Cover Story: Globe Trotters –

Mind-bending twelve-hour flights. Extreme culture shock. A woeful lack of insider knowledge. Is it really worth venturing outside the United States to find the next big thing?

For a growing number of VCs, the answer is yes.

Firms like Greylock, New Enterprise Associates, Benchmark Partners, DCM-Doll Capital Management, IDG Technology Ventures and Sutter Hill Partners have adopted aggressive international strategies. Others, like Matrix Partners, are assessing global deals for the first time and are close to pulling the trigger on their first international investments.

Despite the huge potential upside, global venture investing has proven to be rife with risks. The most obvious is the cultural challenge, such as learning how to navigate old-boy networks and the bureaucracy that permeates foreign business climates.

Those who have gone before have learned how difficult it is to try to export U.S.-style venture capital to emerging economies.This time, however, venture investors believe they have greater odds of success.

For starters, the governments of emerging economies are liberalizing their policies to try to create environments that are conducive to private equity investing. Venture firms are also emboldened by the rise of entrepreneurship in places like China and India, especially as foreign nationals return home in record numbers after cutting their teeth at technology companies in the United States. VCs are also heartened by the low start-up costs in places like Bangalore and Beijing, where startups can keep overhead low and spend less on developing innovative products.

Most importantly, investments in non-U.S. startups are already showing returns. Of the 91 venture-backed companies that went public in the United States last year, 12 were companies based overseas-eight in China and four in Israel. A cursory review of those deals shows that while some of the returns are ordinary-like the 6.1X return for the three backers of Linktone Ltd. (Nasdaq: LTON), they can also be extraordinary, as was the case with China Finance Online (Nasdaq: JRJC). For their $510,000 investment in China Finance, IDG Technology Venture Management and Vertex Management were collectively rewarded in the IPO with shares valued at $67 million-a return of 130.8X.

The mood among investors venturing abroad can be summed up in two words: cautious optimism. They are optimistic because new technologies and new markets are springing to life around the world. But they are cautious because they remember what happened in 1999 and 2000, when they brazenly abandoned the long-held notion that they should stick to what they

know and set out to conquer foreign markets. Some firms, like Whitney & Co., have shuttered their global funds and limped home. Whitney had poured $100 million into scores of Asian startups, but discovered it was much harder to manage investments overseas.

Roger Leeds, a professor of international finance at Johns Hopkins University, says that the first wave of global venturing failed because VCs naively believed that what worked at home would also work overseas. “VCs took for granted things like corporate governance, financial reporting, accounting standards and independent boards,” he says, noting that many of those things simply don’t exist in emerging markets. Investors also discovered there were very limited exit opportunities. Added to this was the fact that governments in these countries were not attuned to the importance of private equity and didn’t bother to promote venture capital.

Gary Rieschel, managing partner of Mobius Venture Capital, remembers being dismayed when he discovered his first investment in China, UTStarcom, was keeping two sets of books-one based on Chinese accounting rules and the other in the Generally Accepted Accounting Principals of the United States. When it came time to file the IPO, it was difficult to reconcile the two sets of books, which almost torpedoed the offering. “You can end up blowing up the company if you don’t have the right financial structures in place,” Rieschel says. UTStarcom ultimately had a successful IPO in early 2000, though its stock price, now at about $10, is well off its high of about $90.

Lip-Bu Tan, founder of Walden International and one of the most respected global investors, admits to having made his fair share of mistakes. Early on, he invested in a consumer electronics company called Swan. The company did well, but he could not receive approval from the Chinese government to take the company public outside China. “I complained to every minister I met,” he says. “It was very frustrating. I simply could not maximize my investment.”

Now, before making any new in investment in China, Tan makes sure he restructures the company so that it is legally domiciled in the Cayman Islands. That way he does not have to seek government approval to list his companies on foreign markets or repatriate assets. Companies set up in that way typically trade their shares on U.S. stock markets in the form of American Depository Shares (ADS), which convert to common stock.

But even legally domiciling a Chinese company outside of that country isn’t a perfect fix. Earlier this year, the Chinese government’s State Agency for Foreign Exchange (SAFE) issued a regulation that calls for any person planning to set up an offshore holding company to first get approval from SAFE. Private equity professionals were angered by the move and, as of early April, were locked in a battle with bureaucrats to do away with the new reg.

Another key lesson Tan has learned from his many years of investing abroad is to invest in only early stage startups. He says “bad habits” are too entrenched in older companies, so he avoids expansion-stage deals. As part of the term sheet, Walden insists on bringing its own CFO aboard and approving any new management team members before they are hired.

In yet another effort to minimize its risk, Walden appoints a roaming controller in every country where it does business. The controller performs random spot checks on portfolio companies to ensure their books are in order. The firm also insists that at least one-third of employees at portfolio companies, at least in the beginning, are so-called “returnees”-people who have studied and worked in the U.S. before returning to their native countries. At a semiconductor company named AMEC-one of Walden’s most recent Chinese investments-17 of the 50 employees are returnees. As a result, Walden feels more confident that the business will be run in a professional manner.

Strategies like those of Walden can minimize risk, but there are some troubling aspects of foreign markets that U.S. VCs can do little to improve-like lack of intellectual property protection, especially in China. In one recent case, Cisco Systems sued Chinese rival Huawei Technologies for allegedly stealing its source code. The case was finally settled out of court in July 2004, with Huawei denying wrongdoing but agreeing to pull some of its products and modify others. The financial terms of the settlement were not revealed.

Investors say the IP situation is improving and that the Chinese government seems more willing to go after local companies who violate IP laws. Some investors believe the potential reward from investing in China outweighs the IP risks. Cisco, for instance, continues to make venture investments in China, despite its troubles with Huawei. In February, the networking giant led a $5 million investment in Beijing-based FoneNet, a provider of video content for mobile phones. It was the fifth deal Cisco has made in China.

One way to get around the IP issue is to avoid it altogether. DCM targets Web-based business services deals in China, so it doesn’t have to worry about IP theft or rampant piracy. With businesses services, if you don’t pay for it, you don’t get it. DCM is excited by everything from Internet-based payroll and HR services to online yellow pages and matchmaking services. One of its most notable deals is 51Job, a Chinese Internet job site that went public on Nasdaq late last year.

Eric Gonzalez, a partner at DCM, says 51Job is the kind of deal that makes global investments a no-brainer, regardless of the challenges and extra headaches. “The capital required to get an overseas company to cash flow break-even is far less than in the U.S.,” he says. For instance, companies in Silicon Valley must pay engineers roughly $100,000-plus per year, whereas in China the same talent can cost about $20,000 per year, according to industry experts.

DCM has already seen a substantial return on its $14 million investment in 51Job. Its shares in the company were worth about $122 million on April 4, giving it an ROI of 8.7X. Its return could still go up: 51Job’s stock price is up nearly 25% from its $14 IPO price on Sept. 28 of last year.

Impressive stories like that of 51Job notwithstanding, some VCs aren’t convinced that they should leave familiar territory in search of big rewards in foreign lands. After all, it’s hard enough to do a deal in your backyard, let alone one that is 10 time zones away. “I look at these guys who fly back and forth every other month and scratch my head,” says Bart Schachter, a managing partner at Blueprint Ventures, a seed-stage investor based in Silicon Valley. “It may be a sexy strategy now, but what happens a few years down the road when deals start to unravel and people are totally burnt out? I’m not sure this model is sustainable.”

Increasingly, firms like NEA, Accel Partners, and Worldview Technology Partners are placing local agents on the ground to scout out opportunities. But even this strategy isn’t foolproof. Rieschel of Mobius, who recently moved from Silicon Valley to Shanghai, says that very few U.S. firms will give their local guys control of capital or the ability to make decisions. As a result, these local representatives are only shown deals that are more likely to appeal to the partners back home, but aren’t considered to be the really interesting deals on the street, he says.

Rieschel adds that when the Silicon Valley VCs take their annual junkets to Shanghai, they get shown completely different deals than he does now that he’s based there. “The deals they see are dressed up to suit the U.S. venture palette,” he sniffs.

Moshe Mor, a general partner at Greylock Partners, agrees that venture capital is traditionally about eight or 10 people in one location interacting in the hallways. When VCs expand beyond a single location and introduce different cultures and new ways of doing business, the challenges can be enormous. Some firms have attempted to overcome that challenge by setting up loosely affiliated offices overseas. According to one source, Sequoia Capital was in discussions to hire the entire partnership of an existing Chinese venture firm. The idea was that Sequoia would put its brand on the firm and then go about raising independent capital. However, the Chinese partners determined that the Sequoia name really didn’t mean that much in China, and that they could make more money on their own, says the source. Sequoia declined to comment.

Greylock, for its part, has steered clear of this franchise approach to global investing. It began investing in Israel almost three years ago, but it wasn’t until early this year that it officially opened up an office there and hired two more partners to focus on the region.

“It took three years and six deals to prove that we liked the market-where we were comfortable with the deal flow, and that we truly understood the strengths and weaknesses of the territory,” Mor says.

Greylock hasn’t had had any exits from its investments in Israel, but Mor says the firm is happy with the progress of its portfolio companies. The firm may broaden its international strategy, having recently made some fact-finding trips to India and China.

Another increasingly popular strategy for investing abroad has been to recruit a reliable local partner who can help mitigate risk. Sutter Hill has established a close relationship with Shanghai-based Chengwei Ventures. Sutter Hill contributed about $10 million to Chengwei’s $100 million fund and Sutter Hill Partner Len Baker now makes three to four pilgrimages a year to check on Chengwei’s portfolio.

So far, Sutter Hill has made three co-investments with Chengwei. One is in AAC, a maker of components for cell phones, while another is in Baby Care, a Beijing company that sells a variety of consumer products to mothers. Baker says that Chengwei sourced all these deals and that his firm is not ready to go out on its own. “We know enough to know we don’t know enough,” he says.

Even DCM, which has found success on its own in China, sees the value of partnering. In April it struck an investment partnership with China’s Legend Capital and put $55 million into one of Legend’s funds. (Legend Capital is the VC arm of Lenovo Group Ltd., China’s largest PC manufacturer.)

Finding the right partners can be one of the most daunting obstacles when investing overseas. Walden’s Tan says a good local co-investor can add tremendous value, but a bad one can sabotage a deal. He recalls a deal in Malaysia where the plan was to maximize the ROI by taking the company public in the United States. But the local partner wanted one of his other companies to acquire it, and he tried suppressing the valuation to keep the sale price low. “Sometimes you never know what to expect,” Tan says.

Tan’s phone has been ringing off the hook from VCs calling to ask his help in venturing abroad. He recently brought Bay Partners, InterWest Partners and Lightspeed Venture Partners into the AMEC semiconductor deal. It was the first Chinese deal for all three of those firms.

Walden doesn’t disclose its return on investment, but it has been able to take profits from many of its overseas deals, Tan says. In the case of SMIC, another semiconductor deal in China, Walden sold stock at the time of the IPO and was able to make a cash distribution to its limited partners, he says.

Some firms may be forced to go abroad whether they want to or not, because markets for many of the technologies they’re familiar with are exploding outside of the United States. That’s why Storm Ventures recently invested in MCubeWorks, a Korean startup that allows cellular providers to deliver broadcast TV and video-on-demand services to handsets. It would not have made sense to do a deal like that in the U.S. because the market will develop in Asia before it ever reaches these shores, says Storm Partner Ryan Floyd.

“When we make any investment, we look at technology breakthrough and proximity to customers,” says Shirish Sathaye, a general partner at Matrix Partners. “A few years ago, those things were not present in India or China. But today, there are some cases where being in India and China puts you closer to the action.” He says India is probably the best market in the world for wireless communications because of its huge number of potential consumers and burgeoning telecom infrastructure.

Earlier this year, Matrix opened an office in Bangalore, where Sathaye works when he is in town to help companies recruit local talent. This market exposure has whetted his appetite, and he admits he is tempted to invest in one or two companies. One reason holding him back is that there are too few local early stage investors who could act as reliable partners and could be trusted to co-invest.

Still, Sathaye says he believes the venture ecosystem will develop rapidly. Already he is noticing a number of high-quality “returnee” entrepreneurs entering the Indian market, as well as a growing number of local companies that may soon be big enough to make acquisitions-and provide exits for VC investments.

Gonzalez of DCM believes the nature of venture capital has changed forever. He says every partner at his firm makes about four trips to Asia annually, even though only about 20% of their deals are abroad. “We are still hungry and aggressive, so it makes sense for us to sacrifice and spend time over there to differentiate our firm,” he says. “The more established firms that have made tons of money may not be interested in getting on planes and traveling the world because it’s hard on the body and hard on the family.” But, as Gonzalez sees it, global venture capital is no longer a luxury. It’s a necessity.


Tom Stein is a freelance writer based in Silicon Valley who specializes in writing about venture capital and startups. He can be reached at