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Investing in China's start-ups is a risky business – but can reap big rewards

Many investors put money into a young company or help fund a project in return for equity in future developments and a share of the profits. But it’s a risky business.

PUBLISHED : Wednesday, 11 March, 2015, 9:45am
UPDATED : Wednesday, 11 March, 2015, 9:45am

Shenzhen is known as the Silicon Valley of China for good reason: tech giants Tencent, BYD, Huawei and ZTE have their headquarters there, and the infrastructure, investment and government support enables the city in the Pearl River Delta to generate more hi-tech enterprises.

Coolpad, Dingoo and G’Five International started in Shenzhen, and The Economist describes the city as the best place in the world to be a hardware innovator. Industry insiders estimate there are more than 2,000 design houses and 5,000 product integrators in Shenzhen alone, as designers, inventors and entrepreneurs from all over the world bring their ideas to life. From tiny portable sensors that record movement on the human body to a mechanical guitar tuner that connects to a mobile phone, purse-bound battery chargers and 3D printers, it's all dreamed up and built in Shenzhen.

“[Shenzhen has] access to a complex ecosystem of small to large scale manufacturing entities, electronic markets, and a fairly open environment of experimentation,” says Silvia Lindtner of the University of California, Irvine, and Fudan University in Shanghai.

How can investors take advantage of this climate of innovation and enterprise and hook up with a promising start-up in Shenzhen? 

“From time to time, there are a few events which allow start-ups to pitch locally and that's a straightforward way to find people,” says Cyril Ebersweiler, the founder of Haxlr8r, a Shenzhen- and San Francisco-based seed accelerator for hardware start-ups. “This includes trade shows. In general, the best way investors get put in touch with any company is through referral...”

Many hi-tech start-ups are gaining inertia in Shenzhen through incubators such as Ebersweiler's Haxlr8r. This seed accelerator awards inventors and entrepreneurs 15-week programmes in which they have access to their offices and workshops in Shenzhen, where they can develop their prototypes, make connections with factories, and get feedback from potential investors and customers. Haxlr8r also jumps on board as an initial investor, giving start-ups cash in exchange for future equity. They have helped more than 50 companies, such as Fabule, Helios and Notch, get off the ground.

Investing in a project that is being incubated by Haxlr8r or another seed accelerator often means looking no further than crowdfunding, as this is among the easiest ways to get involved with these start-ups from abroad. “If you are asking what my advice for investors is: go to Kickstarter and go to Hackerspaces,” Lindtner says. “The companies that have gone through Haxlr8r’s programme have a 100 per cent crowdfunding success rate, with an average backing of US$250,000.”

What kind of return can investors expect from putting their money into a Shenzhen start-up?

Larger investors generally put money into a young company or help fund a project in return for equity in future developments and a share of the profits. “Investors are expecting returns which might happen through an acquisition or an IPO in the next eight years or more,” Ebersweiler says.

Putting money into a hi-tech start-up rarely produces profitable results immediately. “It’s long-term thinking here, and a risky business... but very lucrative when it comes down to living an interesting life and being exposed to multiple industries and human contacts,” Ebersweiler says. He cautions that, “Entrepreneurs should spend time with their potential investor, as the relationship will be worse than a marriage: you can’t divorce here.”

Investors provide more to hi-tech start-ups than money. They are engaging in a partnership with the designers and inventors for the mutual goal of developing interesting, needed products and garnering success. “Investors have to display their understanding of the market and explain how they can help, as good companies have needs beyond money,” Ebersweiler says.

Investing in hi-tech start-ups is a high stakes game. Ebersweiler cautions: “There is no safety net... If the companies go under, you’ve lost it all... About 70 per cent of any given portfolio will be a failure.”