Next-gen start-ups now stamped 'Made in China'

Ma Huateng recently surpassed Alibaba’s Jack Ma (pictured) as China's richest man, according to Forbes’ billionaires list.

Backed by smart money, mentors and the state, China’s aspiring tech entrepreneurs are channelling their inner Jack Ma.

Updated 9 August 2017.

A double espresso from 3W Coffee will kickstart most people’s working day, but many patrons of this Beijing-based cafe are now looking for cash, not caffeine, to give their careers a boost. China’s recent start-up craze means this popular coffee shop has become one of the most fertile meeting places for entrepreneurs and investors involved in the capital’s high-tech sector.

Today, it seems as though every other young Chinese is a Jack Ma or Mark Zuckerberg wannabe. Embracing China’s entrepreneurial Zeitgeist, which has been deliberately stoked by Beijing, these young men and women are increasingly rejecting China’s traditional career paths to seek independent fortune.

It is in Zhongguancun, a neighbourhood in the north-west of Beijing, that many of the city’s tech-focused entrepreneurs choose to congregate. They are drawn to a complex web of “makerspace” coffee shops such as 3W Coffee, backed up by an increasingly well-developed support network of incubators, accelerators, venture capital (VC) firms and angel investors.

Related: Ma Huateng recently surpassed Alibaba’s Jack Ma as China's richest man, according to Forbes’ billionaires list

Today, Zhongguancun’s increasingly mature start-up ecosystem is being replicated to varying degrees across China. This has led to a rise in innovation and marketability among many of the country’s newly founded tech businesses.

“Rather than venues for brainstorming, these are places where start-up stakeholders regularly meet, talk shop and even do deals.” Thibaud Andre, Daxue Consulting

“We are seeing more locally conceived solutions for local challenges,” says Thomas G. Tsao, managing partner and co-founder of Gobi Partners, a leading China-focused VC firm.

“Many new Chinese start-ups are now well suited to the international market. It demonstrates a coming of age.”

Optimism outweighs market volatility 

The burgeoning promise of China’s e-commerce sector, underpinned by the country’s army of smartphone users and an increasingly populous and wealthy middle class, has recently seen investors falling over themselves to fund the next Alibaba or Chinese Uber. Alibaba’s mammoth US$25 billion initial public offering (IPO) last September intensified the investment rush.

Hong Kong-based AVCJ Research estimates that nearly US$16 billion was pumped into Chinese tech start-ups in the first eight months of 2015, up from US$3.8 billion over the same period in 2014. According to New York-based CB Insights, China is now home to 21 “unicorns” – start-up companies valued at US$1 billion or more by VC firms. Smartphone manufacturer Xiaomi, which launched its first phone as recently as 2011, tops the list, with a current valuation of US$46 billion.

In the face of these record-breaking numbers, some analysts offer words of caution. China’s recent stock market volatility and ongoing economic uncertainty already appear to have slowed investment over the past few months. According to Chinese financial data provider China Venture, VC funding for internet companies dropped 50 per cent in the second quarter of 2015 to US$3.7 billion.

Related: Why China now leads the way in innovation

Despite the apparent downturn, most people involved in China’s tech start-up scene remain bullish about growth, downplaying any talk of bursting bubbles.

“Some Chinese unicorns seem overvalued, but many of them are built on solid business models and have further growth potential,” says Trey Zagante, founder of Asia-Pacific based investment and advisory firm Venturetec.

“I expect some slowdown in the Chinese tech sector over the next 12 to 18 months, but long-term prospects are still good.”

Gobi Partners’ Tsao notes that valuations have begun to correct themselves following China’s recent domestic stock market turmoil.

“This represents a ‘deflation’ of the valuation bubble, rather than a ‘popping’,” he says.

“This market correction will bring about a healthier start-up environment.”

Beijing’s nurturing strategy

China’s leaders know that innovation is central to the Chinese economy’s transition away from mass-market manufacturing toward high value-added industrial sectors. Beijing hopes that, by whipping up start-up fever, it can boost creativity, entrepreneurship and job provision.

Today, Chinese television regularly champions innovation and tech entrepreneurship. Chinese Premier Li Keqiang has made numerous visits to start-up cafes, calling for ministries and local governments to “ignite the innovative drive of hundreds of millions of people”. 

This kind of rhetoric is already taking effect. In the first four months of 2015, a slew of Chinese provinces and municipalities – including Hubei, Shanghai, Jiangxi and Qinghai – introduced tax incentives and stipends to help college students with start-up ventures.

In January 2015, Beijing announced plans to establish a US$6.5 billion VC fund to help seed companies in emerging industries, including innovative tech start-ups.

“Beijing is now employing a whole raft of measures to support China’s high-tech industrial development,” says James Ji, a consultant with Hong Kong-headquartered Sino-Bridge China Consulting Ltd.

“The government knows that funding a tech start-up is a high-risk business. By reducing the risk, it hopes to encourage more of the private investment essential for growth.”

Related: 下一代创业企业将尽显“中国制造”本色 (Chinese version)

Collaborative approach reaps success

Compared with the US, where tech start-ups are largely concentrated in California, the picture in China is much more fragmented.

Beijing’s efforts at encouraging entrepreneurship have seen high-tech zones mushroom across the country. Start-ups based in the most developed areas typically enjoy high-speed internet, generous government funding and access to start-up incubators and software engineers.

“Clearly, some of these high-tech zones are already hubs of innovation, while some are underdeveloped,” says Reid Wang, another consultant with Sino-Bridge China Consulting Ltd.

“Most of the highly successful ones are distributed along China’s southern and eastern coasts.”

The principal vehicle for Chinese high-tech zone creation has been the Ministry of Science and Technology’s Torch Program, which also provides funding, establishes incubators and supports VC firms. Formerly criticised for its scattergun, heavy-handed approach, it has gradually reformed itself into a considerably more successful initiative.

“All along, Chinese tech start-ups have been crying out for ‘smart’ capital,” says William Bao Bean, managing director of Chinaccelerator and an investment partner at SOS Ventures, a global VC firm with offices in Shanghai, Shenzhen and Hong Kong.

“In the past, China’s high-tech zones would simply gather established brands together and offer tax breaks. Now we’re seeing government funds increasingly collaborate with entrepreneurs and investors looking to put their own money into select start-ups. It’s a far more effective way of nurturing profitable innovation.”

Zhongguancun rising

In China, different industrial sectors are concentrated in different geographical areas. These differences are reflected in local high-tech zones and the nature of their start-up support.

Known as the “Silicon Valley of Hardware”, Shenzhen’s numerous factories and design firms attract start-ups that need to develop hardware on a budget. This has seen the local growth of hardware incubators and accelerators, such as SOS Ventures’ HAX accelerator.

Rising property prices and labour costs have seen many would-be entrepreneurs shift their focus to rising second-tier cities, such as Chengdu. With a plentiful supply of local talent, the Sichuan capital is rapidly gaining a reputation as the best place in China for gaming-related start-ups.

Yet it is Beijing – and more specifically the area of Zhongguancun – that perhaps shows the greatest similarity to Silicon Valley. With start-ups based here primarily involved in the technology, media and telecommunications (TMT) sector, it was said to have generated 49 new ventures a day in 2014.

"Many Chinese start-ups are now well-suited to the international market. It demonstrates a coming of age." Thomas G. Tsao, Gobi Partners 

Starting life as a mishmash of electronics shops, Zhongguancun is today home to tech heavyweights, such as search engine Baidu and computer manufacturer Lenovo, as well as the head office of Xiaomi. Around a third of all China’s venture capital investment takes place here, while government figures show that revenues from the Zhongguancun Science Park – which became China’s first National Innovation Demonstration Zone in 2012 – were up 10 per cent to more than US$240 billion in the first half of 2015.

Like other high-tech hubs, Zhongguancun needs access to capital, which is where the coffee shops come in.

“Cafes such as 3W Coffee play an important role in Zhongguancun’s start-up environment,” says Thibaud Andre, a consultant with China-based Daxue Consulting. 

“Rather than venues for brainstorming, these are places where start-up stakeholders regularly meet, talk shop and even do deals.”

Bringing knowledge back to China

In the past, China’s ability to develop fully-fledged, Silicon Valley-style start-up environments was hampered by several factors. The country’s education system, still largely based on rote learning and exam preparation, does little to engender genuine creative thinking. A lack of experienced mentors also made it tough for nascent tech start-ups to gain traction. 

The growing role of the Chinese overseas returnee within China’s tech sector has helped to mitigate both these problems. Armed with a range of invaluable skills, many have founded their own start-ups, while others provide mentorship and funding. According to Beijing-based think tank the Center for China & Globalization (CCG), 70 per cent of Nasdaq-listed Chinese high-tech firms have been founded, or are headed up, by such repatriates.

Tech start-ups have also been helped by the rise of China-based angel investors. Today, a growing number of independent venture capitalists are turning to earlier-stage funding as they seek to add value and avoid the crowded growth capital space. According to financial services firm Zero2IPO Group, such investors completed 766 deals in China in 2014, up more than 350 per cent on 2013.

“China is now home to a growing community of serial entrepreneurs who are actively investing in the next generation of start-ups,” says Rui Ma, a partner at US-based 500 Startups, an early-stage seed fund and accelerator program.

“They bring an increasing amount of value to the table.”

“The most successful angel investors embed themselves within the start-up ecosystem, build a strong reputation for adding value and offer founder-friendly investment terms,” says Venturetec’s Trey Zagante. 

Providing money, structure, education, mentorship and access to business networks, accelerators and incubators is a key element in every start-up ecosystem. Together with angel investors, they are frequently the first entities to offer start-ups funding. According to Chinese Government figures, there were 1600 tech incubators in China by the end of 2014.

While the best Chinese incubators and accelerators boast strong networks of mentors and investors, many lack depth and structure, operating more as community hubs and co-working spaces.

“It is essential for Chinese accelerators and incubators to bring on board the right management and mentors to guide start-ups properly,” says Gobi Partners’ Tsao.

“Some offer start-ups support when times are good but are nowhere to be seen during a market downturn. 

“In the short term, I think we’ll see the culling of some players, but those that remain will be more professional.”

Incentives for growth

In terms of disruptive innovation, China still has a way to go before it is home to one, let alone multiple, Silicon Valleys. Likeany start-up, its high-tech zones and communities will naturally evolve toward their optimal state or will fail and have to try again.

With direct access to China’s legions of digital consumers, Chinese “techpreneurs” have the will and incentive to keep pushing the boundaries of innovation. This, coupled with an increasing amount of expertise, creativity and smart money, should see the number of Chinese unicorns continue to grow. 

November 2015
November 2015

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