Case Study: StartUp Capital Ventures

Entering the Chinese Venture Capital Market

John Dean, the Managing Partner of StartUp Capital Ventures (SCV), settled back into his seat as his flight took off from Beijing to San Francisco. He and Danny Lui, a Partner at SCV who knew the Chinese market well, were returning from a meeting with Gavin Ni, the CEO of Zero2IPO, a market research firm focused on the Chinese venture capital market. Although Zero2IPO was a solid investment target for SCV, the business model had some noticeable shortcomings. John and Danny were looking at it closely in part because of pressure from Charlie Eubanks, one of SCV's anchor investors.¹ Eubanks recently told them that he would not provide the capital needed to close SCV's first fund unless the firm committed a substantial portion of the portfolio to China.  If Eubanks pulled his money out, John envisioned other investors quickly becoming skittish. John and Danny considered how to handle the ultimatum. Given that SCV was relatively small by design, the first investment had to be a homerun in order to validate the firm's strategy and set their team up to raise a successful second round. On the other hand, the Chinese VC market had grown extremely competitive over the past few years. VC firms had flooded the region with capital. It had quickly become difficult for U.S.-based investors, especially of smaller funds, to find a desirable deal at a reasonable valuation. While they doubted that an investment in Zero2IPO would ever be a failure, they wondered whether a lackluster return would be an equally risky outcome at this juncture.

China is one of the oldest continuous civilizations in the world, with organized society existing for more than 10,000 years. While the country has a complex and dynamic past, the scope and pace of change in China within the past 30 years have been unprecedented in the nation's long history. Following Mao Zedong's death in 1976, Deng Xiaoping became the country's new leader. Deng had played a central role in establishing the pragmatic economic policies that preceded the failed Cultural Revolution, and he was committed to repairing and reforming China's economy.³ By 1979 he had largely reconsolidated the Chinese Communist Party's (CCP) power and began driving reforms in agriculture, trade and investment, China's state- owned enterprises and its government institutions.

John's team also planned to fi11 a niche market in which early-stage technology companies sought more funding than was typically provided by angel investors, but less than was attractive for large VC firms (that usually wanted to make a minimum initial investment of $7 million or more). Yet, SCV offered many of the same benefits to Chinese entrepreneurs that larger VC outfits did, including:

•  A channel to foreign markets and portfolio companies

•  Experience building global companies

•  The ability to improve corporate governance

•  Guidance on an attractive exit strategy

•  General business management expertise.

Case Study ‘StartUp Capital Ventures’

Answer all of the following 5 questions:

1. What does a VC firm need to consider as it enters a foreign market such as China? What are SCV's strengths and weaknesses as it looks at the Chinese market?

2. Assess the venture capital market in China versus today. Is it becoming a more or less attractive market for investors?

3. Should SCV invest in Zero2lPO? Why or why not? If SCV invests — under what terms should John and Danny make their offer?

4. Would you advise John Dean to take capital from Charlie Eubanks? Why or why not?

5. Think about the importance of the first investment of a new venture fund. Is the first investment more or less critical if the fund has yet to close (i.e. it is at its early days)?