He believes subsequent quarters will amount to “another strong year for China VC investment,” but that doing venture in China is becoming increasingly complex.
“Yes, the opportunities in China are real,” he noted in an email interview. “The real question is, do you have the ability to discern what's a real opportunity from what’s a perceived opportunity, and if you do find the real ones, do you have the ability to get in at an attractive risk/reward price point?”
Hot areas for investment in the first quarter, according to VentureOne, include information technology investments, which garnered 64 percent of all Chinese deals in the quarter. That’s down from 2005, when IT investment snared 71 percent.
Consumer and business services are the largest segment for Chinese venture capital investment outside of the IT sector, representing more than half of the deals in the products and services category.
Bigger Bets
Stephen Harmston, director of global research at VentureOne, noted that about 70 percent of the deals in China have been focused on seeding or first rounds, but the bulk of those rounds still go to established companies that are either shipping a product, or already profitable. And the bets are getting bigger: the median size of deals in China is growing larger, reaching $9 million in the first quarter of 2006, up from $7 million last year and $5.2 million in 2004.
Mr. Cao attributes the tendency to bet on black ink is partly associated with China’s strong IPO pipeline.
“Many investors are trying to make that last bet before a company goes public, while others fearing the valuation for later-stage deals are pumping money into [Series A rounds], sometimes, sacrificing management talent and [a] concrete business model,” he wrote.
Lightspeed’s approach, he added, is not getting caught up in a VC feeding frenzy, but rather taking a cautious and long-term approach, and being choosy about what partners and entrepreneurs with whom they work.