Recruiting in China

Report on VC investment in China in first half of 2006 sees more money chasing deals.

July 12, 2006

Beijing—Venture investment in China in the first half of 2006 nearly doubled to $772 million compared to the same period in 2005, according to a new report.

The report, released by Zero2IPO, a Beijing-based venture capital research firm, at the China Venture Capital Semi-Annual Forum 2006 on Tuesday, found that 121 Chinese firms received venture investments, an increase from the first half of 2005 by 49 percent.

The number of firms, however, also represents a 17 percent decline from the 147 firms that landed venture funding in the second half of last year. Still, total venture investment has risen 5.4 percent over the second half of 2005.

“Valuations are up, and the average deal size is now $6.2 million, up from $4.2 million last year—an increase of almost 50 percent,” said Zero2IPO CEO Gavin Ni.

But Mr. Ni called this trend a “low-grade fever,” not a clear valuation bubble.

‘Things may get even hotter.’
-Rocky Lee,

Eleven new China-focused funds were raised during the first half of the year, with an average fund size of $90 million.

Non-Chinese funds continued to dominate, with 71 percent of projects funded by non-Chinese venture firms. Eight-five percent of total venture investment came from dollar-denominated funds.

The Lion’s Share

IT firms continued to win the lion’s share of funding with 84 IT companies receiving $562 million in venture backing in the first half of the year, representing 69 percent of the total number of venture-invested firms and 73 percent of the investment dollars.

The Internet sector in particular attracted the largest number of investments and greatest total amount of venture funding. Thirty-nine Internet companies were funded in the first half of the year, with $276 million dollars invested.

“During the first and second quarters, we saw some very aggressive plays by investors, especially in the web 2.0 space, with high valuations that some of the VCs are now having second thoughts about,” said Rocky Lee, a Beijing-based venture and private equity attorney at DLA Piper Rudnick Gray Cary.

“There seems to be a return to a focus on business models, revenue models, and other fundamentals,” he added.

Telecommunications followed IT, with 18 projects receiving $152 million. Eleven integrated circuit companies drew a total of $50 million, and seven software companies were funded for a total of $42 million, the report said.

“This was something of a surprise to me,” said Mr. Ni. “I had anticipated that there would be more non-TMT [technology, media, and telecommunications] deals in the first half. But the non-TMT deals tend to take longer, and we expect they will make up a greater percentage in the second half.”

Beijing Leads Shanghai

Beijing-based firms accounted for 51 percent of the received investment dollars and 40 percent of funded companies. Shanghai trailed with 20 percent of the investment dollars and 29 percent of the companies.

Fifty-eight firms—69 percent of firms attracting funding—were early-stage startups, pulling in a total of $241 million for an average of $4.1 million per project, said Mr. Ni.

Rules issued by China’s State Administration of Foreign Exchange (SAFE) in April and July scared off overseas venture investors in the first half of 2005. But with the repeal of the SAFE regulations in October, VC money gushed back in.

“A number of VCs are doing larger and larger deals,” said Mr. Lee. “This might be driven by higher valuations, or it might be because the target companies have to have larger war chests in this increasingly competitive environment.”

“In the second quarter alone, we closed eight venture deals,” said Mr. Lee. “We helped deploy almost $100 million in that quarter alone.” With new opportunities related to third generation (3G) applications now heating up, he added, “things may get even hotter.”