Venture in China

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China

I get many questions about the role of China in the venture business and I respond to a description of activities deployed by the Chinese government to boost innovation, received from a Chinese engineer (his comments listed near the bottom) residing in the U.S. who manufactures his product in China.

While our implementation of venture capital in the U.S. is fraught with failure (to which the engineer responded to), China’s political system may be the biggest deterrent to a profitable venture ecosystem that aims to produce tangible socioeconomic value to the world.

The United States, while imperfect and if it corrects its self-induced economic stupidity soon, remains best positioned to lead the world in groundbreaking technology innovation. But it is our leadership position to lose, if we do not wake up to the bleak reality of innovation’s mediocre arbitrage.

 

My response to the Chinese engineer (his comment below):
Thanks for your insight into China, truly appreciated.

Dictatorship (of the healthy kind) would help venture recover in the US as well (by forcing the deployment of prime risk), and as a result reinvigorate the support for groundbreaking innovation. Unfortunately our leaders have a better understanding of politics than economics. All of our financial systems in the U.S. are in blatant violation of free-market principles (by not regulating what freedom actually means) and thus are economically non-renewable, and they will all inevitably turn subprime. Venture failed for the exact same economic reasons as real estate.

China, I believe, will have some challenges with venture moving forward.

  1. China is currently copying the bad habits from Silicon Valley that have proven not to work. That approach will ensure China’s initial foray in venture will not succeed.
  2. Producing outlier venture performance that drives life-changing socioeconomic value is quite a different beast than the production of downstream innovation. Upstream innovation can really only be produced by entrepreneurs with the freedom to think of this world anew (supported by the economic principles of a free-market), something China’s political system would be reluctant to embrace.
  3. Disruptive innovation cannot be judged by the government as the arbiter, outlier innovation is detected by outlier investors, not by any type of socialism (deployed either by a capitalistic, communistic or dictatorial political system).
  4. I believe the more prosperous the middle class becomes in China, the more unrest they will create and leave China if it does not relinquish some of its rigid control. Smart people don’t let themselves be suppressed. So, China’s growing intellectual capacity to innovate will be a blessing and a curse in one package.

So, I think short-term China can tap into phenomenal resources to produce innovation that will bring the quality of life of the majority of its population up to par with other countries. Frankly, China currently benefits from deploying modern-day slavery to the manufacturing of groundbreaking ideas from elsewhere, something that is simply unsustainable, but will help it accelerate its ascent on the economic ladder.

And so the real question will be if China will ever be able to operate competitively in a global market that aspires to the free-market principles of a self-regulating economy. Because only that mechanism can produce innovation worthy of venture style returns.

So, I predict the role of venture in China to be minimal because of the unique freedoms such innovations require, despite that I see a massive opportunity for many other kinds of (downstream) innovation in China for years to come.

But I’d be happy to have China’s leaders convince me otherwise.

The U.S. will recover, but not too soon. As in the words of Winston Churchill: “The US will always get its act together only after it has exhausted all options to do the opposite.” That is, as long as its people (like me) keep pushing for a better world we are all responsible for leaving behind.

Best,

Georges

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The above is a reply to a chinese engineer who commented on our recent article titled: “Why 99.4% of venture capital firms fail”:
It is very true. Most local VCs are investing into “who knows who!” and not based on the innovation qualities. We have some very innovative patented products and I just like running to a wall when approaching local VCs.

Late last year we received the patent from China and things change dramatically. With the Chinese patent granted, we started to tap into the funding support from China. China has government guideline for supporting new start up and government sponsored venture funding on innovation products. There are 4 basic requirements for applying these supports:
1- Things China needs
2- Things China does not have
3- Own the IP
4- World status technology

These guidelines are issued to all the leading city governments, national grade and province grade industrial parks. Most people cannot visualize what these mean. Here is one of the sample:
Late April I visited the innovative project open house in Nanjing City, China. It was carried out in a huge convention center with 10 of thousands attendees. The city government divided the industrial sectors into about 17 industrial zone/parks. These parks set up their booths in the convention halls and very eager to bring in new business/ technology into their parks. In other words, these parks run by the city government are competing to get good projects.
Any projects that get the city evaluation team approval will receive grant, VC funding and government loan guarantee. The government also provides privilege status to those innovative technology such as lower tax rate and tax relief for the first 5 years; free rent to founder employees and free office/space up to 500 square meters for 3 years.

These are just things most American never heard off.

However, if you understand their strategy you will not be surprised. If your company’s products can sell, there is a 17% value added tax for selling in China for all businesses. The regular business income tax rate is 25% (15% for innovative status). The business brings jobs to the park and workers will pay income tax. Each industrial park will have a portion to all these tax your company generated. As results, all these parks are so eager to get new innovative businesses and the government is sponsoring these grants, venture funds and loans to support.

They do not care about if you have a plan to sell in China. Based on passing the four basic requirements, these parks can help you to sell your products to the vast Chinese market.

Here is another example how large some of the national graded industrial parks are: Suzhou Science & Technology Town- owns(issued by the government) 300 square kilometers of land with over 20,000 businesses established within currently. They have set plans for growth for next 30 years. Brand new buildings everywhere within the parks and looks better than Silicon Valley.

Most importantly, they have plans and will mentor new businesses from start up to success and eventually be publicly traded.

 

We encourage comments that are relevant to our observations, conclusions and the specific topics discussed in this blog, either in agreement or disagreement. Leaving your insightful comments here will ensure others can learn from them too.  Keep in mind however this is not a place to spew your own theories (go write your own blog), but the best place to question or approve our observations.

About Georges van Hoegaerden

Georges is a serial entrepreneur, venture catalyst, 4x CEO, board director turned innovation economist (by fate). His ideas have raised $14M in venture capital and produced over $100M in returns. More.

  • drllau

    I was in China several years ago (after GFC was peaking) and was reviewing some of the science-tech parks. My impression was that they’d went more for hard instrastructure (buildings, IT, etc) rather than soft. Alibaba did most of their core dev out of several apartments in Hangzhou than a formal business/software park. Whilst China could do with a more dynamic private sector, the rigidity of thinking (imagine bureacrats allocating resources) means that the outlier ideas are likely to be ignored if it doesn’t fit within a profile. On the other hand, I do see more pro-active angels which if self-reinforcing and avoid being crushed by SOEs, may mature into a new breed of CEOs turned VCs. This may not necessarily be in high-tech, I can point to the example of growth of independent petrol retailers pre-1999 before a Ministry mandated that only the 2 oil giants could operate the chains.

    • http://venturecompany.com/ Georges van Hoegaerden

      The point of (all of my) blogs is not to over-analyze what happens (downstream), but to figure out what should happen (upstream, the true definition of economic innovation) to improve the world(s) we live in.

      If the goal of China is to create a renewable economy that can continue to compete globally (instead of merely support itself) then you cannot have a economic marketplace that is in violation of free-market principles.

      Supporting entrepreneurs with “free” stuff or artificially greasing their skids does not automatically make them free-thinkers that can re-imagine the world. Innovation requires a culture of fearless thinkers, which takes in the best of circumstances (the inverse of a dictatorship) some 30 years to build. And from all I see and hear, I am not at all convinced China is on the right path to becoming a free-market economy in which entrepreneurs who challenge the status quo are or will be handsomely rewarded.

      Yes, modern day slavery deployed by China today will yield high amounts of operational efficiencies that the business world may look at in envy (because it allows them to sell cheaper products and saves them money). But the gradual rise of the middle class in China will either force it to change economically (and become like us) or will make those who have made enough money to no longer accept suppression and leave China for the freedom they and their children aspire.

      So, China’s role in innovation that is applicable to the rest of the world will be highly dependent on its ability to free itself from its current dictatorship. But dictatorships are a great way to invent and deploy economic focus, the kind of (upstream) economic focus I would like to see our government deploy.

      China has too little freedom to build a renewable economy today (they may not need today), and we have deployed Neanderthal economic freedoms (we need to get rid off today) that built an unstable economy in which a financial system eleven times the size of production is deflating our ability to continue to drive meaningful socioeconomic value.

      The real question is which country will wake up to its macro-economic challenges first.