Commentaries

Ex-Google China chief’s dream factory

Google’s former China head Kai-Fu Lee wants to create China’s next internet giant in a factory. He believes that by combining the smartest entrepreneurs, the shrewdest business people and the brightest business ideas, he will be able to create five highly sellable companies a year. That sounds like an ideal model for venture capital, but is he being realistic?

Lee’s plan, formulated while he spent time in hospital over the summer, follows a battle with Beijing regulators who wanted to censor Google  searches that lead to pornographic sites. It has drawn strong support from investors.   Lee has managed to raise $115 million in just one month, winning support from YouTube Inc. co-founder Steve Chen, as well as Foxconn Electronics, Legend Group, New Oriental Education and venture firm WI Harper Group.     They believe that as China embraces a start-up culture, Lee’s business, which is a mix of venture capital and development lab, will be well positioned to capitalize. Lee’s plan is to hire 100 to 150 young engineers, help nurture their ideas, then spin off 50 to 75 of them a year with funding from his venture, whiling hiring new people to make up for the loss.    However, it looks as if his company, called Innovation Works, has yet to line up ideas or engineers. This kind of “incubator” model became popular in the U.S. and Europe during the dot-com boom, but most of them just burned through a lot of money and then folded.   Lee and his backers believe that China’s market is more favourable, as it is at a crucial point regarding “cloud computing” and mobile technology, and there is a strong need for early-stage funding.   The new fund is still starting off, but Lee plans to expand from its base in Beijing to places such as Taiwan, the Asian hardware manufacturing base and his hometown.

Investors are attracted by Lee’s reputation as the single largest magnet for talent in China. Lee, who went to school in the United States, has won a loyal following from Chinese students through his numerous coaching books, public speeches and blogs, although critics say he has spent too much time promoting his personal brand.

An expert in speech recognition technology, he founded Microsoft’s China research lab in the late 1990s. When he left to join Google, Microsoft sued him for violating a promise not to join a competitor.

Nimbler local rival Baidu now dominates China’s search market with 75.7 percent in terms of total search queries, dwarfing Google’s 19.8 percent share, according to iResearch. At Google, Lee was caught between the Beijing authorities who insist that foreign web companies censor the Internet and his U.S. bosses who demanded he drum up more business in China.   He has wanted to break away from his corporate role to start his own company for a decade, but it looks as if he is stuck in the corporate mindset. Lee is adopting an almost a planned economy approach to an industry that has always relied on markets to determine who is the fittest to survive. Indeed, he is even promising to tailor-make companies for interested foreign investors.   A factory model lowers the risk for investors as they will enjoy more control, but that also means less incentive and ownership for entrepreneurs, since their roles are reduced to that of employees. Why would young people take their ideas to Lee rather than make a go of it themselves?    Unlike Silicon Valley, China does not have an ecosystem where start-up companies can easily find angel investors. Even though China is a hotspot for venture capital, with $50 billion chasing mid- to late-stage projects, less than $1 billion in total is earmarked for early-stage projects.

Lee prides himself on his doggedness in chasing after talent. One year while at Google he made offers to graduates, only one of which was initially rejected. He called the student, found out that his girlfriend thought Google was a bit of a start-up, then asked for his girlfriend’s number and called her up. That year he achieved a 100 percent offer acceptance rate.    Nevertheless, it remains to be seen whether Lee can retain his ability to attract and inspire the best young people now that he is no longer at Google. He needs a lot of them to make his dream come true.

Khosla’s bet on cleantech looks speculative

If the world is counting on innovative companies to solve global warming, we may be in trouble. Venture investment in cleantech is slumping. Venture capitalists in the US poured $2 billion into 139 cleantech start-ups in the first half of 2008, according to data from PricewaterhouseCoopers. In the first half of this year, venture investments in the sector plummeted to $513 million in 89 companies.

Of course, venture investment in general has gone off a cliff, from over $15 billion in the first half of 2008 to $6.8 billion this year. But it seems odd that cleantech, the new, new thing that VCs seek, has plunged more than the average.

Some of the slide can be attributed to a sensible response to economics. In the middle of last year oil was north of $120 a barrel. Today it’s $68. That makes alternative energy a much tougher economic proposition, whatever one believes about the importance of reducing carbon emissions globally. What about government regulation to make alternatives more attractive? Drive east on I-580 from Silicon Valley and you’ll get to the Altamont Pass. Nearly 5,000 small wind turbines were installed there in the 1970s because of a favorable tax break for wind power which eventually lapsed, pulling the rug out from under the nascent wind industry. It’s a powerful reminder that fiscal policies can be fickle and a bad foundation for an enduring company.

With energy generation a tougher proposition, the VC investment that remains is shifting to energy efficiency. Some of the Valley’s blue-chip VCs are eager to pump Silver Spring Networks, which makes software and services for a smart energy grid. There’s grand talk about 1.5 billion electricity meters needing to go digital over the next several years. But it’s hard to see Silver Spring or any of the other current portfolio companies being the next Netscape, EBay or Google — the kind of venture home-run that really sets investor hearts beating faster. Given the scale of the energy industry — about $1 trillion in the US alone — there should be plenty of space for that kind of transformational business hit. It hasn’t happened yet.

At the root of the cleantech bust is that there are fundamental science problems that need to be solved before many of the current ideas are investable. For all the strides in solar power, photovoltaic cells are still too inefficient to be cost-effective. No one has cracked the problem of energy storage for solar, wind and tidal energy. Carbon sequestration is a regular mantra in political speeches — particularly for legislators from coal-producing states — but it’s still a largely theoretical exercise.

Venture capitalists, for all their rhetoric about pushing ground-breaking innovation, are bad at science projects. In fact, one of the most damning verdicts a VC can offer is to tell someone that their start-up idea is a “science experiment”.

There’s one Silicon Valley grandee, however, who disagrees. Vinod Khosla made his first fortune as a founder of Sun Microsystems, a famously brainy place in its early years. He went on to be a star partner at Kleiner Perkins Caufield & Byers, with personal hits like Juniper Networks and NexGen/AMD, as well as flops like Dynabook. For the last five years, he has been investing a few hundred million of his own money, in nearly 40 cleantech start-ups as well as IT companies. He told Sarah Lacy earlier this year that cleantech would “clearly” create ten Googles. Now Khosla Ventures has raised $1.1 billion in two funds, the largest first-time fund since 1999 and the largest amount raised by any fund since 2007.

Start-ups better off with angels than VCs

Self-financed angel investors are often found where venture capitalists fear to tread. They typically provide seed financing to start-ups that is counted in the thousands or tens of thousands instead of the millions VCs have to throw around.

A newly released academic study (52-page Acrobat file) finds angel investors also cut the start-ups they invest in better deals, both in early financing rounds and in cases where the company eventually makes its way to an initial public stock offering.

If our conjecture is correct, then an entrepreneur may be better off avoiding a venture capitalist altogether and going to an angel to obtain their financing. …. While venture investors are prone to underprice IPO firms, reducing the proceeds from the offering, angel investors have incentives more aligned with non-venture capital, pre-IPO shareholders.

The working paper by William Johnson and Jeffrey Sohl  of the University of New Hampshire’s Center for Venture Research found that a substantial number of initial public offerings have angel investors as their only investors — 13.4 percent.

The authors of the study also find that firms with at least some angel involvement exit via IPOs earlier than purely venture backed firms. They suggest another factor is at work here — angels are typically not just wealthy individuals with a passive interest in the companies they invest in but former executives or professionals with an intimate knowledge that can give entrepreneurs a leg up in terms of business experience.

The bad news for entrepreneurs is that angel investment appears to have fallen sharply relative to venture capital. An annual survey by the Center for Venture Research released earlier this year found angel investment declined nearly 26 percent  to $19.2 billion in 2008. That compares to the $30.9 billion invested by VCs last year, an 8 percent decline from 2007, according to data from the National Venture Capital Association and Thomson Reuters (See Jan 24, 2009 release).

But don’t count angels out just yet. A check of Google shows searches for venture capitalists falling steadily since data started being kept five years ago. Searches for venture capitalist in 2009 are only slightly above those for angel investor.

from MediaFile:

Less and less funding for venture green shoots

VC fundrasing falls off cliff

Hard-pressed private equity firms complain a lot about the difficulties in making classic leveraged buyouts work. Some talk of elbowing in on early-stage investments of the sort which venture capital is known. They won't have lots of competition from incumbents.

The latest data from the U.S.-based National Venture Capital Association shows new fundraising activity among venture capitalists falling off a cliff, with the lowest number of funds raising money -- 25 -- in 13 years and the smallest number of dollars committed -- $1.7 billion -- since 2003.

U.S. venture capital fundraising is now just 14 percent of recent peak levels in the fourth quarter of 2007, when 86 funds raised $12.3 billion. That was the year that $36 billion was ploughed into venture investments. This year, VC will be lucky to attract one-third of that amount.

NVCA President Mark Heesen says industry consolidation is finally in store as some venture firms wait until 2010 or beyond to go back begging for funds from their limited partners, but others  throw in the towel. "There will be firms that will not be able to raise a follow-on fund and our industry is positioned to contract over the next five years through this type of attrition," Heesen says.