How To Invest In Chinese Startups Like A Pro
When it comes to early stage investing, the funding environment in Hong Kong has traditionally been dominated by a small number of property developers such as Horizons Ventures and a handful of angel investors. This should come as no surprise considering the majority of the wealth in the city was created from property investments.
The tide is turning however, with a fresh crop of “rising star” VC firms making waves in the ecosystem. One of the most notable VCs in Hong Kong is David Chang, who runs MindWorks Ventures. I had the opportunity to sit down with him after his firm made headlines, first after leading the Series A round of LaLaMove last year (on the short list of becoming Hong Kong’s first unicorn), and most recently after co-leading a seed round with Alibaba’s Hong Kong Entrepreneur Fund into Qupital (both investors’ very first fintech investment in HK).
Chang is no stranger to early-stage investing. His father was a well known venture capitalist in Silicon Valley who used to be colleagues with Arthur Rock, the man who grandfathered of the term “venture capital” after he backed the so-called "traitorous eight" of Fairchild Semiconductors in the 1950s.
Chang did so well that within a couple years he was approached by a UK-based group of ultra high net worth family offices who wanted to have exposure in Asian technology startups. Getting access to deals, particularly in China, is a very painful process that is oftentimes completely closed off to outsiders. MindWorks presented the perfect solution of being a professionally managed entity with deep access and exposure to China, while being domiciled in Hong Kong, which ensured no restrictions on capital control.
Early stage investing in China
Startup investing is extremely connection-based and cliquey in China, much more so than Silicon Valley. Access to great deals is limited to members of a very tight circle and the preferred medium for interaction is Tencent’s messaging app WeChat.
Here’s how it works: One of Chang’s old corporate clients from his investment banking days was a Chinese software company called Kingsoft. Chang spend a lot of time cultivating relationships with a number of the C-suite managers while doing banking work for them. Over time, these C-suite managers would go out on their own to start new technology companies and would naturally tap their existing network of connections first to seek funding. It’s a very similar concept to the PayPal Mafia and proves the power of a strong network. In China, things can change overnight and connections can make all the difference when it comes to getting access to the best deals.
Investing advice from a professional
Alright so let’s say you don’t have the deep personal connections but you still want to get involved. The first rule, Chang says, is if you’re going to do early stage investing, leave your money with a VC firm. I can vouch for this personally given my experience flushing my own money down the toilet trying to pick the next unicorn. Leave it to the professionals who do it for a living and you will dramatically improve your chances right off the bat.
Second, always consider the potential market before considering an early stage investment. As a an early stage investor the returns you are aiming for should be anywhere from 100 - 1,000x. This is why it is critically important to consider the size of the total addressable market (TAM) before anything else.
“Take the presentation and start from the last page. Look at how big the market size is. If that number is big, then we can start talking. Always look at how big the market size and work in reverse order,” advises Chang.
Many companies you screen have great founders, good cash flow but are uninvestable due to the return profile. If all you aim is to make a modest double-digit return on your investment, there are many other less risky asset classes out there. A final piece of advice that Chang takes from his own firm’s playbook is to avoid the seed stage if at all possible.
“We want to basically off-load the risk to these earlier stage investors in the market, which we see as being extremely overcrowded. People see phenomenal companies growing from seed investments, but that is probably one out of 10,000 companies,” says Chang.
That all said, the best opportunities still exist in China due to the sheer size of the market. Chang is still very bullish on China but understands that Chinese investors are getting increasing smart and savvy now, which has driven valuations up across the board. Be patient and allow some of these companies to reset and actually realize revenue before jumping in as an investor.
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