Road To Riches? Everyone is buzzing about China … again. Do VCs really stand a chance of making it over the wall? We spoke with battle-scarred investors to find out what you need to do to succeed. –

Depending upon whom you talk to, the story about China is different. The “old-timers”-those who have been making venture investments in China for 10 to 15 years-will tell you horror stories and complain about the heavy lifting they had to do to open the market. Talk to one of the newer firms and you hear unbridled enthusiasm.

It’s more than your standard trade press penchant for making something big of a trend du jour. Big money is being made right now. Richard Hayes, head of private equity investment at CalPERS, astonished the audience at the National Venture Capital Association’s annual meeting in San Francisco in May when he spoke about a Chinese investment made by The Carlyle Group, where CalPERS is a limited partner. The investment has already repaid CalPERS’ entire participation in the Carlyle fund, which “is only 30% drawn down,” Hayes said. It’s the kind of streets-are-paved-with-gold story that makes investors lean forward in their seats.

It’s also the kind of story that investors hope to hear more of, since they’ve been pouring billions of dollars into China. It received more foreign direct investment (FDI) than any other country in 2002 and was second only to the United States last year, with $57 billion worth of FDI, much of it in the form of private equity. While venture capital is still a small part of this trend-under $2 billion last year-you’d be hard put to find a venture firm today that isn’t at

least considering investing in the largest nation in the Far East.

Active investors are spending more than half their time in China. Longstanding Asian investors-such as Crimson Private Equity, H&Q Asia Pacific (H&QAP), Newbridge Capital, Pacific Venture Partners, Walden International, Warburg Pincus and W.I. Harper-are shifting their focus in Asia toward China. Meanwhile, those firms that have invested in Greater China in more recent times are expanding their presence in China. That large group includes AsiaTech, Carlyle, Crystal Ventures, DCM-Doll Capital Management, Draper Fisher Jurvetson (DFJ) ePlanet, Intel Capital, JPMorgan Partners (JPMP) and Orchid Asia. Not to be left out, a new generation of China investors led by experienced venture firms like Battery Ventures may go straight to China and avoid old centers of Asian investing (such as Hong Kong, Singapore and Taipei) altogether.

“The development of China will be the world’s biggest economic trend over the next 20 years,” says Oliver Curme, a general partner at Wellesley, Mass.-based Battery. Curme has followed China investments over the last several years. “We won’t jump in with both feet but we’re convinced that there are lots of opportunities,” he says. “Firms who don’t participate in China are going to lose out.”

Need To Know

Before you go to China, you should listen to those who have gone before. VCJ has complied a list of recommendations from veterans (see sidebar, “Rules of the Road,” page 37). Barry Taylor, a managing director in the Menlo Park, Calif., office of Warburg Pincus, says that there are four ways to invest in China: (1) Back Chinese entrepreneurs who want to build new businesses. (2) Back people born in the United States but whose parents were born in China and who want to return to start businesses there. (3) Work with electronics companies in Taiwan that are migrating into China. (4) Practice what Art Wang, a principal at Pacific Venture Partners in Redwood Shores, Calif., calls “roach motel” investing. That is, invest in joint ventures with State Owned Enterprises (SOEs) or buy assets from SOEs and form new companies with former government managers. “SOEs are places where investors go in, but they don’t come out,” Wang warns.

In addition to “how,” investors targeting China need to understand the “who,” as in who’s already there. Answer? An all-star cast of U.S.-based VCs that have spent a decade or more making investments in China (see sidebar, “Key Players in China,” page 33). Many of the firms are headed by Chinese founders whose familial and cultural ties pulled them back to their land of origin. Among them are those who identify themselves as the “49ers,” people whose families fled to Taiwan when Mao Tse-Tsung and the Communist Party conquered Mainland China. They’re typically over-achievers-like Ta-Lin Hsu, founder and chairman of H&QAP, and Lip-Bu Tan, founder and chairman of Walden-who achieved remarkable success in academia or in the sciences before their boundless energy drove them into finance and venture capital. Their attitude is, in the words of Walden’s Tan, “Follow me.” That is to say, they’re open to sharing their experience, contacts and deals with their peers in the venture community. If you decide that you want to get started in China, there is no better place to start than with the principals of a firm like Walden or H&QAP.

It also helps to have some context for the timing of investments in China. “There have been three recent eras of doing business in China,” says Hsu. The first was the period from 1993-1996, which saw Sino-foreign joint ventures, incentives from the Chinese government and lots of failures that left a legacy of horror stories in the private equity community. Then came the era of the Wholly Owned Foreign Entity (WOFE) from 1996 to 2003, in which VC-backed Chinese companies were wholly owned subsidiaries of operating companies based in the Cayman islands. Finally, the market entered a new era this year. It’s a “less-regulated era in which investment is changing once again,” based on a maturing regulatory and legal environment, Hsu says.

Where To Now?

Once you know the “how,” “who” and “when” of venture investing in China, you can consider the “where.” In the past firms entered China through one of the three great financial centers: Hong Kong, Singapore or Taipei. For some those centers will continue to provide points of entry for investing, if only because of established business relationships in those cities. But those starting out in China should keep the following geographical analysis in mind. “Shanghai is the center of semiconductors and IT manufacturing, and Guangzhou [Canton] and Shenzen are logistics, contract and light manufacturing centers,” says Peter Chu, managing director of AsiaTech Ventures in Palo Alto. “Beijing is the center for software, telecommunications, biotech and service providers.” It’s an overly broad characterization of a nation that is physically as large as the continental United States, but Chu and many of his peers agree that it’s a useful description nevertheless. These three regions are important focal points for the industries mentioned and, more importantly, they have English language, foreigner friendly infrastructure that non-Chinese investors need.

VCs interviewed by VCJ are putting their offices where their advice is. The marquee names of United States investing started their China work with offices in prestigious Hong Kong addresses alongside global private equity investors. Those firms include Carlyle, Goldman Sachs, H&QAP, Intel, JPMP, Morgan Stanley, Newbridge, Pantheon, Walden and Warburg Pincus. Today most of these firms have opened (or have plans to open) offices in Shanghai and Beijing. DFJ relocated its senior VP, Fan Zhang, to Beijing in 2002. That same year H&QAP opened its third China office, in Shanghai. Meanwhile, W.I. Harper, which opened its Beijing office in 1996, closed its Hong Kong office in 2002 and has since expanded in Beijing.

Dan Carroll, now a managing director of San Francisco-based Newbridge Capital (which is backed by The Texas Pacific Group and Blum Capital), opened H&QAP’s offices in Hong Kong a generation ago. He observes that the old geographic orientations of Asian investing are rapidly changing. “Many Chinese entrepreneurs are entering China via Taipei because of its proximity to Shanghai,” so Taipei is seeing an increase of interest by venture investors, Carroll says. And while few people will openly say it, Hong Kong and Singapore are the big losers as investors migrate into China. “Hong Kong was becoming too expensive,” says AsiaTech’s Chu. “Hong Kong may be more convenient, but the same caliber of skills are available in Taiwan, and Taiwan has a better technology base.” Says another VC who asked not to be named: “Singapore is just too far away.”

Hsu suggests another reason why Asian investment is shifting outward from Singapore: “The Singaporeans have been less successful [in China] due to their rigidity,” says the chief of H&QAP. His comment was echoed by others who say that Singapore has a business demeanor and attitudes adopted from the British that do not play well in China.

Why China?

One word encapsulates the book that we could write about why VCs should take a serious look at China: momentum. It’s the biggest marketplace in the world, the most populous country, with a middle class alone the size of the entire population of the United States. It’s also the fastest growing economy in the world, with an 8% to 12% growth rate per annum over the last decade.

To understand the “why” of doing business in China it helps if you understand the evolution of China’s role in global business from a low-cost manufacturing center to a producer of sub-systems, assembly and packaging to the role that China has today as both a world-class competitive developer of products and as a world-class market for products. Once you understand that, the reason “why you invest in China, is because every business today has to have a China component if it is to be [globally] competitive,” says Chris Albinson, a managing partner in JPMP’s San Francisco office.

In going to China, venture-backed companies are merely following in the footsteps of the corporations that entered China a decade ago, household names like Boeing, General Electric, General Motors, Procter & Gamble, Volkswagen and Wal-Mart. The elite companies of the U.S. technology community have been there for some time, too. That group includes Cisco, Hewlett-Packard, Intel, IBM, and Motorola. Other tech superstars, like eBay and Yahoo, have bought mainland China operating companies within the past year after making inroads in the market.

There is cause for optimism. The biggest reason is the rapid growth of China’s technology markets. Pick any stage, market or sector and you’ll find someone who’ll tell you that it’s the place to be. There are too many to write about in one story, so while we could wax enthusiastic about real estate, banking, financial services, biotech, pharmaceuticals, IT, outsourcing, infrastructure or other areas, we’ve picked the one topic that we heard about most: chips.

Feeling Chipper

The size of the semiconductor opportunity over the next decade, says Walden’s Lip-Bu Tan, “is similar to the growth of semiconductor manufacturing in Taiwan over the last decade, which went from a $10 million market in 1990 to $3.5 billion [this year]. And China is a market 10 times as large as Taiwan.” George Scalise, president of the U.S. Semiconductor Industry Association, concurs. “China currently consumes 20% of the world’s production of semiconductors,” but that will grow to 40% over the next decade, Scalise predicts.

In the past, says Michael Lee, formerly of W.I. Harper, “90% of China’s semiconductors were imported. And the 10% that were made locally were all on the low-end,” but that’s changing because of the cutting-edge, foundry-produced chips that increasingly come from fabs in China.

You don’t have to look any further than the “Made in China” sticker on the back of your computer, phone, home appliance or monitor to understand why. “Manufacturing for consumer electronics moved to Asia a while ago,” says John Paul Ho of Crimson. “Increasingly design is shifting offshore as well. As that shift takes place it takes component selection with it.” Translation: Chinese engineers in Chinese manufacturing plants specify Chinese semiconductor parts and components. “802.11 chips going into [cell phones or other consumer electronics products] are going to come from a Taiwanese [or Chinese] startup,” not from one of the dozen or so U.S.-based, VC-backed startups, Ho says.

JPMP’s Albinson describes the change this way: “The [Chinese]-based startup will develop the product, they’ll sell the product to Chinese customers and manufacturers,” which in turn will sell finished goods to both domestic and international markets. In the process “design-to-manufacture times are being cut to half of what they are in the [United States] today, and to 60% of cost” in the United States, Albinson says.

Chinese manufacturers are working overtime and displacing U.S. firms relentlessly in the manufacturing cycle for both domestic and international sales. Ho says that even design decisions for products bearing labels such as Apple, Dell and Hewlett Packard are being made in China, not the United States where only the overall specifications are developed.

“Semiconductors [in China] are hot,” says Michael Scown, corporate counsel for Intel Capital in Asia. With investments in 120 companies across Asia (outside of Japan), Intel Capital is perhaps China’s most active VC investor. Intel has also invested over $500 million into semiconductor facilities in China and is in the process of opening its second test and assembly plant.

There is another important factor influencing the shift of semiconductor startups and manufacturing to China: low costs. “Remember that 70 [semiconductor design] engineers in the United States cost the same as 900 engineers in China,” says JPMP’s Albinson. “What we’re observing is a 40-year [in the making] nexus of events for semiconductors.” In the past the semiconductor manufacturers first made and sold products in the United States, then expanded their manufacturing and marketing overseas.

Today, Albinson says, we’re moving to a model in which the entire specification, design, manufacturing, test and assembly are moving to China. Joseph Tzeng, managing director of Cleveland’s Crystal Internet Ventures, adds one more compelling explanation for the shift in semiconductors. “We dropped the design time for a [semiconductor device] from 28 months in the United States to about 18 months by working in China,” he says, noting that China’s 24-hour-a-day design cycle overwhelms the more staid pace of U.S. design and development. At a time when technology companies are talking about “good-enough” technology, adding “faster” and “cheaper” appears to give Chinese startups an advantage that will insure that even the highest of high tech industries is headed for China.

“How can you fund a deal on Sand Hill Road if you don’t know what is going on in China?” posits John Paul Ho of Crimson Private Equity. “We passed on three [chip] deals that Sequoia, Kleiner Perkins and others took later, because we knew of competitors in Asia that had been funded a year ago who already had working products.”

Crimson isn’t the only private equity investor betting that China will become a semiconductor powerhouse. Fan Zhang, a senior vice president at ePlanet DFJ Ventures, invested in Shanghai’s Penstar Technologies, which designs ICs for digital televisions and LCD displays.

Got Guanxi?

Now that you have a list of basics and you’re ready to wade into Chinese investing, you need to set realistic expectations. Once again, the old hands are generous with their advice. Veteran after veteran told VCJ that investors new to China need to grasp that the fundamental nature of business in China is grounded in a complex set of social, familial and business relationships. It’s called “Guanxi.”

Many countries-including Israel, Japan and the United States-have societal and business interrelationships, but in China it’s a 24/7 way of life. Relationships shape how business is done much more than business school-delivered wisdom. “In China, everything is lobbying, not marketing,” says Ron Nechemia, CEO of Los-Angeles based EurOrient, a financial institution that models itself on the International Monetary Fund. If a particular business deal requires a government contract or a license, “you are constantly in Beijing trying to get approvals or permits,” he explains.

Guanxi reflects at its deepest roots the little understood fact that “China doesn’t like outsiders” says Tzeng of Crystal Internet Ventures. That may sound harsh or overly dramatic, but China’s relationship with other nations is historically troubled. In the 19th century colonial powers occupied the country’s capital and divided its provinces into markets. Memories also linger of the invasion of China in the 20th century by Japan and its brutal occupation of Manchuria (China) from 1931 until the end of World War II. Reduced to its essence, this past means that the Chinese like deep relationships, based on trust, with the people with whom they do business.

“There are two models for doing business in China,” says Crimson’s Ho. “One is the relationship game [Guanxi] that plays off of your connections in doing business. [For example], in the domestic market, banking, telecom [and infrastructure business] require contacts in the government.” The second model is based on meritocracy, more like the international system or U.S. way of doing business that is coming into its own in China, particularly in the high tech arena.

Another trend that involves the phenomenon of Guanxi is similar to what happened in Taiwan in the 1980s, when a generation of U.S.-educated engineers returned to Taiwan where they had family connections to build that country’s technology and financial infrastructure.

“Today that same thing is happening [in China] as TI, HP, Cisco and Intel grads are returning” to the mainland, says Walden’s Tan. The Chinese government is encouraging this trend, paying a bounty for certain types of returnees (like managers and engineers) with the hope of luring back the best and brightest of the country’s far-flung progeny.

Be My Partner

How long does it take to build the kind of credibility and relationships you need to succeed in China? “There are many ways to develop and build Guanxi, but most of them take time and frequent interaction,” says Wang of Pacific Venture Partners. “After all, trust can only be developed over time through a dependable track record.” There are few shortcuts around this for foreign companies that are seeking to conduct business in China, but one way to accelerate the process is to work with a local partner who already has his own Guanxi and can help facilitate the development of key relationships. Says Wang: “The concept of Guanxi is not easy to define, but if you have it in China, your life will be made much easier. If not, well, best of luck to you.”

Peter Liu, chairman of W.I. Harper Group, an Asia-focused private equity firm based in San Francisco, cautions that Guanxi is “only a small portion” of doing business in China. “You must study, learn their culture and gain trust,” Liu says. “There’s lots of wining and dining and gift exchanges. It takes three to five years to build a relationship.”

Jean Eric Salata, managing director of Baring Private Equity Asia, stresses that international investors must partner with the powerful new [domestic] players in China, taking a small part of the businesses they’re starting. Over time, it’s “the local players [indigenous Chinese investors] that are going to be the winners [in China],” Salata concludes.

Building relationships is just one of many challenges that investors will confront in China. Another big one is China’s centrally planned economy. Economic policy and regulations can change at a moment’s notice. At times government actions appear maddeningly arbitrary. At others the government takes blatantly protectionist actions on behalf of Chinese interests. In both instances, change may come abruptly. That was the case when foreign investors woke up and saw headlines in the Asian Wall Street Journal earlier this year about the Chinese government abolishing tax exemptions for foreign-owned enterprises and raising taxes from 3% to 20% within the year. Contrast that with Alan Greenspan’s yearlong campaign for a point increase in the primary credit rate.

Or the announcement in December of 2003 that foreign IT manufacturers would have to adhere to the Chinese government-developed Wired Authentication and Privacy Infrastructure (WAPI) standard for encryption in all semiconductor products sold in China by June 1 of this year. Many believe the announcement prompted the Bush Administration’s trade representative, Robert Zoellick, to announce that the United States would bring action against China in the WTO for anti-competitive practices. The WAPI flap also caused tech heavyweights like Intel and Broadcom to announce that they would cease to ship new semiconductor products to Chinese manufacturers. China’s government has since relented, announcing no fixed schedule for WAPI’s implementation.

The most frequently heard complaint about doing business in China is that the regulatory and legal environment is immature, evolving and complex. “China is a difficult place for VCs because foreign and corporate law are not linked,” says Intel Capital’s Scown. David Chao, a co-founder and managing general partner of DCM, adds, “Corporate law in China is only 10 years old and it is still evolving.”

If it sounds difficult, it is. Even experienced multinational companies can run afoul of China’s regulatory system. Carrefour SA, a global French retailer, opened branches in Chinese cities after obtaining local permissions, but the company was subsequently informed that it had exceeded national government policies, forcing Carrefour to sell several stores and issue a formal apology. The most favorable remark we heard in this regard comes from AsiaTech’s Chu, who says that while “the legal and regulatory environment is immature, it’s navigable.”

It’s not just the laws and regulations of business that are immature. Business is new, too. Until recently it has been “impossible to align the interests of U.S. and Chinese management,” says Carroll of Newbridge Capital. “The government has been the source of [endless] worries. Graft, corruption and IP theft have all been the result of deep flaws in [the structure of American/Chinese] joint ventures. The last 15 years have been a slow, middle step to capitalism.”

Carroll can cite multiple examples of deals gone awry in China’s commercial system. The most recent was Newbridge’s failed attempt to buy part of a bank in China with Taiwanese partners. The sale fell apart when Chinese politicians and Newbridge’s Taiwanese collaborator decided to cut Newbridge out of the deal at the last minute. In another deal gone sour, Newbridge made a co-investment in a Chinese soymilk company. It later discovered that its local joint venture partners were selling the company 80% of its raw materials at a considerable markup. They were also confronted with the “nefarious” prospect of competing with their own joint venture’s managing director when he and their local investors decided to knock off the company’s products in a competing business.

Ta-Lin Hsu knits his brow when he recalls H&Q AP’s two-year effort to bring a major tire manufacturer to China: The deal fell apart when the firm’s erstwhile Chinese partners didn’t bother to show up to sign closing documents because they decided at the last minute that they didn’t want to pay the 3% IP royalty to the manufacturer.

Most companies, especially technology companies, “have had only three to five years of experience with issues like governance, equity sharing and transparency that are relatively new in China,” says Wang of Pacific Ventures.

If these considerations aren’t enough to make even the most sanguine VC dyspeptic, be prepared for more acid in the belly if you truly want to work in China. One of the most unsettling issues is that the rules of business in the United States don’t apply. “Their expectations are entirely different from ours,” says Nechemia of EurOrient. “There is a willingness to accept little or no return, just in order to build a business.”

Which brings us to another constant complaint by investors: people issues. “The problem is that the [pace of new] business [formation] has outgrown the pool of middle managers,” says Michael Lee. VCJ interviewed Lee one week before he was transferred to W.I. Harper’s Beijing office to help oversee its expanding interests there. Within four weeks Lee had left W.I. Harper to become the president of a Beijing-based software company. The juxtaposition of Lee’s admonition with the fact that he himself was so quickly subject to the very condition he had described is an irony that all businesses going to China should note.

“There are plenty of good engineers in China, but no managers,” Lee says. “Around 500,000 graduate with a degree in science and engineering every year.” It’s the oft-heard refrain that appears unlikely to have an immediate remedy, so in the interim firms opening offices in China are hiring foreign-born Chinese to represent them.

Hui Wang, president of First China Capital, a Malibu California-based former Rand Corporation analyst and advisor to the Chinese government, decries the situation. “VCs normally send U.S.-trained VCs back to China, typically an ABC [American Born Chinese], but that’s not enough today,” Wang says. “Or they hire a Taiwanese-born Chinese or even Hong Kong-born individuals, but [U.S. VC firms] have to overcome this bias for hiring. The big mistake U.S. firms make is to try and take shortcuts,” such as hiring someone because they speak English or using head hunters in Hong Kong rather than taking the time to develop relationships in China. Wang says that firms need local talent for local markets. Locals are more flexible in their work attitudes and are cheaper to employ, as well.

The biggest concern for U.S. investors should be how to get their money out once they invest it in China. “There is a huge piece [of the private equity cycle] missing in China,” says Newbridge’s Carroll. “There is no stock market that can return VCs’ money to them as quickly as they need.”

Venture firms have preferred investing in WOFEs (pronounced “woo-fees”) over investing in joint ventures over the last few years for a host of reasons. The primary reason was that it was nearly impossible to invest directly in Chinese startups domiciled in China. “There was no concept of [private] property in Chinese law for over 40 years,” says Intel Capital’s Scown.

On top of standard language and cultural issues, foreign investors had to confront a host of other potential stumbling blocks: a court system that did not function well, the fact that foreign control of corporate entities was either prohibited or proscribed, high transaction costs, corruption and outright theft at startups. VCs in particular were disadvantaged because Chinese entrepreneurs weren’t even familiar with term sheets, and due diligence was slow and costly. As a result investors used WOFEs, offshore legal entities in which standard legal and accounting practices are applied to assets that are located in China. WOFEs were the only realistic way for investors to exit from Chinese investments, Hsu says. For example, venture-backed Semiconductor Manufacturing International (SMIC) was set up as a WOFE by H&QAP, DCM, New Enterprise Associates and others to ensure liquidity for their investment in the semiconductor fabrication company. SMIC went public in March and investors’ shares in the company are traded on the New York Stock Exchange as American Depository Receipts (ADRs).

Other companies besides SMIC have successfully used the WOFE structure to sell ADRs on the New York or Hong Kong stock exchanges, but it takes an exceptional company to succeed at that. Beyond the two-dozen companies that will go public on the NYSE or Hong Kong exchanges in 2004, the rest of the year’s exits in China will leave VCs holding Renimbi (non-convertible Chinese currency) or Chinese company stocks, and “you can’t distribute either of those to your LPs,” warns AsiaTech’s Chu.

WOFEs will continue to play a role in China, but VCs say that direct investing in China will increase in proportion to improvements in the country’s commercial law, corporate governance, accounting practices, IP protection, ownership and, most importantly, the development of an indigenous stock market associated with a freely controvertible currency.

Still hot for China? Maybe George Raffini, managing director at HSBC Private Equity Asia in Hong Kong, will cool you down. “Valuations are too high,” he says. “In the past we’ve put 30% of our new Asian investments into China, but we’ve cut that back to 8 percent.” Scown of Intel Capital explains that valuations for VC-backed companies never went down in China as they did in the United States after the tech bubble burst. The result, says Lily Wong, corporate counsel for Pantheon in San Francisco, is that the pace of private equity investments in China actually slowed down during 2003.

“It is an appropriate time to be investing now-in the post WTO era-but we’re overdue for a [market] correction,” says W.I. Harper’s Liu. The reason? The torrid growth of China’s economy, he says.

Even though “most people involved with China and investing think that there is a bubble growing due to over-heating, it’s a risk people are willing to take to participate in the growth there,” says Chu of AsiaTech.

The bottom line? “You have to invest in China with a long term view. Lots of things are changing: capital markets, regulations, exits, local business practices. Everything is in flux,” says Pacific Venture Partners Wang. You need patience. “Think about your exit from day one,” advises H&QAP’s Hsu. “You need to do a WOFE as a minimal effort, but not a joint venture.”

And “don’t forget to protect your downside,” advises Orchid Asia’s Li. “Unexpected things happen in China. You need a plan for how much you’re willing to put in and a point at which you will cut your investments.”

Finally, don’t forget where you are. “The Chinese government is no longer against capitalism, but it’s still a Marxist government,” Liu says. “You have to be careful.”

Don’t Wait Too Long

While it’s important for investors to understand the challenges that will confront them if they go to China, it is equally important for them to know that the market is a work in progress and progress is indeed being made. “Just 15 years ago 80% of the economy was controlled by the government,” says Orchid Asia’s Li, who authored a book about China’s technology industry. “Today that figure is more like 40%.” That, Li says, shows that the Chinese government learns from its mistakes.

Another bright spot is China’s entry in the World Trade Organization, which has already helped resolve some of the problems for foreign investors, says Nechemia of EurOrient. As China meets WTO compliance in areas such as intellectual property protection, investment in China will rise, he predicts. In addition, the introduction of the Qualified Foreign Investment Law in 2003 has improved the investment environment.

China may be an inevitable destination for venture capital firms. “China ranks second after the United States as a source of global growth, ahead of both Japan and Germany,” says Laura Tyson, chairman of former President Clinton’s Council of Economic Advisors and now Dean of the London University School of Business. “China is tied to the United States in subtle ways,” including its role as a manufacturing center for U.S. domestic markets, Tyson notes. In other words, China provides cheap labor for the United States. The reality of China’s growth is based in that role and the fact that a U.S. manufacturing worker earns a little over $21 per hour while a China-based manufacturing employee earns just over $1.20. Simply said, the design and manufacture of products is moving to China.

VCs have to be close to the company founders, designers, engineers, OEMs, manufacturers and others who create the products that Americans consume. Whether you’re walking down the aisles of Wal-Mart or shopping for a new blade server, those consumables are increasingly made in China. And, for the first time the nostrum that architectural design will remain in the United States is being challenged. At the bleeding edge of technology, that area closest to original research, where U.S. technology continues to lead the world, the United States has an advantage, but even there, we no longer possess a monopoly.