VC China

The Hidden Unicorn: China Venture Capital Fails to Spot OnePlus

1917_big

Missed investment opportunities are rarely this glaring. Despite having hundreds of firms managing billions of dollars and employing thousands of people all supposedly out scouring China for the next big thing, China’s venture capital industry not only failed to invest in the single-most successful startup in recent Chinese history, mobile phone manufacturer OnePlus, most failed even to take note of the company’s existence. Meantime, a fair chunk of the tech savvy population of Europe and the US was enduring long waits and by-invitation-only rationing system to buy one of its prized mobile phones.

Since its founding less than a year-and-a-half ago, OnePlus went from bootstrap startup to likely “unicorn” (a billion-dollar-plus valuation) faster than any company in Chinese history. Unlike China’s other unicorns — Xiaomi, Meituan, newly-merged Kuaidi and Didi Dache and drone maker DJI Innovations — OnePlus hasn’t yet raised a penny of VC or private equity money.

With its first phones going on sale just one year ago, OnePlus has racked up a rate of growth as well as a level of brand awareness in Europe and the US never seen before from a new Chinese electronics manufacturer. OnePlus is the real deal. Revenues last year from May through December were $300mn. This year, OnePlus is on track to surpass $1 billion in sales, mainly in the highly-competitive US and European mobile phone market.

Over roughly that same period, China PE and VC firms invested over $15 billion in 1,300 Chinese firms, many also operating in the mobile industry, either as manufacturers or service providers. Needless to say, not a single one of these VC-backed startups has performed as well over the last year as OnePlus, nor created half as much buzz.

If China venture capital has a big fat blind spot it’s for companies like OnePlus. That’s because China venture capital —  which now trails only the US in the number of firms and capital raised —  is most comfortable backing Chinese companies that copy a US online business model and then tweak it around the edges to make it more suitable to the China market.

OnePlus couldn’t be more dissimilar. It is disruptive, not imitative. It takes a special kind of venture investor to recognize and then throw money behind this kind of business. OnePlus’s bold idea was to compete globally, but especially in the US and European markets, against very large and very rich incumbents —Samsung, Google, LG, Motorola, HTC — by building a phone that targets their perceived weak spots. As OnePlus sees it, those competitors’ phones were too expensive, too slow, of middling quality and the Android software they run too difficult to customize. At the same time, OnePlus sought to turn the sales model in the US and Europe on its head: no retail, no carrier subsidy, phones built-to-order after the customer had paid. Until a month ago, only those with an invitation were allowed to buy.

Nothing quite like it had ever been attempted. Will OnePlus continue its ascent or eventually crash-and-burn along with other once high-flying mobile brands like Blackberry and Nokia? Whichever happens, it’s already achieved more with less than any Chinese company competing for market share in the US and Europe. That augurs well.

From my discussions with OnePlus’s 25 year-old co-founder Carl Pei, it seems few China-based venture firms sought out the company and those that did failed to make much of an impact. The company instead opted to run on a shoestring, by cutting the need for working capital by building phones only after the customer paid. They also economized on marketing and advertising, typically where much venture money gets burnt.

OnePlus spent a total of about USD$10,000 on advertising. Instead, it poured its effort and ingenuity into building a mass following on the three major US social media platforms, Youtube, Twitter and Facebook. There’s no better, cheaper or more difficult way now to establish a brand and build revenues than getting lots of praise on these social networks. OnePlus’s success at this dwarves anything previously achieved by other Chinese companies. Compared to Xiaomi, OnePlus has double the Facebook likes, four times the Twitter followers and five times more Youtube subscribers. All three, of course, remain blocked inside China itself.

Sales of OnePlus phones also got an immeasurable boost from a string of flattering reviews in some of the most influential newspapers and tech blogs in the US and Europe.

Having reached a likely billion-dollar-plus valuation and billion-dollar revenue run-rate as a very lean company, OnePlus is now near closing on its first round of venture finance. But, it is planning to raise money in Silicon Valley, not from a VC firm in China. DJI just opted for a similar strategy, raising $75 million from Accel Partners of Palo Alto at an $8 billion valuation to expand its sales and production of consumer and commercial drones. DJI, like OnePlus, is based in China’s high-tech hub, Shenzhen.

One can see a pattern here. Many of China’s more successful and globalized companies prefer to raise money outside China, either by listing shares abroad, as Alibaba did last year, or raising money direct from US venture firms. US-based venture firms were early investors in Baidu, New Oriental Education and Ctrip , all of which later went on to become multi-billion-dollar market cap companies listed in New York.

Why do so many of China’s best companies choose to raise money outside China, despite the fact there’s now so much money available here and valuations are often much higher in China than outside? I have my theories. One thing is indisputable: being local hasn’t conferred much if any advantage to China’s venture capital industry.

Being China’s hidden unicorn hasn’t evidently done OnePlus much harm. It has revealed, though, some blinkered vision at China’s venture capital firms.

 

The Big Churn — How High Partner Turnover Damages China’s Private Equity Industry

China PE partner turnover 

What’s the biggest risk in China private equity investing?  Depends who you’re asking. If you ask LPs, the people who provide all the money that PE firms live off, you will often hear a surprising answer: turnover at PE firms. Nowhere else in the PE and VC world do you find so many firms where partners are feuding, quitting or being thrown off the bus.

A partnership at a PE firm was meant to be a long-term fiduciary commitment. In China, it rarely is. The result is billions of dollars of LP money often gets stranded, and possibly wasted. That’s because when a partner leaves, it often creates a bunch of orphaned investments. The departing partner is generally the only solid link between the PE firm and the investee company. Everyone left behind is harmed — the PE firms, the companies they invest in, and the LPs whose money is trapped inside these deals.

As the CEO one of Asia’s largest and most professional LPs told me recently, “Before committing to a new China fund, we spend more of our time trying to figure out how the partners get along than just about anything else. Will they hang on together through the life of the fund? We know from experience how damaging it is when partners fall out, when key people leave. We know turnover can mean we lose everything we’ve invested. And yet, we still often get stung.

In my nearly-twenty years in and around the PE and VC industry in the US, Europe and Asia, I’ve never seen anything quite like what happens here in China. A quick look through my Outlook contacts reveals that almost half the PE partners I know working in China have changed firms in the last five years. One reason you don’t see this elsewhere is that partners expect to earn carried interest on the deals they’ve made. If they leave, they forgo this.

Carry is a kind of unvested pay. On paper, it’s often quite sizable, and should represent the majority of a PE partner’s total comp, as well a kind of golden handcuff. The only reason for partners to leave is they believe they won’t get any of this money, either because of failed deals or, more commonly, large doubts that the head partner, the person running the firm, will share the rewards from successful deals.

Most China PE firms are partnerships in name only. There is usually one top dog, usually the founder and rainmaker. This person can unilaterally decide who stays, who goes, who gets carry and who gets a lump of coal. Top Dog tends to treat partners like overpaid, somewhat undeserving hired hands.

So, why have partners at all? Often it’s because LPs insist on it, that they want PE and VC firms in China to be structured like those elsewhere. The business card says “Partner” but the attitude, expectations and level of commitment say “Employee”.

Senior staff (VPs, Managing Directors) also frequently depart. In the US, you don’t often see that much, since these are the people in line to become partners, which is meant to be the crowning achievement of a long successful career in the trenches. They leave because they don’t believe they’ll be promoted, or if they are, that they’ll see any real change in their current status as wage-earners.

At a party celebrating a recent IPO of a PE-backed Chinese company, I ran into the PE guy who led the original investment, did all the heavy lifting. He had since left and joined another firm. He laughed when I asked why he would leave before the IPO, with his old firm certain to earn a big profit on his deal. “I don’t know who will get the carry, but I was sure it wouldn’t include me,” he explained.

Partners jump ship most often because someone is offering a higher salary, a higher guaranteed amount of pay. Their new firm will usually also offer them carry. Both sides will negotiate fiercely over the specific terms, what percent with what hurdle rate. And yet, more often than not, it seems to be a charade.

From day one, the new partners may already thinking about their next career move, how to trade up. Emblematic of this: here in China, when PE partners join a new firm, they almost always refer to it as “joining a new platform”. Note the choice of words: platform, not firm.

The LPs — and I speak to quite a lot of them — acknowledge, of course, that there are other big risks in China, that individual investments or even a whole portfolio turns sour. But, this is a risk inherent in all PE investing everywhere. High partner turnover is not.

If you’re interested, you can click here and read the email exchange I had recently with a newly-departed partner at one of China’s better-known VC firms. As I write there, I hate to sound like a scold. I know PE partners also want to earn a good living, and should work where they are happiest and best compensated. But, China’s PE industry serves a deeper economic purpose and holds in trust the assets of both investors and companies. “Looking out for Number One” should not be the only career goal of those working in senior levels in the industry.