Year in Review: China

You know it’s been a rough year for the venture industry when even investment in China is down.

Until last year, venture investment in the world’s largest emerging market had risen this decade at a pace brisk enough to spark fears of a speculative bubble. Between 2002 and 2008 alone, VC investments soared from $418 million to $4.2 billion annually, according to research firm Zero2IPO. U.S. investors piled into the market over that period, with several top-tier firms launching first and follow-on funds in quick succession.

The financial crisis cooled that momentum. Both venture fund-raising and investments dipped significantly in 2009 compared to year-ago levels. And while the Organization for Economic Cooperation and Development estimates the Chinese economy grew at rate exceeding 8% last year, thanks to a healthy dose of domestic stimulus, investors remained skittish about over-committing fund reserves.

“Several of the China funds that raised money in 2006 slowed down the investment pace,” says Richard Lim, managing director at GSR Ventures, a venture firm affiliated with Mayfield Fund that announced a close on a $383 million third fund last January. And although there were a number of venture-backed exits, there was nothing that Lim would describe as a blockbuster.

But Lim predicts the picture will improve this year. He expects more money will go into venture deals, driven in part by growth sectors such as e-commerce, online advertising, LED lighting and social games. He is also bullish on the smartphone market, which, driven by 3G, iPhone and Android, “should see the emergence of interesting applications companies in the next few years.”

Little of that enthusiasm was visible for most of last year. For the first three quarters of the year, VCs made a total of $1.67 billion in disclosed investments in 273 deals, according to Zero2IPO. By comparison, over the same period a year earlier, investments totaled $2.93 billion. For the full year of 2008, VCs invested a total of $4.21 billion in 607 deals, Zero2IPO says.

Still, 2009 looked on track to end stronger than it began. Deal volume increased sequentially each quarter, with 53 deals in Q1, 99 in Q2 and 122 in Q3. As of early December, Q4 looked poised to continue the upward trend, with several large investments reported. They included a $35 million round for Shanghai Golden Monkey Group, a candy and snack food maker backed by BOCI China Fund and New Horizon Capital; a $20 million round for Beijing Kaixin Ren Information Technology, a social networking site backed by Northern Light Venture Capital and Qiming Venture Partners; and a $15 million round for Tencho Technology, a maker of computer peripheral products backed by Legend Capital.

VCs were also heartened by signs of life in the IPO market in the third quarter. A total of 46 Chinese companies went public on overseas or domestic markets in Q3, raising a combined $20.7 billion, according to Zero2IPO. By comparison, just 16 companies went public in the first half of the year, raising $2.85 billion.

Several of the China funds that raised money in 2006 slowed down the investment pace.

Richard Lim

The biggest VC-backed IPO was for Peak Sport Products, a clothing manufacturer that raised about $222 million on the public market. Peak had raised $45 million a few months before going public from Sequoia Capital, Legend Capital and Shenzhen Capital Group.

Other big IPOs included the $145 million offering from Saturday Shoes, a clothing maker that previously raised an undisclosed amount from Legend Capital, and the $94 million offering from Accelink Technologies, an optoelectronics company backed by $2 million from Changyuan Yingjia, according to Zero2IPO.

The IPO market revival, however, does not appear to have convinced limited partners to pour more money into China-focused funds. Overall, 2009 was a comparatively weak period for venture fund-raising, with China-centric funds raising $3.46 billion in the first three quarters of the year, according to Zero2IPO. That was less than half of the $7.31 billion that foreign and China-based venture groups raised in 2008.

The pace was slowest in the first quarter, when funds raised $889 million. It picked up in the second and third quarters, when funds raised $1.37 billion and $1.2 billion, respectively.

As usual, VCs experienced in the China investment scene fared best in raising capital. One was Joe Zhou, former general partner at KPCB China, the China fund of Kleiner Perkins Caufield & Byers. Zhou left to start his own firm in March 2008 and a little over a year later he pulled together $200 million to launch Keytone Ventures with Stella Jin and Peng Jin, two investors formerly with the IDG-Accel China Growth Fund.

Another fund-raising success story was Spring Capital Asia, which brought in $151 million for the first close of its debut fund.

The standout fund-raising trend for the year was the move to Renminbi-denoted funds. (Renminbi, aka, RMB, is the currency of the People’s Republic of China.) Investors had been cautious about raising funds in the local currency thanks to rules that have not been clear regarding foreign partners’ ability to eventually exit their investments.

The third quarter was the first time that RMB-denoted funds surpassed U.S. dollar-denoted funds. Of the $1.26 billion raised, more than 84% was raised in China’s currency, according to Zero2IPO.