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China’s venture-capital industry fuels startup boom

CHINA

'China speed': Venture capital fuels a startup boom

Commuters ride past a large group of ride-share bicycles at a distribution area during rush hour in Beijing.

Startup enterprises in China are experiencing a level of investment like never before. The fear of missing out on the next big thing has given life to businesses such as Lin Bin's bike-sharing service, Kala Bike, among others. As a rush of new ideas gears up to make it to market, Nathan VanderKlippe reports on the cycle of funding that has made the country the second-largest venture-capital industry in the world

By the time Lin Bin made his first order for bicycles this January, he knew exactly where he stood relative to his competitors. He was hopelessly behind.

In cities such as Beijing and Shanghai, much bigger companies were buying bikes by the tens of thousands, stocking sidewalks with armadas of brightly coloured rides that could be rented for 20 cents an hour. The bike-sharing craze rocketed market leaders Mobike and Ofo to $1-billion (U.S.) valuations in months. By the end of this year, investors expect nearly 10 million shared bikes will have sprouted on Chinese streets, an Internet-age echo of the time Beijing roads, before they became dominated by cars, were thick with bicycles. Now, though, people locate a ride with a smartphone app, which they use to unlock it and then, at the end, pay electronically.

With money from a classmate, Mr. Lin ordered just 5,000 bicycles, painting them in sky blue to stand out against competitors when they arrive in Putian, his home city in southern coastal Fujian province.

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"There is no need for us to fight for number one, but we could work hard for number four, no?" Mr. Lin said. "Fourth is not so bad."

In a country where business ideas quickly become business stampedes, he is far from alone. At least 20 bike-sharing companies have emerged in China seemingly overnight, each adding its own bright colour to what is now a veritable rainbow of shared pedal power.

A worker from bike share company Ofo puts a damaged bike on a pile at a makeshift repair depot for the company where thousands of derelict bikes are being kept after coming off the road.

It's not just bicycles: More than 200 Chinese companies leaped into the electric-car business. A rush to deliver health advice on phones brought out some 2,000 mobile health apps, three of which were valued last year at above $1-billion. In a similar craze for beauty apps, China's Meitu, which allows users to quickly beautify selfies, went public late last year at a valuation of $4.6-billion. There are signs the next wave will sweep up companies making virtual-reality products.

Behind each has been the volcanic power of China's venture-capital industry, the second largest in the world, as the country's fast-moving entrepreneurs set about finding new ways to get rich, encouraged by a national government looking to push the economy away from reliance on the coal, steel and concrete industries that powered its rise.

Last year, Chinese venture capitalists invested $31-billion, three-quarters of the U.S. total, according to figures tallied by KPMG. And the sector has grown with extraordinary speed, tripling in size since 2014 alone (U.S. venture capital grew by just 20 per cent in that time).

Much of the money in China has come from larger corporate and private equity sources "that previously were investing in infrastructure within the mainland or within more traditional industries," said Cheung Ho Yeung, an analyst with management consultancy Arthur D. Little.

Looking for better prospects elsewhere, they have diverted some of their money and attention to startups, driven in part by "the phenomenon of not wanting to miss out," he said.

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Employees work at Meitu Inc.’s office in Hong Kong. Meitu, the Chinese maker of selfie apps, went public late last year at a valuation of $4.6-billion.

The Chinese government has added to the spending by creating enormous venture-capital funds that, in 2015, were estimated to stand at $330-billion by consultancy Zero2IPO.

It's a "herd mentality," Mr. Cheung said, "but I would say the fundamental reason is because most of these money managers cannot find better returns on investment anywhere else in China."

But speed is also among the more distinctive characteristics of China's business environment. In the time it takes other countries to discuss the merits of trains versus trucks, China has built thousands of kilometres of high-speed rail – 1,900 kilometres came into service last year alone. Though the Internet was late to flourish in China, Chinese online spending has now far eclipsed that of the United States; local buyers are nearly twice as likely to purchase groceries online as the global average. Cash is being replaced at immense speed by cellphone payments. Some 109 million people have emerged from poverty into wealth equivalent to the U.S. middle class in the span of a decade or two.

The convulsions of constant change have created a population more willing to embrace new things, one of the reasons China's digital economy has grown at such a fast rate, with a growing number of companies that are leaders in global innovation.

In shared bikes, for example, 18.9 million people used such services last year; in 2017, that's expected to leap to 50 million, according to China E-Commerce Research Center statistics reported in state media.

Electric automobiles sit connected to a charging station operated by Tellus Power Inc. at an underground parking lot in Beijing.

Indeed, "China speed" has become one of the Beijing's buzz words, promoting its ability to get things done, and fast.

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The upside is that never before have entrepreneurially minded Chinese had so much ability to finance new things. Chinese Premier Li Keqiang has boasted that last year, 15,000 new businesses opened in China each day.

The downside is that it's hard to be discriminating with so much money looking for a home.

"Venture capital is all about group psychology, and there is very little independent critical analysis among venture capitalists, especially today," said Shirley Lin, a former partner with Goldman Sachs who now teaches at Chinese University of Hong Kong. And, she added, "venture capitalists in China are particularly group-oriented."

The resultant distortions go beyond good money-chasing bad ideas. A cash-rich environment can also lend power to those with the biggest war chests, rather than those with the best concepts.

"When you have too much money in the system, the good guys get funded – but also the idiots," said William Bao Bean, a prominent venture capitalist in China. "And when everybody is funded, people start using money as a weapon."

Take food-delivery services, which have transformed how Chinese urban dwellers consume food – by ordering in rather than eating out or cooking at home. But in the battle for market share, companies have offered deep discounts, competing on their ability to buy customers.

A group of food delivery drivers line up as they prepare for work along a street in Beijing.

The result? "China's entire population of students ate 50-per-cent off for a year and a half, courtesy of venture capitalists," Mr. Bao Bean said.

China's bike-sharing companies, too, have courted customers with massive subsidies, making it often possible to simply ride for free.

In that kind of cash competition, eventually "everybody ends up dying except for the top two or three people," said Jeffrey Towson, a professor of investment at Peking University.

"It's like, who can suffer the most and take it," he said. "Whoever can spend the most and bleed the most survives. That seems to be a China thing."

On a small scale, that's what has happened with Mr. Lin's Kala Bike, which he founded last October. By December, he had cobbled together $118,000 (Canadian) in investments and, in the new year, placed an order for 5,000 bikes. By Jan. 25, he had 500 on the streets, a testament to the way China's manufacturing prowess can enable companies to race into business. Using WeChat, the Chinese social-media app that connects to a user's bank account and makes money transfer easy, he was also able to very quickly build an online platform for his service.

In the first two weeks, 2,800 people put down deposits and went on 48,000 rides – not a terrible record.

But after the first week, Mr. Lin started to notice something wrong. His bikes were disappearing, stolen by users, destroyed, repainted or ridden to distant places where they couldn't be located. On Feb. 14, Mr. Lin's main investor pulled out. The next day, five company staff went looking for their bikes. They failed to locate 76.5 per cent of them.

The popularity of bike shares has exploded in the past year with at least 20 providers now battling for market share in major cities across China.

By that time, users were clamouring to get back their security deposits, worried that Mr. Lin would steal their money. He sought to allay their fears by posting his own mobile phone number, and paid more than $40,000 out of his own pocket.

The negative publicity didn't kill his company, though. It saved it. In the midst of the storm, another investor came in, offering nearly $600,000. Kala Bike regained its footing. With help from the local government, it found about two-thirds of the missing bikes, and is back to delivering new ones to the streets.

Another competitor, Yong'an Xing, has now moved into town. But Mr. Lin said its arrival has spurred growth for his service. "We have very nice biking numbers," he said. "People are using our bikes 4,000 to 5,000 times a day now."

He's confident, too, that he can survive even if bigger services move in, and is already eyeing other markets for expansion.

"We have already settled on some target cities," he said. His first criteria: "It can't be a mountain city."

With a report from Yu Mei

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