Friday, November 04, 2005

Feeding the mouth that will bite you.

November 4, 2005
VC Nation
Excited and Wary, Investors Look at China



WHEN Joe Schoendorf, a Silicon Valley venture capitalist, was in Shanghai a few years ago to hear a pitch from a Chinese start-up company, he sensed something familiar. He interrupted the meeting, walked to the window and pulled back the curtains.

"What are you looking for?" he remembers the would-be entrepreneurs asking.

"I just wanted to make sure I was in China and not back in Palo Alto," he responded.

China's high-technology community, with its brains and competitive spirit, is probably more like its counterpart in Silicon Valley than any other in the world.

Yet Silicon Valley's views of investment in China have tended to swing between wild optimism and deep anxiety - with the anxiety going beyond a fear of losing money. Some worry about helping Chinese start-ups move up the technology food chain.

These days, the Valley venture capitalists are sharply divided in two camps: one rushing into China and one holding back.

"The Valley is excited and it's scared at the same time," said Richard Shaffer, editor in chief of VentureWire, a venture capital newsletter publisher.

The dominant perspective is that China is a vast sea of opportunity, from its low-cost skilled labor pool to its enormous consumer market that is more than one billion strong.

In fact, it is now routine for venture investors to demand that their start-up firms place the bulk of software development and manufacturing efforts in China or India. (A supply chain problem at a manufacturing arm in China, however, can easily ruin financial results in any given quarter.)

For China skeptics, the concern is that American investment will help energize a formidable competitor, which could come to dominate both markets and technologies.

The fear is based in the Valley's complex relationship with China as supplier, partner, customer and competitor. Most venture capitalists say this evolving relationship will define the future of the Valley and maybe even technology development in the United States.

The Ningbo Bird Company is one case in point. It went from being a contract manufacturing supplier for Motorola to being a serious rival in the Chinese handset market in a matter of a few years.

Still, last year, most of the Valley seemed to throw caution aside as venture firms invested nearly $1.3 billion in China, up nearly 30 percent from 2003, according to Zero2IPO, a venture capital research and consulting company based in Beijing.

But in the first half of this year, investment slowed drastically after several changes in Chinese securities regulations. Those new rules caused "a decline of 50 percent in the first two quarters," said Dixon Doll, managing director of Doll Capital Management, based in Menlo Park, Calif.

The lull is ending, though, in part because of the high-profile success of the initial public offering of Baidu, a Chinese search engine company that was able to raise $86.6 million in August, and a securities rule change in October. In September, Sequoia Capital, a major backer of Google, was reported to be planning a $200 million fund and hiring several employees in China.

That announcement followed an earlier joint agreement this summer by Accel Partners, a leading Silicon Valley firm, and the International Data Group to set up a $250 million fund.

There have even been reports recently that Kleiner Perkins Caufield & Byers, the Valley's highest-profile venture firm, was creating its own China fund, though people briefed on the firm's plans said that was not true. While Kleiner has recently added Colin L. Powell as a partner to serve as a "rainmaker" in Asia, it remains concerned about changes in Chinese security laws that could complicate the return of investment funds to the United States.

Mr. Schoendorf, who is an Accel partner, sees benefits in helping China to become a fierce new competitor. He likens this moment of anxiety and promise to the 1970's, when Japan began to compete successfully with the United States.

"The Chinese graduate more engineers than we do," he said. "They're smart, they work hard, and so the only way to compete with them is to remain more innovative."

Copyright 2005 The New York Times Company


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