The Unspoken Rules of Venture Capitalists in China
王根旺 王根旺

The Unspoken Rules of Venture Capitalists in China


  Written by Xucheng Lu, The Founder magazine (

  Many venture capital (VC) firms have won the respect of Chinese entrepreneurs by virtue of their professional competence and occupational conduct. But other firms show another side -- that of the "business vulture." They do not follow professional ethics in their actions, bringing repeated injury to entrepreneurs.

  Who Owns a Company?

  If you lost control of your company, would you be able to do any more than Alibaba's Jack Ma? is one of China's largest online dating platforms. When the company listed on the Nasdaq in May 2011, founder and C.E.O. Gong Haiyan held a 20.27 percent stake, and chairman Qian Yongqiang held 23.13 percent. Gong was originally an entrepreneurial novice. After graduating with a masters from Fudan University in 2005, she managed her company full-time. Qian, a co-founder of New Oriental, gave her US$ 2 million and strongly demanded to be chairman of the board. is China's first business-to-consumer (B2C) company to list on the Nasdaq. After its IPO in October 2010, company founder and C.E.O Gu Beichun held a 11.6 percent stake, while Sequoia China Founding Partner Neil Shen held 62.8 percent.

  There are many similar examples. MatrixPartners China Founding Managing Partner David Zhang said that compared to entrepreneurs, who take on the greatest risk and fight on the front line, there is no way individual angel investors and institutional investors should hold a majority stake in a company. "Some people, with no tenable reason, squeeze the entrepreneur, who is the soul of the company, out and make the company their own, fundamentally damaging the reputation of the venture capital business," Zhang said.

  Once an investor becomes the largest shareholder, the company's development in many cases is beyond the control of the founding team.

  Kuxun co-founder Wu Shichun is still angry today. In October 2009, Kuxun was sold to the travel review site TripAdvisor. "Although they were venture capital investors, they were particularly afraid of risk. As soon as the industry cooled or the economy entered a cyclical trough, they were thinking about how to get out. They sold the company, forced the sale of the company, disregarding the feelings of the founder," Wu said.

  The "Boss" Mentality of Investors

  Many founders find the "boss" mentality of investors even more annoying than the fact that they seek controlling stakes.

  Dolphin Browser Founder Yang Yongzhi was born after 1980. In the fundraising process, he was summoned by an investor at a well-known VC firm. He complained to The Founder Magazine that the investor "did not have the most basic respect" for him. "After meeting, he didn't ask some reasonable questions but talked at me instead, like teaching a child, to prove how great he was. If you don't agree with me, why did you come to me?" Later, Yang obtained investment from Sequoia China and MatrixPartners China.

  Other investors show an attitude of distrust toward company founders.

  In 2010, former KongZhong Vice President Fang Qingyuan became chief operating officer of Jiayuan. Gong was made a figurehead. Later, with the support of workers and other shareholders, Gong regained control of the company. In March of this year, former KongZhong Vice President Wu Linguang became co-C.E.O. with Gong, indicating the possibility of Gong again being made a figurehead.

  "Their Term Sheets Would Be Garbage"

  In relationship between founds and VC firms, most firms are cautious about the investment letter of intent (term sheet), but some firms are more casual. China Renaissance Vice President Zhao Xiang analyzed the capital that China Renaissance had matched with projects. After granting term sheets, the proportion of U.S.-dollar funds that did not follow through with investments was around 30 percent. The proportion of local yuan funds that ultimately did not invest was as high as 80 percent.

  The cover story of the current issue, "The Gingko Predicament," discusses the intrepid work of Gingko, a large VC firm. At the outset, Gingko lures small entrepreneurs with the promise of high prices and tells them not to talk with other investors. But after the entrepreneur actually rejects other investors, Gingko often refuses to invest for any number of reasons. Such a practice can really put entrepreneurs in trouble.

  Evercare Founder Li Bing encountered a VC firm that did not respect the term sheet. "After other investors withdraw and the entrepreneur's decision-making latitude shrinks, they begin beating the seller down on a variety of grounds."

  As to the investor strategy of putting pressure on prices and delaying after the signing of the term sheet, Shenzhen QVOD Technology Founder Wang Xin expressed his understanding and called it a reasonable tactic. "The investor is also working. Of course he wants to maximize profit," he said.

  Legend Capital Managing Director Liu Erhai said he bitterly abhors this behavior among his peers. "I don’t believe that a company with a brand would haphazardly hand out term sheets. If (an investor) frequently issued term sheets, then cancelled, then issued another, then canceled it, their term sheets would be garbage, would be nothing!"

  Even if some investors ultimately sign a formal contract, they may also set traps. Interestingly, many VC firms that are obviously doing business in China hand over a final text that is only in English. The result is that some entrepreneurs think the term sheet contains "standard terms," and sign without understanding the full story. NVC Lighting Founder Wu Changjiang told The Founder Magazine that when he initially brought in investment from SAIF Partners China Founding Partner Andrew Y. Yan, he was forced to eat such a loss.

  "Putting Them in Their Own Pockets"

  In the recent NVC Lighting storm, Founder Wu Changjiang was forced to leave the board of directors, and Andrew Yan became chairman of the board. The relationship between the two was tense. The incident became a hot topic in financial media reports, and it came to light that Yan and another partner Lin Heping "asked for 3 percent options" when they invested in NVC Lighting in 2006.

  On August 17, NVC Lighting minority shareholder Hejun Vanguard opened dialogue with the board. Yan and another colleague admitted that that year they each held a 1.5 percent stake and stressed that the situation was a result of business negotiations, which were industry practice. "In investment this is very common," Yan said.

  In addition, Yan revealed that SAIF has invested in 150 companies in China in which SAIF partners have options in as many as 100. He also said that 50 percent of the board options will return be returned to the fund. "The rest is not mine. Everyone splits it."

  In general, besides management fees, the general partners of management funds can also receive investment income of 20 percent (carry). If what Yan said is true, the profit sharing ratio of the options is much higher than 20 percent. This means that general partners can raise the value of the invested company in exchange for a certain proportion of options, thus bringing more profit for themselves. The benefits of limited partners may be harmed as a result. GSR Ventures Partner Zhu Xiaohu wrote on his microblog, "There is a clear conflict of interest."

  A number of founders and investors told The Founder Magazine that when investing, partners at VC firms do indeed get options, but this uncommon. Qiming Venture Partner in Charge Tong Shihao said that partners are representatives of their funds. If they receive shares or options, they should share them with the fund's shareholders and other partners not hold them exclusively. But as far as he knows, there are indeed some partners who "put them in their own pockets."