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Why so many U.S. VC firms are holding back on startup investments in China

3:47 pm by | 0 Comments

china flag

Alibaba’s recently announced $16 billion IPO has VentureBeat reporters scratching our collective head: Why weren’t more U.S. growth funds involved in Alibaba’s rise to domination?

Alibaba has a hand in every game imaginable: Social networking, payments, travel, online commerce, and dozens more. Its own list of investments rivals that of any major VC firm.

But somehow, while one U.S. private equity firm (Silver Lake Partners) and Yahoo participated in the mega-giant’s funding, most American firms sat it out.

So, why? Why are U.S. investors squeamish on one of the most exciting investment opportunities on planet Earth right now?

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For many of the folks we spoke to, it comes down to an acknowledged lack of understanding about the Chinese startup market. It’s booming, but it’s hard to know the entire competitive landscape. It’s hard to sniff out a good deal in a less regulated economy. Plus, China has a history of volatility, both socially and politically, that has put a bad taste in many investors’ mouths.

As Upfront Ventures partner Mark Suster told VentureBeat, “Of course, there are amazing opportunities for great investments in China. There are also great returns to be had in Brazil, Turkey, Nigeria, etc. But each market requires knowledge of local entrepreneurs, ethics, trading practices, legislation, governmental structures, exit markets, etc.

“It’s hard enough to be a great investor when you completely understand the landscape. Stray outside your boundaries with caution. The great investors build great local and international teams. We’re focused on what we’ve done well with for 17 years – U.S. and Europe.”

For others, the skittish attitude toward Asian investments is based on something between one-off personal experiences and passed-down horror stories.

One investor we spoke to told us he made a single investment in China; in order to get his money out of the deal, he had to engineer a reverse IPO for the startup. Another individual was convinced not to invest in China because of a tip that Chinese entrepreneurs in general were deceptive — advice that comes across as a mix of cautionary tale and casual racism.

Of course, this trend has notable exceptions. A handful of U.S. investments in Chinese startups have made our own headlines.

ByeCity, a Chinese outbound traveling service, announced in March that it has secured nearly $20 million in financing, in part from Jafco’s Asia arm. An unnamed American VC helped pump $25 million into pet-focused company Boqii, and social marketing service Kmsocial raised tens of millions in February, with participation from Fidelity Growth Partner’s Asia office. Also, mobile game portal Joyme took in a $21.5 million round led by BlueRun Ventures earlier this year.

And a handful of megafirms have their own operations in Asia and make frequent investments in China — Mayfield Fund, Khosla Ventures, Kleiner Perkins, and Sequoia Capital, to name a few.

Still, other firms tout the risks of investing in Asia, both in private and public companies. From Matthews Asia:

Investments in Asian securities may involve risks such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in emerging markets involves different and greater risks, as these countries are substantially smaller, less liquid and more volatile than securities markets in more developed markets.

But the sword doesn’t cut both ways apparently. Some harder-to-fund startups are finding gold in China’s hills. According to a report from research firm CB Insights, Chinese firms (and larger companies) are investing in U.S. startups at a record rate.

From the report:

Between 2007 and 2013 year-to date, China and Taiwan-based investors participated in over 150 deals totaling $2.6 billion. … Among the recent tech investments involving big money from China-based investors are Fab.com’s $150 million Series D in June (Tencent), Quixey’s $50 million Series C (Alibaba Group), and JustFab’s $40 million funding led by Hong Kong-based Shining Capital Management. With Alibaba forming a venture arm to exclusively invest in the U.S. market and Tencent already investing across the maturity spectrum from Fab’s round at a $1 billion valuation to seed deals, it appears that the rise of Chinese investors in U.S. startups is only getting going.

Returning to Alibaba, Homebrew partner Hunter Walk said, “When there’s such tremendous value created, some investors might look backwards on missed opportunities (maybe the chance to have sold a company to them for stock, etc.), but [Chinese investment is] probably more a topic of discussion going forward for some of the larger global investors.”

In the meantime, Yahoo, which owns a 40 percent stake in the Chinese giant, will see a huge payday when the IPO happens — which will be as soon as possible, according to Alibaba’s S-1 filing.

This article originally appeared on VentureBeat

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