Tim Burroughs, 13 November 2017
Gary Rieschel, founding managing partner at Qiming Venture Partners, got his first taste of China VC while working for SoftBank in the 1990s. He recollected to AVCJ how the industry made its mark on a global scale
Q: How did you get into venture capital?
A: In the late 1980s, I met Masayoshi Son from SoftBank and we became friends. In 1995, when he was setting up SoftBank’s operation in the US in a more formal way he had the idea of running a venture capital firm. So we played a round of golf and after the round of golf I went to his room and it was filled with spreadsheets on his 100-year plan for SoftBank and part of that plan was a VC fund. During the course of that discussion he asked me if I was interested in running that and November 1995 is when I became a venture capitalist.
Q: What was the US investment climate like at that time?
A: Netscape had just gone public so you had a software product that could bring together all these various hardware components. For example, I had worked at Intel in semiconductors, Sequent in computer systems and Cisco in networking. All of a sudden there was software sitting on top of this, enabling those technologies to work in a more efficient way. It was right at that seminal moment of those things coalescing that we created the SoftBank Venture Capital Fund. It was pretty clear from the market dynamics that the internet was going to become a very significant trend, and because we took the approach that we were only going to do deals related to the internet, a couple of early investments made a big impact: USWeb, which founded by a group out of PwC and Novell; and the $108 million Yahoo transaction in March 1996. All of a sudden, everyone in Silicon Valley – much as they are today with the SoftBank Vision Fund, by the way – was saying, ‘Wait a second, who are these guys?’ At the time, the large VC funds were typically $200-300 million. There wasn’t really anyone e time who had put their flag out and said we want to be the largest internet investor, and that’s what SoftBank did.
Q: And China…
A: There wasn’t really any venture capital in China except for IDG and some other small pools of capital. I arrived in 1999 and helped Chauncey Shey set up SoftBank China Venture Capital, which was SoftBank’s corporate money. Then in 2000, right around the time the crash was happening, Cisco bought out SoftBank’s position in Cisco Japan – which was a joint venture I created while at Cisco – and as part of that deal it made a commitment of $650 million to the SoftBank Asia Infrastructure Fund, or SAIF Partners. I ran the fund for the first year and then hired Andy Yan to manage it on a formal basis. That was the beginning of what I would call the institutionalization of VC in China. In 2004, we helped launch Feng Bo at Ceyuan Ventures. He and his brother had been at NewMargin Ventures before that. And then in 2005, I moved to China and set up Qiming with Duane Kuang. At that point it was quite obvious that the institutionalization was going to occur and the opportunity China represented was roughly what the US represented. It was the first time there was a nether market where you could legitimately say that not just in one sector but across very many sectors the China market would be roughly the equivalent of the US for venture capital.
Q: How did the industry build momentum from there?
A: I would say that two things happened. First, some of the major US firms came into the market. You had NEA combining with Greylock Partners to do Northern Light Venture Capital. You had Sequoia Capital hiring Neil Shen. Andy had grown the SAIF platform, and IDG had started to expand. There were also a couple of IPOs: Tencent was in the market even though the market cap was relatively low, Baidu and Sina had both gone public. Alibaba had not but the Taobao launch had drawn everyone’s attention to the potential of e-commerce in China. People started to realize that China was going to bypass fixed-line infrastructure and the entire country would be built on mobile. That was the first wave, in 2005-2006. Over the next two years, the basic building blocks of the industry were put in place. Then in 2009-2010 the renminbi-denominated funds started to launch. The listing requirements had been relaxed and you had the Shenzhen board and the Chinext exchange, so there was liquidity in domestic currency. Coming out of that, you really had an explosion as China’s venture capital industry moved on to the world stage at a large scale – to the extent now that China does as much in a quarter as Europe does in a year.
Q: How difficult was it to raise capital in the early days?
A: We formed Qiming in November 2005 and closed our fund in January 2006. It’s hard to equate two-and-a-half months to a difficult fundraising. At the time, endowments and foundations were willing to take a bit of a risk on China as an opportunity without necessarily knowing which teams would be successful. The likes of Princeton and Harvard did 10-12 different funds. Now they all have far fewer because after seven years and multiple funds they could decide which firms they thought were structured to be around for the long term. What they were surprised by in that first wave was the amount of turnover, due to the tendency of funds to splinter off and everyone do their own thing. There was also the fact that Kleiner Perkins did quite a poor job in China. It caused a lot of US investors to say, ‘This must be harder than we think if someone like KP is having a difficult time.’ And then Sequoia’s launch wasn’t completely smooth. So there was a bit of a learning curve, but what the LPs also realized was that the companies being created had significant opportunities ahead of them – from the way users bases were growing, how e-commerce penetration was starting to take off.
Q: Were you surprised by the speed at which renminbi funds emerged?
A: I wasn’t surprised that there wound up being a large pool of domestic money interested in venture capital. What I think took everyone by surprise was when you talked to a large US institutional investor, they rarely told you that you aren’t deploying capital fast enough. But the renminbi funds had that cycle where you could invest 18 months before a listing, and Jiuding Capital and a number of other players piled into that very aggressively. You had IRR numbers that looked spectacular because the return on the IPO was 5x and your money was in the company for 12-18 months. As a result, the renminbi fund investors were constantly pushing us to invest faster. We used to joke that the US investors would say, ‘Steady, take it easy,’ and the renminbi investors would say, ‘Don’t miss the party.’ It has also taken a decade for there to be substantial institutional investors in the renminbi space. Qiming’s first couple of renminbi funds were 100% individual money and now they are probably 80% institutional money.
Q: To what extent has the market now become normalized?
A: The holding period for China funds, whether they are in dollars or renminbi, have now lengthened to be roughly the same as what the US institutions would have expected. People might tell you it’s a 10-year fund life but virtually no one is completing a fund within 10 years – it’s 12-15 years. Our average holding period at Qiming is probably now virtually the same as any top firm in the US. The renminbi funds went from three-year holding periods to six or seven years. They are normalizing to the traditional cycle of what it takes to get a business from small stage to a meaningful stage and then to an exit.
Q: Meanwhile, the opportunity remains large…
A: There is virtually nothing now in China that is untouched by technology and untouched by the kind of investments we are making. Liquidity has lagged in China relative to US funds and that creates a little anxiety. If you are a US institutional investor, your exposed allocation is higher than you originally expected. But the bigger picture is that the Chinese entrepreneurial community has expanded dramatically. It used to be you would struggle to find a great CEO. Now you have many people who are proven CEOs. The struggle moved to finding complete teams, but you can now do that as well. I think the industry is maturing at a nice rate, although in China things happen a little faster than elsewhere. And some groups have shown over multiple funds they can hold on to their key folks, which matters in venture. Since our holding periods are so long, it’s very difficult if you are invested in a company for eight or nine years and you have three different partners managing that relationship. It’s important that you can put the team together for multiple funds.
Q: Can M&A address the liquidity issues in China?
A: You used to have virtually no M&A activity in China. Now there is some, and ultimately there will be substantial activity. The attitude of the Chinese entrepreneurs used to be, ‘Why should I pay you to do this when my team can replicate what you’ve done in six months? I don’t have to buy your company.’ But as the likes of Tencent, Alibaba, Baidu and JD.com have expanded rather dramatically they have realized that they can’t necessarily do everything. The other big change is the expectation of the consumer in China. When I first came to China 18 years ago to look at venture capital, consumers expected something that was just good enough for China, which meant it was probably not at a world standard. Today, consumers don’t accept that. If you are buying something in China you expect a service or a product to be at the same level as anywhere else in the world. It is no longer possible for even an Alibaba or a Tencent to say, ‘let’s do a cheap version of this, put it under our brand and people will accept it.’ That will not work. So, a lot of different factors have come together. We haven’t quite seen the reforms in the capital markets that we would like to see, and I think that remains the single biggest barrier to the China venture capital market being a virtual equivalent to the US market.
Q: Is China unique in that it can become an equivalent to the US venture capital market?
A: It’s something people talk quite a bit about now – they look to India and ask if it could replicate China. I don’t think so. I think that, for all the various social issues in China, the government has been able to mandate certain capital investments that make it very hard to replicate the model in any other country. The investment in physical infrastructure here has been rewarded to such an extraordinary degree. If you are starting a logistics company in China it’s all sitting there for you to take advantage of, and that wouldn’t be the case in virtually any other developing market. India has proven itself to be quite a challenge in terms of building out a robust infrastructure, whether it’s power, roads, water. So I don’t see it overtaking China. And then people talk about Vietnam – but that’s the size of a medium-sized Chinese province. There is really no other market on earth apart from the US that is completely self-sufficient in terms of sources of capital, investing capital and liquidity.
