China’s booming start-up culture lures venture capitalists in search of the next US$1b unicorns

China, the world’s second largest venture capital market, may have seen a record number of new start-ups last year, but it’s struggled on another abstract metric of success -- the output of unicorns, or young companies with a valuation of at least US$1 billion.

“It is a fact that many newly set up companies would fail. It is not just the case in the mainland China but many start ups in Silicon Valley in the US also have a lot of failures. It is not easy to find the unicorns,” said Young Guo, general partner of IDG Capital Partners.

The world’s leading unicorns ranked by valuation are Uber, Xiaomi, Airbnb, Palantir Technologies and Didi Kuaidi, Uber’s main rival in China, according to data tracker CB Insights.

“Sometimes you have some companies you think are unicorns but they eventually fail. So the unicorns sometimes are just illusion. As a venture capital company, we are meeting many new start-ups to try to find the unicorns for investment opportunities. However, the process is just like hiring staff. You may interview several hundred people for a job but eventually you would only hire one or two,” Guo said during a presentation at the 7th Asian Leadership Conference in Seoul. The South China Morning Post is a media partner to the conference.

“We do believe unicorns exist but it is just very rare,” he said.

According to a study of Zero2IPO Partners released Wednesday, a total of 4.43 million new companies were established in China last year, an increase of 21.6 per cent from a year earlier.

“It is equal to eight new companies set up every minute last year. This is because Premier Li Keqiang visited Beijing’s Zhongguancun and Shenzhen, the mainland version of Silicon Valley,which sparked a wave of start-up activity.”

Last year, China’s venture capital investment totalled US$20.69 billion for 3,445 start-ups, compared with US$16.88 billion for 1,1917 companies in 2014. The previous venture capital record was US$13 billion for 1,505 start-ups in 2011.

Jarod Li, research director of Zero2IPO, said 2011 saw a surge of foreign venture capital investment before the market cooled the following year when mainland authorities suspended new listings. Premier Li’s visit, which the fund managers considered as a sign of government support for start-ups, has helped rekindle interest from venture capital and entrepreneurs alike.

Among common reasons that some companies fail, Guo cited the wrong business model, overspending and keen competition. For example, he said China now has 120 live online video streaming operators.

Chinese unicorns stand the best chance of spring up from the fields of technology, media, culture, consumption and health care, he said.

Among the changes that are reshaping the economic landscape, consumers are spending more on food and drink, fashion, and travel. Technology and entertainment are other fast growing sectors.

In addition to being a fast-growing sector, Guo said only companies with the right business model and those lucky enough to get the investment cycle right, are likely to make it to unicorns.

Internet concepts that only offer information online are not likely candidates. In contrast, companies with ties in to transaction and payments have better prospects.

“Scale is also important. The companies would need to capture a high number of users in a short period of time to create the scale so that the other competitors would find it hard to compete,” Guo said.

For culture-related companies, audience reach is important.

“A company that invest in movies that can sell to global audience would be better than those entertainment firms that could only serve certain local markets,” Guo said.

Companies that can help customers match deals or sales could also become potential unicorns. He cited the hypothetical example of company that could help steel companies sell over-supplied stock. But he cautioned that a matching platform was difficult to construct in such a way that satisfies both parties to a deal.

Even if the start-ups fail to reach unicorn status, Guo said they could be successful if they have the right business model and can follow the Chinese saying of “accumulate a lot, use little.”