Monday, 17 September 2012

But what’s it really like to set up in China?

By: Joram Sengendo (Summer Analyst) 

In my last post, I considered why western investors and start-ups should place China at the forefront in their overseas expansion plan; now, let’s look at what it is like to set up there. There are several characteristics of the start-up scene in China that differentiate it from any other region in the world. These are summarised as follows:

       1.     There is a need for the older generation within management
Kevin Dai founded Comsenz in 2002 as a software company tasked with providing solutions to the inefficiencies introduced when blogging and community sites integrate several complex features within themselves. In speaking about his early days in the company, Kevin spoke of the importance of hiring older more experienced senior managers in order to sustain expansion of the company. This is because China is a traditional hierarchical society, and young people are expected to defer to the older generation and not to be their bosses – even in start-ups!

2.     Labour costs are relatively lower than those in Silicon Valley and Europe
China’s labour costs are still significantly lower than those in USA and in Europe, which would prove to be especially beneficial to young start-ups that require just as much talent as Silicon Valley, but have much fewer resources. For example, the mobile antivirus application maker TrustGo has 4 employees in US and 40 in USA where software development is done.

3.      People do not pay for software
Companies such as Microsoft which depend on selling their software would find it difficult to survive in this market. The young Chinese internet users very rarely give up their money to buy original software, but will spend their money on physical goods and online games. It is these two latter revenue streams that start-ups should plan to depend on, in addition to other more creative sources.

4.      Competition is more than fierce – it’s incredibly brutal
This point is especially illustrated when one considers the fact that there exist anywhere between 3000-5000 Groupon clones in China alone. With every new and profitable revenue model developed anywhere in the world, one can be certain that it shall be mimicked in China.

5.      Setting up a company in China is extremely difficult
Incorporating a company in China is very difficult, especially for foreigners, and for companies hoping to raise funding in dollars. For the latter, other than QLFPs the most recommended method for raising dollar funds is through Variable Interest Entities (VIEs). This involves setting up a company in the Cayman Islands that controls a subsidiary in Hong Kong, that controls a foreign subsidiary in China, that controls a local subsidiary in China. A start-up also has to acquire the Chinese Internet Content Service Provider licence and must set up trusts for employees in order to grant employee stock options.

6.    Start-ups are deprived of online developer services and technology-infrastructure is outdated
There are several services which are taken for granted in the West, such as AWS, Heroku, Sendgrid, Twilio, Brain Tree, GitHub and Google Apps that are not available in China. In China, start-ups must manage their own hardware and may even have to build their own email servers.

       Furthermore, several Chinese start-ups are still on .NET and php while most start-ups in the West are fully utilising Ruby on Rails and Node.js for Pc internet development. This is not as problematic for mobile internet development where Google and Apple have standardized their development tools through Android Developer and iOS-XCode.

7.     Beijing is the hottest start-up spot …
Beijing has a brilliant talent pool and its main start-up hotspot, Zhong Guan Cun, is located next to China’s finest universities: Peking University and Tsingshua University. These advantages have made it 10 times bigger than its closest rival Shanghai.

8.    … but Shanghai has better deal-flow
Shanghai is China’s financial capital and this fact is not lost to VCs and Private Equity who have set up shop in the city. If start-ups are looking to deal flow, they shall have to set up a base in this city.

9.      The China VC market is very large
With the Chinese economy performing so strongly over the past decade, VC fund have grown extremely large making China the second biggest VC market outside of the USA. While the money is plenty, start-ups shall have to acquire the right connections to access these funds.

10.     The local start-up mentality places low chances on their company’s acquisition
Because intellectual property law is still in its infancy in China, start-up ideas are very easily stolen and mimicked by large established players. As such, the mentality of most start-ups is to focus on sustaining their company towards an IPO, or on maintaining the business as a lifestyle choice. 

      Both these opinions reveal that Chinese start-ups do not place much faith in big payouts through acquisitions, and even IPOs may be muted due to the threat of mimicking one’s products and services. This also has several implications with regards to employee remuneration: in China, employees seem to prefer big salaries over high equity, and are in many times more willing to work for large established names than to work for start-ups. The latter is also because Chinese culture is one that favours stability, and the older generation tends to push younger graduates to avoid the risk of a start-up job.

11.     Incubators tend to house start-ups for much longer than would be expected in the West
This fact is a result of the Chinese culture, which dictates that adults should live with their parents until marriage. In this case, the incubators are in a sense the parents of the start-ups, and it is common place to meet teams of 30-40 people that are still housed in the incubators that they were conceived in.

12.     Chinese talent seeks respectable working environments despite the start-up’s age
While US start-ups are more than comfortable renting out garages and scrappy offices in their infancy, start-ups in China have to be a lot more conscious about their appearance and the buildings in which their offices are housed. Chinese engineers do not want to work in home offices or scrappy surroundings, which forces start-ups of any age to hire out beautiful offices that would be expected of more established companies in the West. Chinese talent is also well known to have a high turnover, which is driven by the benefits and packages offered by competitors. With the wealth of opportunities in China and the need for qualified talent, companies are very worried about hiring while most employees are not worried about getting hired.

13.     Chinese New Year is the time to quick, and the time to get hired
The Chinese New Year has become the time to quit because most bonuses are paid out at this time, after which opportunistic employees leave their firms. On the flip-side, it is also the time to get hired because several openings suddenly become available for new recruits!

14.     There is a lack of good management in China
China is still an emerging economy and its business environment still shows many signs of infancy. One of these signs is poor management of businesses on the continent. This affects not only the small start-ups, but several other large established companies. One recent example is that of Sina Weibo, which accepted too many short-term debtors in a famous case of Working Capital mismanagement.

     Why not join us at our upcoming place4BRICs networking event to discuss your interests and the opportunities in China and other emerging markets.

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