Pacific News Service, Commentary, George Koo, Posted: Sep 04, 2003
Editor's Note: Like it did with Japan some 20 years ago, America seems to be looking East for an excuse for its own troubled economy. This time, China and its currency, the renminbi, are the scapegoat.
If the recent action of members of Congress bemoaning the loss of U.S. jobs is any indication, the United States is suffering from another anxiety attack and loss of confidence. These lawmakers accused China, in particular, of sabotaging the American economy by unfairly undervaluing its currency, the renminbi, against the dollar.
Bear in mind that China first pegged its currency to the dollar almost 10 years ago. When, three years later in 1997, Asian economies suffered a flight of capital and drastic devaluation of local currencies, China was universally praised for holding fast to the peg: it refused to devalue the renminbi in order to protect its share of export trade. (Interestingly, China's exports inexorably marched on despite a stronger currency relative to its faltering neighbors.)
Since then the dollar has weakened against world's major currencies, including the renminbi. Now, suddenly, forcing China to raise the value of the renminbi is being touted as the magical cure to America's economic ills.
This is somewhat reminiscent of America's ire with Japan some 20 years ago. At the time, Japan also held a huge trade surplus and was accused of keeping its yen artificially weak relative to the dollar.
Japan acquiesced and raised the value of the yen. But that did not solve America's economic woes in the early 1980s. Detroit screamed the loudest about the "unfair" competition, but failed to recapture lost market share even as Japanese carmakers raised their prices.
Some long-forgotten member of Congress even smashed a Japanese-made VCR on the steps of Capitol Hill to great fanfare, but this contributed not a whit to solving America's economic problems.
Whereas Japan was a closed economy that discouraged foreign investment and therefore outside participation in its economic growth, China has been open to foreign direct investment and attracted more of such investment than any other nation last year.
Companies invest in China by building manufacturing facilities there. China provides a productive work force at stable wage rates; one that works hard, learns fast and makes a wage high enough to raise its living standards.
Companies that have invested in China make more money by being able to export high quality goods at reasonable prices.
American consumers benefit by being able to buy these goods at a reasonable price and thus improve their standard of living without having to deal with the chaos of escalating inflation.
It has been a winning arrangement for all.
Those who claim that China is enjoying an unfair advantage with an artificially weak renminbi have failed to explain how any currency revaluation is going to bring jobs back to the United States.
Consider the most extravagant claim: The renminbi is being artificially depressed by 40 percent. Even if the renminbi were adjusted upward by 40 percent -- from 8.28 yuan to one U.S. dollar, to 5 yuan to $1 -- the average cost advantage of the Chinese worker over the U.S. worker would drop from 20 to 1 to a "mere" 12 to 1. How much net gain in jobs for the United States will result from that?
The reason China has become the factory for the world is because companies that used to supply the U.S. market from Taiwan, Korea and Mexico have moved their production to China to remain in business. The truth is that most of those jobs have not been in the United States for decades.
Some economists point out that China buys in the global markets almost as much as it sells. China buys products for domestic consumption, and it also purchases intermediate materials that need to be converted into export products. An economically strong China is looked upon as a possible tractor to pull the world out of the economic muck.
Wringing one's hands because we have been beaten in terms of cost and productivity won't solve anything. As recent as three years ago, we were bragging about the superiority of American technology and productivity. We need to get back to that frame of mind.
Forcing the renminbi off the peg is tantamount to destabilizing China's economy. And nobody wins from a weakened Chinese economy.
Thursday, September 4, 2003
Wednesday, May 14, 2003
Book Review - “The Chinese in America” by Iris Chang
NCM, George Koo, Posted: May 14, 2003
Iris Chang in her latest book, The Chinese in America, examines the phenomenon of an immigrant community still regarded as foreign despite having lived in America for more than 150 years. To Iris, the Chinese experience in the United States has been more of a series of repetitive cycles rather than a monotonic progression from victims of brutal abuse to becoming widely accepted as a “model minority.”
Chang chronicles early experiences that branded the Chinese. In 1877, there was Denis Kearney, a demagogue who rose to political power by fanning an anti-Chinese hysteria, accusing them of stealing the white man’s livelihood. In 1950, Senator Joseph McCarthy began a witchhunt to look for communists under every bed and an inquiry on “who lost China” to communism. The Chinese American community especially felt the heavy siege of suspicion and glare of McCarthyism.
In 1853, the conviction of killers for the murder of Chinese immigrant Ling Sing was overturned on the grounds that the “inferior caste of people who were non-citizens,” meaning Chinese, cannot testify against whites. In 1982, Ronald Ebens and Michael Nitz used a baseball bat to bash Vincent Chin to death. Even though Chin was born in America, Ebens and Nitz did not spend even one night in jail.
Ling Sing’s case prompted the phrase “not a Chinaman’s chance.” After nearly 130 years, Vincent Chin’s chances fared no better.
Everett Drumwright, then U.S. consul in Hong Kong, concluded in his Foreign Service report, filed in 1955, that nearly all Chinese in America were illegal aliens capable of all sorts of dastardly deeds including spying for China.
FBI Director J. Edgar Hoover also subscribed to the notion that the Chinese community teemed with spies from China. Later, FBI analyst Paul Moore was to refine Hoover’s theory by suggesting that China recruited spies differently relying on “ethnic affinity” rather than the customary blandishments of cash and sex.
Moore’s testimonies before the House Select Committee headed by Congressman Christopher Cox contributed to a sensational report alleging that more than 10,000 PRC company offices in the United States are intelligence gathering stations and all Chinese in the United States regardless of citizenship status are potential spies.
Opponents of President William Clinton used the Cox Report to accuse him of losing nuclear warhead missile technology to China. In response, his administration promptly offered Dr. Wen Ho Lee as the designated sacrificial lamb, the book suggests.
Lee was thrown in solitary confinement for months on 59 charges, all but one of which were later thrown out. He pled guilty to one count in exchange for time spent in jail. One can argue that Lee’s experience was an improvement over the fate of his predecessor scapegoats that were lynched, burned or shot by periodic rampaging mobs in the late 1800’s.
The author also drew positive parallels. Yung Wing became the first Chinese to graduate from a major university (Yale in 1854) and opened the door for others. In the early 1900’s, Chan Chung Wing became the first Chinese to practice law in California. Bessie Jeong was the first Chinese American woman to graduate from Stanford and became a practicing physician.
By breaking the mold, the trailblazers paved the way for others to follow. Today, accomplished Chinese Americans occupy every profession from Tsung Dao Lee and Chen Ning Yang (Nobel laureate physicists), to I.M. Pei (architect), Yo-Yo Ma (music), David Ho (medicine), Elaine Chao (government), to Gary Locke (politics), Charles Wang (software), Jerry Yang (Internet) and many more.
Of course, all Chinese Americans should read this book to truly understand how their roots in America were planted. They will be better braced for the next time they face a random invitation to “go back to where they come from”—even if this means Peoria. This book is not just for Chinese Americans but also for all newly arrived immigrants and conscientious citizens that care to appreciate the deficiencies of American democracy.
To read Iris Chang’s book is to understand that the only recourse is to stand for what is right and vigorously protect the principles that have made America a diverse nation from which its unique greatness sprang.
Iris Chang in her latest book, The Chinese in America, examines the phenomenon of an immigrant community still regarded as foreign despite having lived in America for more than 150 years. To Iris, the Chinese experience in the United States has been more of a series of repetitive cycles rather than a monotonic progression from victims of brutal abuse to becoming widely accepted as a “model minority.”
Chang chronicles early experiences that branded the Chinese. In 1877, there was Denis Kearney, a demagogue who rose to political power by fanning an anti-Chinese hysteria, accusing them of stealing the white man’s livelihood. In 1950, Senator Joseph McCarthy began a witchhunt to look for communists under every bed and an inquiry on “who lost China” to communism. The Chinese American community especially felt the heavy siege of suspicion and glare of McCarthyism.
In 1853, the conviction of killers for the murder of Chinese immigrant Ling Sing was overturned on the grounds that the “inferior caste of people who were non-citizens,” meaning Chinese, cannot testify against whites. In 1982, Ronald Ebens and Michael Nitz used a baseball bat to bash Vincent Chin to death. Even though Chin was born in America, Ebens and Nitz did not spend even one night in jail.
Ling Sing’s case prompted the phrase “not a Chinaman’s chance.” After nearly 130 years, Vincent Chin’s chances fared no better.
Everett Drumwright, then U.S. consul in Hong Kong, concluded in his Foreign Service report, filed in 1955, that nearly all Chinese in America were illegal aliens capable of all sorts of dastardly deeds including spying for China.
FBI Director J. Edgar Hoover also subscribed to the notion that the Chinese community teemed with spies from China. Later, FBI analyst Paul Moore was to refine Hoover’s theory by suggesting that China recruited spies differently relying on “ethnic affinity” rather than the customary blandishments of cash and sex.
Moore’s testimonies before the House Select Committee headed by Congressman Christopher Cox contributed to a sensational report alleging that more than 10,000 PRC company offices in the United States are intelligence gathering stations and all Chinese in the United States regardless of citizenship status are potential spies.
Opponents of President William Clinton used the Cox Report to accuse him of losing nuclear warhead missile technology to China. In response, his administration promptly offered Dr. Wen Ho Lee as the designated sacrificial lamb, the book suggests.
Lee was thrown in solitary confinement for months on 59 charges, all but one of which were later thrown out. He pled guilty to one count in exchange for time spent in jail. One can argue that Lee’s experience was an improvement over the fate of his predecessor scapegoats that were lynched, burned or shot by periodic rampaging mobs in the late 1800’s.
The author also drew positive parallels. Yung Wing became the first Chinese to graduate from a major university (Yale in 1854) and opened the door for others. In the early 1900’s, Chan Chung Wing became the first Chinese to practice law in California. Bessie Jeong was the first Chinese American woman to graduate from Stanford and became a practicing physician.
By breaking the mold, the trailblazers paved the way for others to follow. Today, accomplished Chinese Americans occupy every profession from Tsung Dao Lee and Chen Ning Yang (Nobel laureate physicists), to I.M. Pei (architect), Yo-Yo Ma (music), David Ho (medicine), Elaine Chao (government), to Gary Locke (politics), Charles Wang (software), Jerry Yang (Internet) and many more.
Of course, all Chinese Americans should read this book to truly understand how their roots in America were planted. They will be better braced for the next time they face a random invitation to “go back to where they come from”—even if this means Peoria. This book is not just for Chinese Americans but also for all newly arrived immigrants and conscientious citizens that care to appreciate the deficiencies of American democracy.
To read Iris Chang’s book is to understand that the only recourse is to stand for what is right and vigorously protect the principles that have made America a diverse nation from which its unique greatness sprang.
Friday, March 28, 2003
For China, Iraq Conflict is America's War
Pacific News Service, Commentary, George Koo, Posted: Mar 28, 2003
Editor's Note: China is officially opposed to the war in Iraq, but recent actions show China is most concerned with improving its relationship with the United States and keeping its giant economy growing.
On a recent business trip to Shanghai I asked people about the conflict with Iraq. They had little to say. To the Chinese, this is America's war.
China's top advisory body recently expressed "shock and concern" with the war. But unlike France and Russia, which have strongly opposed the war with belligerent statements and U.N. Security Council veto threats, China's response has been relatively mild.
It has never been in the Chinese character to tell another nation what to do. China long ago concluded that confrontation with the United States was not in its national interest. After Sept. 11, 2001, China actively sought common cause with Washington in fighting terrorism. China's former president, Jiang Zemin, visited President George Bush at his Crawford, Texas, ranch in the fall of 2002 to seemingly seal the alliance.
Since then China has gone out of its way to cultivate friendly relations with the United States.
As the U.S.-led military action in Iraq began, a spokesman from Beijing's Foreign Ministry expressed "regret and disappointment" and indicated that the invasion "violates norms of international behavior." His comments, read during a regularly scheduled briefing, did not criticize the United States by name.
After the first missiles landed on Baghdad -- shown live on China Central Television -- reaction on the street was considerably stronger. The U.S. bombing of the Chinese embassy in Belgrade seemed to bubble to the fore, as most concluded that, in the words of one man, "the U.S. is being a big bully again."
Officially, China continues to work within the U.N. charter and in cooperation with other nations to look for a peaceful solution. Clearly, China is reluctant to take any lead in opposition to the unilateral U.S. action. In any case, events on the ground and in Iraq's airspace are likely to overtake any further and futile attempts at diplomacy.
Looming on the horizon is the threat from North Korea, which the Bush administration seems to think is within China's capability to resolve unilaterally. China has demurred, but offers to assist the U.S. in multilateral diplomacy -- alas, not a strong suit for the Bush administration.
China's priority remains its domestic economy, which must continue to grow at 7 to 8 percent per year in order to create the jobs needed to soak up laid-off workers and rural migrants.
Unfortunately, China's economy is also fueled by oil, and this spells potential future conflict with the United States. In 2000, 31 percent of the oil consumed by China was imported. Within 30 years, China's dependence on imported oil is expected to increase to 84 percent. Much of the world's oil is located in the Gulf region.
China can only hope that by the time competition for oil arises, the United States will be too busy or too exhausted to pick another fight.
Editor's Note: China is officially opposed to the war in Iraq, but recent actions show China is most concerned with improving its relationship with the United States and keeping its giant economy growing.
On a recent business trip to Shanghai I asked people about the conflict with Iraq. They had little to say. To the Chinese, this is America's war.
China's top advisory body recently expressed "shock and concern" with the war. But unlike France and Russia, which have strongly opposed the war with belligerent statements and U.N. Security Council veto threats, China's response has been relatively mild.
It has never been in the Chinese character to tell another nation what to do. China long ago concluded that confrontation with the United States was not in its national interest. After Sept. 11, 2001, China actively sought common cause with Washington in fighting terrorism. China's former president, Jiang Zemin, visited President George Bush at his Crawford, Texas, ranch in the fall of 2002 to seemingly seal the alliance.
Since then China has gone out of its way to cultivate friendly relations with the United States.
As the U.S.-led military action in Iraq began, a spokesman from Beijing's Foreign Ministry expressed "regret and disappointment" and indicated that the invasion "violates norms of international behavior." His comments, read during a regularly scheduled briefing, did not criticize the United States by name.
After the first missiles landed on Baghdad -- shown live on China Central Television -- reaction on the street was considerably stronger. The U.S. bombing of the Chinese embassy in Belgrade seemed to bubble to the fore, as most concluded that, in the words of one man, "the U.S. is being a big bully again."
Officially, China continues to work within the U.N. charter and in cooperation with other nations to look for a peaceful solution. Clearly, China is reluctant to take any lead in opposition to the unilateral U.S. action. In any case, events on the ground and in Iraq's airspace are likely to overtake any further and futile attempts at diplomacy.
Looming on the horizon is the threat from North Korea, which the Bush administration seems to think is within China's capability to resolve unilaterally. China has demurred, but offers to assist the U.S. in multilateral diplomacy -- alas, not a strong suit for the Bush administration.
China's priority remains its domestic economy, which must continue to grow at 7 to 8 percent per year in order to create the jobs needed to soak up laid-off workers and rural migrants.
Unfortunately, China's economy is also fueled by oil, and this spells potential future conflict with the United States. In 2000, 31 percent of the oil consumed by China was imported. Within 30 years, China's dependence on imported oil is expected to increase to 84 percent. Much of the world's oil is located in the Gulf region.
China can only hope that by the time competition for oil arises, the United States will be too busy or too exhausted to pick another fight.
Friday, January 3, 2003
Twisted Flights, Flawed Logic - Time for Taiwan to Face Economic Facts
Pacific News Service, George Koo, Posted: Jan 03, 2003
Editor's Note: The roundabout flights from Shanghai to Taipei are just the beginning of Taiwan's convoluted logic when it comes to China, writes PNS contributor George Koo. Missing a golden opportunity last year to improve relations with its giant neighbor, Taiwan must take steps in 2003 to stop job loss and brain drain across the Taiwan Strait.
For the first time ever, thousands of Taiwanese living in Mainland China will fly from Shanghai, uh, somewhat directly to Taipei to celebrate the Chinese New Year, coming Feb. 1, at home. Specially chartered planes will take off from inside China and touch down in Hong Kong or Macao before proceeding to Taipei.
But instead of a short, one-hour hop from Shanghai to Taipei, the planes will fly two long legs of a triangle, roughly quadrupling the flight time, just to be politically acceptable to Taipei. The planes will be empty of passengers on the return part of the trip. Why? Because there is no formal recognition between governments across the Taiwan Strait, Taipei reasons that the planes cannot behave as if they were bona fide commercial flights.
The passengers will have ample time to ponder the absurdity of it all. Their flight path is comparable to flying from Boston to New York via St. Louis.
Taiwan's business community has been clamoring for direct links to the mainland. Some $600 million is spent annually on unnecessary airfare, to say nothing of wasted time in transit.
Since he came to power in 2000, many of President Chen Shui Bian's backers have urged him to move boldly toward full independence from Beijing. The end result is like the charter flights, a compromise that pleases no one and solves nothing.
Last year, the Chinese Year of the Horse, could have been a breakthrough year in cross-strait relations. Both sides just entered WTO and needed to begin bilateral discussion to work out the details. Instead, the horse never left the post. Taipei so artfully stalled that only now have they agreed to meet and begin discussions.
Meanwhile, it has become increasingly obvious that benefits of cross-strait relations are all going in one direction: to China. Taiwan capital, people, production equipment, ideas and products are going to China. By some estimates, as much as $100 billion -- more than one-fifth of the total foreign investment in China -- originates from Taiwan.
What about investment in the other direction, from China to Taiwan? None, because in contrast to Beijing's open door, Taipei's policies restrict visitors from the mainland, rendering such investments impractical.
Advocates of Taiwan independence, particularly those residing comfortably in the United States, like to point out that one cannot live by bread alone, but must have the personal freedom of choice. Sadly, Taiwan's economy has been rolling steadily downhill, and unemployment is at an all-time high. Political choice is hardly on the agenda of folks without bread.
Some of the best and brightest are choosing with their feet. They now live and work in China, most conspicuously in the greater Shanghai area. They are putting roots down in China, bringing their families and buying homes.
One Taipei study estimates that those leaving for the mainland represent 25 percent of Taiwan's economic elite. Their absence ripples throughout Taiwan's economy.
Taiwan's housing market is depressed because more are selling than buying. Instead of seeing their favorite customers every week, popular restaurants now see them every two to three months -- on their periodic return from China.
Even Taiwan's Lions Club feels the economic shift. In the first six months of last year, its membership dropped from 35,000 to 31,000. At its peak, club membership included more than 40,000 professionals. At every meeting, someone else is missing, having left for the mainland.
Taiwan is becoming a depressing place, especially so because the government seems so unaware of the economic consequences of its politics.
Two out of three Taiwan tourists go to the mainland for vacation. Only 1 out of 10,000 tourists from the mainland is able to visit Taiwan. In just 10 months last year, 12 million tourists went globetrotting from China. The Taipei government could see immediate economic benefits merely by welcoming an annual projected stream of 300,000 visitors from across the strait.
President Chen dares not open Taiwan to the mainland for fear of losing his political support and for reasons rooted in paranoia. During the debate about direct flights from the mainland, someone in his administration actually opposed them on the grounds that an unfriendly plane could make a Sept. 11-like beeline for the presidential palace in Taipei.
Chen's approval rating is at an all-time low, as is Taiwan's economy. Everyone is watching to see if he will take decisive action in 2003 to turn things around. If not, his re-election in 2004 is not assured. He came to power with less than 40 percent of the popular vote. He may have to do considerably better next time and not count on a divided opposition to again put him in power.
Editor's Note: The roundabout flights from Shanghai to Taipei are just the beginning of Taiwan's convoluted logic when it comes to China, writes PNS contributor George Koo. Missing a golden opportunity last year to improve relations with its giant neighbor, Taiwan must take steps in 2003 to stop job loss and brain drain across the Taiwan Strait.
For the first time ever, thousands of Taiwanese living in Mainland China will fly from Shanghai, uh, somewhat directly to Taipei to celebrate the Chinese New Year, coming Feb. 1, at home. Specially chartered planes will take off from inside China and touch down in Hong Kong or Macao before proceeding to Taipei.
But instead of a short, one-hour hop from Shanghai to Taipei, the planes will fly two long legs of a triangle, roughly quadrupling the flight time, just to be politically acceptable to Taipei. The planes will be empty of passengers on the return part of the trip. Why? Because there is no formal recognition between governments across the Taiwan Strait, Taipei reasons that the planes cannot behave as if they were bona fide commercial flights.
The passengers will have ample time to ponder the absurdity of it all. Their flight path is comparable to flying from Boston to New York via St. Louis.
Taiwan's business community has been clamoring for direct links to the mainland. Some $600 million is spent annually on unnecessary airfare, to say nothing of wasted time in transit.
Since he came to power in 2000, many of President Chen Shui Bian's backers have urged him to move boldly toward full independence from Beijing. The end result is like the charter flights, a compromise that pleases no one and solves nothing.
Last year, the Chinese Year of the Horse, could have been a breakthrough year in cross-strait relations. Both sides just entered WTO and needed to begin bilateral discussion to work out the details. Instead, the horse never left the post. Taipei so artfully stalled that only now have they agreed to meet and begin discussions.
Meanwhile, it has become increasingly obvious that benefits of cross-strait relations are all going in one direction: to China. Taiwan capital, people, production equipment, ideas and products are going to China. By some estimates, as much as $100 billion -- more than one-fifth of the total foreign investment in China -- originates from Taiwan.
What about investment in the other direction, from China to Taiwan? None, because in contrast to Beijing's open door, Taipei's policies restrict visitors from the mainland, rendering such investments impractical.
Advocates of Taiwan independence, particularly those residing comfortably in the United States, like to point out that one cannot live by bread alone, but must have the personal freedom of choice. Sadly, Taiwan's economy has been rolling steadily downhill, and unemployment is at an all-time high. Political choice is hardly on the agenda of folks without bread.
Some of the best and brightest are choosing with their feet. They now live and work in China, most conspicuously in the greater Shanghai area. They are putting roots down in China, bringing their families and buying homes.
One Taipei study estimates that those leaving for the mainland represent 25 percent of Taiwan's economic elite. Their absence ripples throughout Taiwan's economy.
Taiwan's housing market is depressed because more are selling than buying. Instead of seeing their favorite customers every week, popular restaurants now see them every two to three months -- on their periodic return from China.
Even Taiwan's Lions Club feels the economic shift. In the first six months of last year, its membership dropped from 35,000 to 31,000. At its peak, club membership included more than 40,000 professionals. At every meeting, someone else is missing, having left for the mainland.
Taiwan is becoming a depressing place, especially so because the government seems so unaware of the economic consequences of its politics.
Two out of three Taiwan tourists go to the mainland for vacation. Only 1 out of 10,000 tourists from the mainland is able to visit Taiwan. In just 10 months last year, 12 million tourists went globetrotting from China. The Taipei government could see immediate economic benefits merely by welcoming an annual projected stream of 300,000 visitors from across the strait.
President Chen dares not open Taiwan to the mainland for fear of losing his political support and for reasons rooted in paranoia. During the debate about direct flights from the mainland, someone in his administration actually opposed them on the grounds that an unfriendly plane could make a Sept. 11-like beeline for the presidential palace in Taipei.
Chen's approval rating is at an all-time low, as is Taiwan's economy. Everyone is watching to see if he will take decisive action in 2003 to turn things around. If not, his re-election in 2004 is not assured. He came to power with less than 40 percent of the popular vote. He may have to do considerably better next time and not count on a divided opposition to again put him in power.
Wednesday, November 27, 2002
Role of Venture Capital in the Development of High Technology in Silicon Valley
Text of a speech given in China, November 2002
In less than 2 decades, “Silicon Valley” became the name of a real place, a place that won worldwide recognition as ground zero where commercial breakthroughs in high technology occurred regularly. Silicon Valley, located south of San Francisco became the birthplace of such high tech giants as Intel, Sun Microsystems, Cisco Systems, Oracle, Applied Materials and Genentech—all leaders in their field. The proliferation of semiconductor start-ups that grew into major companies and equipment and material suppliers that grew by supporting this industry led to the coining of the term, “Silicon Valley.”
The emergence of Silicon Valley as the world’s high tech capital would not have been possible without the use of venture capital. Indeed, venture capitalism, i.e., risky investments in emerging young companies for the purpose of earning high returns, also became a widely recognized professional discipline. This recognition came after its spectacular investments in such companies as Apple Computer, Cisco, and Yahoo returned thousands of times original invested amount. No other place in the world has been more successful in the use of venture capital than Silicon Valley. In recent years, Silicon Valley with only about 2% of the U.S. population has attracted as much as 40% of all the venture capital invested in the U.S. During the height reached in 2000, over $60 billion were invested in the U.S. in privately held young companies.
Therefore, no place is better suited to study the relationship of venture capital to development of high technology companies than Silicon Valley. Understanding Silicon Valley is essential to understanding how venture capital can be utilized elsewhere to achieve comparable outcome.
How does venture capital work?
The idea of making early investments in privately held companies for a chance to earn high rate of return did not originate in California but in the traditional east coast financial centers such as New York and Boston. The success of their early investments in Apple, Intel and some others led to decisions to establish branch offices in the San Francisco area which in turn led to the formation of new venture capital partnerships as others follow and as some of original partners split off to form new firms. Success breeds success and as venture capital firms boast of average annual returns of 25 to 35%, more funds become available to make these investments and more groups are formed to manage the invested capital and funds. It is not unusual today for established venture capital firms to manage one billion dollars or more.
Venture capital is invested in early stage, privately held companies in hopes of gaining a windfall profit when such company becomes publicly listed or is merged with another company whereby the acquiring company pays handsomely for their equity stake. It is very important to keep in mind that venture capital investments depend on clear-cut route to being able to liquidate their investments. Most high tech start-ups, as many as 4 out of 5, fail and the investment is written off. However, a successful venture capitalist will manage to make at least one investment that brings a return to more than make up for the losses. Because of the risky nature of these investments, venture capitalists rarely make investments in profitable but slow growing businesses. Such businesses take a long time to go public and do not offer a big enough potential return. Rather, venture capitalists look for companies with the potential of outstanding return on investment. In Silicon Valley, this potential is often referred to as having an anticipated revenue stream of a hockey stick. Companies engaged in developing high tech breakthroughs are more likely to experience the hockey stick phenomenon than say a chain of fast food restaurants. This is why venture capital goes to where high tech breakthroughs are being made.
While the need to make huge return on investments explains the attraction of venture capital to the high tech industries, it does not explain why Silicon Valley can attract such a disproportionate share of the venture capital. To understand that, it is necessary to examine the culture and other characteristics of Silicon Valley.
The Silicon Valley culture and infrastructure
In many ways, Silicon Valley is unique even within the U.S. No other place is as diverse as Silicon Valley. Silicon Valley has room for people from all over the world and they all come, attracted by the pleasant weather and the diversity of people. Diversity is crucial in high technology because diversity automatically ensures many different ways of thinking and looking at problems leading to a host of solutions. Only in this manner can the best solution be synthesized out of contending ideas and emerge as the commercial winner. In a way, high tech innovation is similar to Darwinian survival of the species. Namely, endangered species bordering on extinction suffer from narrow gene pools while healthy species enjoy wide and diverse gene pools. In Silicon Valley today, as one indication of its inclusive diversity, over 30% of the companies are founded or managed by immigrants from China, Taiwan and India.
The best and brightest are attracted to Silicon Valley not only because of the inclusive nature of this place--certainly overt discrimination because of someone’s skin color and other differentiation has largely disappeared. The other reason is that entrepreneurs in Silicon Valley can readily find others of like mind to band together and approach venture capital investors with business plans and proposals. In Silicon Valley, venture capitalists do not refuse to invest on someone just because the particular entrepreneur comes from a failed venture. Since most ventures do fail, the investor gives the entrepreneur credit for having gained valuable experience even if the previous venture failed. This tolerance for failure is crucial in encouraging entrepreneurs to take risks and start companies. The importance cannot be over emphasized. In Silicon Valley, “it is OK to fail.” No other place has quite the same open-minded attitude.
With the success of high tech industries and the growth of venture capital in Silicon Valley, the economic infrastructure also expanded and became part of the environment. Infrastructure needed to support high tech companies include law firms and accounting firms to help them form proper legal structure and organized to meet Securities Exchange regulations with proper stock ownership incentive programs for not just the founders but also for employees joining the high tech enterprise. The legal and accounting firms also help the venture capital firms structure their investments and keep track of their gains and losses. Other parts of the total infrastructure include public relations and advertising firms that serve the marketing and communication needs of high tech companies. Investment banks help the companies with initial public offering and follow-on secondary offerings in the equity market and propose mergers. Specialized commercial banks and leasing firms were established just to serve the high tech companies that more traditional banks dare not touch because the latter did not understand the nature of high tech companies and were frightened by its high mortality rate.
An entire profession emerged that called themselves “free lance technical writers.” These writers contract their services to high tech companies to help them write user’s manuals, technical brochures and a host of documents to help the companies convey what they have developed to the public. Human capital firms helped high tech companies set employee hiring policies and help locate and recruit people with the needed skill sets. Successful entrepreneurs often retired from active management and became consultants and advisors to venture capital firms and to other start-ups. Arguably the trend to outsourcing gained impetus from Silicon Valley because young start-ups have limited resources and most in need of outside assistance. Most models of Macintosh from Apple Computer, for instance, were designed by independent product design services and made by contract manufacturers.
Frequently overlooked but a vital part of the Silicon Valley infrastructure is the widespread presence of professional associations. These associations organized along industries or common interests meet regularly. Ostensibly, these meetings feature speakers and topics of general interest to its membership. Equally important, these gatherings offer opportunities for professionals to meet regularly with each other and form friendships, to network and exchange ideas and resumes and to assess the potential of each as a future co-founder of the next new start-up enterprise. The Churchill Club meets frequently hosting panel discussions on high tech development and regularly draws an audience of 4-500. AAMA, the oldest Asian American organization in Silicon Valley, draws 1-200 in their monthly dinner meeting. AAMA used to be known as Asian American Manufacturers Association but since not much was being made in Silicon Valley nowadays, the name was recently changed to Asian American Multi-Technology Association. Younger organizations such as Hua Yuan Science & Technology Association and China Information Networks Association tend to organize their events on weekends and can draw over 1000 young Chinese professional to their events. The Indus Entrepreneurs was organized as network for immigrant professionals from South Asia and widely recognized for not just their conferences but as a breeding ground for many successful high tech enterprises founded by Indians and Pakistanis. There are many other networking organizations and associations in Silicon Valley that space do not permit listing here. The important point is that the success of Silicon Valley is dependent on an environment where people can mingle and ideas cross-pollinate.
In summary, the success of Silicon Valley begins with its open environment where all comers with the skills and drive to succeed are welcome. Venture capital then followed to invest in this concentration of entrepreneurial energy. The spectacular returns from these investments in turn spawned a host of supporting professions that made Silicon Valley the high tech capital that it is today. A frequently asked question from foreign visitors is: “What should the government do to encourage the birth of other Silicon Valleys?” The flippant retort from most denizens of Silicon Valley is: “As little as possible.”
Government’s role in Silicon Valley
Most Silicon Valley entrepreneurs regard the government as more of a hindrance than help. For example currently a heated debate is going on between the venture capitalists and entrepreneurs on the one side and the Security Exchange Commission on the other. The SEC wants to force all companies to account stock options as a real expense. Silicon Valley companies argue that stock options are vital incentives for people working in young companies and cannot be accurately valued when the success of the company is still in doubt. If companies are forced to expense stock options, the worry is that then stock options would cease to be a preferred method to motivate the employees. At present, engineers and others join young companies for the excitement of starting something new and toil long hours at below market wages because they are motivated to see their company succeed and their wealth realized through stock options.
Silicon Valley companies also resent the export control policies of their federal government. They regard such policies as unreasonable and arbitrary and directly impact their competitive position. As a spokesperson from Semiconductor Manufacturing International Corporation recently pointed out, SMIC can buy equipment from European supplier and expect delivery in two weeks, from Japan in two months and from the U.S. the delivery is uncertain and may take 6 months or more, most of that time spent getting necessary government clearances.
However, the U. S. federal government also plays a vital role in at least two major respects to ensure the continued development of high tech industries. The most important is in promulgating clear and transparent regulations that govern the equity market. Other than making sure that the rules and regulations apply to all companies equally, the government stays out of the way. Whether a company is ready for a public listing in the stock market is controlled only by the market conditions. When the market is strong and many investors are participating, even some of the inferior companies can go public because of high public demand for new issues. When the market is weak, even the best companies have difficulty getting a listing.
Letting the market decide when and if their investee companies can become publicly listed is extremely important to the venture capitalist. When they make an investment, they hope to liquidate in three to five years. Best way to liquidate is to list their portfolio company in the stock market. The venture capitalist watches the stock market with care, constantly comparing the reception of the stock market to how their portfolio company might be worth. They are in regular conversation with the investment bankers to determine when to best offer a portfolio company to the initial public offering (IPO) process.
The federal government also plays a vital role as the provider of funds for research and development work that no venture capitalist would contemplate underwriting. These R&D work tend to be fundamental in nature with no certainty of outcome and no practical applications in sight. Best examples that come to mind would be research grants from National Institute of Health to various university research labs that led to breakthroughs in genetic engineering. Then a host of companies were funded by venture capital and other private capital sources to convert the laboratory discoveries with additional downstream development into commercial successes. The discoveries from the labs at the medical schools of Stanford and University of California at San Francisco led directly to the formation of Genentech and Chiron and the San Francisco bay area now hosts the largest cluster of biotech firms in the U.S. Advances in modern medicine and therapy would not have been possible without government support. Government funding in military defense and space exploration also led to commercial successes in the private sector. The Internet and many advances in electronics and materials can be directly attributed to original funding by the federal government.
Thus the role of the government can be simply summarized. The primary responsibility of creating a fair, open and regulated environment for the equity market is vital to maintaining the confidence of the investor public and ensuring a clear path of liquidity to the venture capitalist. No professional venture capitalist can operate in an environment where he cannot see a path to liquidating the investment. Secondly, government funding is essential to generating basic technological advances. Only the central government can assume such risks and technological advances drive innovations with commercial implications.
The venture investing process
In Silicon Valley the venture investing process has more or less evolved into a standard procedure. Some firms specialize in investing in the first round of funding where the risk is highest but the potential return is also highest since the amount invested can be relatively small for the equity stake comparable to later rounds of investment at higher cost. Other firms prefer later rounds of financing; some even invest only in the round just prior to the company going public. By and large, venture capitalists never consider themselves as passive investors but claim to help their investments succeed by being active investors. They add value by serving on the board of the investee companies, by acting as advisors to the management team, by helping to recruit needed executives, by introducing the investee company to other companies for the purpose of forming alliances and by introducing the company to the financial community (Wall Street). Not all venture capital firms are accorded with the same regard. Entrepreneurs pursue blue ribbon firms that consistently enjoy above industry average returns not just for their money and their connections. Having such famous venture capital firms as investors imply endorsement and validation of the company and its business objectives.
It should not be surprising that venture capitalists place highest importance in the character of the people they are investing in. The venture capitalist needs to know if the team of entrepreneurs has integrity, can get along with each other and can work with the investor. Their worst nightmare is to invest in a dishonest team who will stop communicating with the investor after funding and run the company without input from the venture investor. In Silicon Valley the due diligence process is rigorous. Usually the venture capitalist after extensive analysis and deciding that interest exists in investing in the company will offer a term sheet outlining the boundaries of the deal. Such term sheets are always subject to verification of representations made by the entrepreneurs in the due diligence process. There are even professional service firms to perform the due diligence investigations. A typical claim by many venture capitalists is that out of every 100 business proposals and plans they review, only about 10 are invited to face to face meetings resulting in 2-3 term sheets and only about half or less of those conclude in actual investments.
Despite the emphasis on technology, Silicon Valley venture capitalists are rarely dazzled by just the technology. They do not invest in “solutions looking for problems to solve.” They look for and ascertain that there will be markets for the products being proposed by the entrepreneur. In other words the business potential is more important than the novelty of the invention. They are fond of saying if they must have an “A” and a “B,” then they would rather have an A team for marketing and a B team for R&D than the other way around.
While venture capital has played a vital role in transforming Silicon Valley into a high tech capital, only about 25% of the Silicon Valley start-ups receive professional venture capital funding. Others start by their own bootstrap, or funds from family and friends. I have not seen a comparison of the survival rates of the two kinds start-ups but not all professionally funded companies survive and non-professionally funded enterprises can also grow into major companies. The most famous example of the latter was Hewlett-Packard, which was started by the two founders long before there was a Silicon Valley and venture capital. Cisco was founded by a husband and wife team and grew for a long time without venture capital.
Conclusion
In the final analysis, high technology development depends on having skilled and motivated people in an open environment where ideas can be freely tested. Entrepreneurs with the best ideas are more likely to attract professional investments. The best managed companies and sometimes the luckiest companies are most likely to reach the critical mass and become an attractive investment for the investing public or as a target for acquisition. Venture capitalists with the best record of making successful investments will have the least problem of raising new funds to invest in new companies. As they become successful, they become better known and are likely to be introduced to superior ideas from more proven entrepreneurs. The quality of their deal flow improves and thus increases the probability of their making more profitable investments. Such accelerating cycle applies to both the proven entrepreneur and the successful venture capitalist. The market forces determine the fate of their efforts.
Another question sometimes asked is: “How to attract premier venture capital firms from Silicon Valley to operate in places like China?” The answer is: “With a great deal of difficulty.” Venture capitalists are hands-on investors. They need to be near their investee companies and they need to be able to help their portfolio companies succeed. To most venture capitalists, with selected exceptions, China is far away and is a place they do not understand and can offer little added value. The exceptions are those individuals that are familiar with both sides of the Pacific, knowledgeable in both environments and can help their investee companies bridge the gap and gain an advantage by establishing cross border alliances. They can make astute investments on both sides and gain leverage by introducing companies from one side to work with the other.
The future is bright for China to develop high tech industries because China has plenty of human talent and entrepreneurial energy. As soon as the path to liquidity can be clearly defined, more and more professional venture investors will come to China with funds to invest. Let the snowball roll down the mountain!
In less than 2 decades, “Silicon Valley” became the name of a real place, a place that won worldwide recognition as ground zero where commercial breakthroughs in high technology occurred regularly. Silicon Valley, located south of San Francisco became the birthplace of such high tech giants as Intel, Sun Microsystems, Cisco Systems, Oracle, Applied Materials and Genentech—all leaders in their field. The proliferation of semiconductor start-ups that grew into major companies and equipment and material suppliers that grew by supporting this industry led to the coining of the term, “Silicon Valley.”
The emergence of Silicon Valley as the world’s high tech capital would not have been possible without the use of venture capital. Indeed, venture capitalism, i.e., risky investments in emerging young companies for the purpose of earning high returns, also became a widely recognized professional discipline. This recognition came after its spectacular investments in such companies as Apple Computer, Cisco, and Yahoo returned thousands of times original invested amount. No other place in the world has been more successful in the use of venture capital than Silicon Valley. In recent years, Silicon Valley with only about 2% of the U.S. population has attracted as much as 40% of all the venture capital invested in the U.S. During the height reached in 2000, over $60 billion were invested in the U.S. in privately held young companies.
Therefore, no place is better suited to study the relationship of venture capital to development of high technology companies than Silicon Valley. Understanding Silicon Valley is essential to understanding how venture capital can be utilized elsewhere to achieve comparable outcome.
How does venture capital work?
The idea of making early investments in privately held companies for a chance to earn high rate of return did not originate in California but in the traditional east coast financial centers such as New York and Boston. The success of their early investments in Apple, Intel and some others led to decisions to establish branch offices in the San Francisco area which in turn led to the formation of new venture capital partnerships as others follow and as some of original partners split off to form new firms. Success breeds success and as venture capital firms boast of average annual returns of 25 to 35%, more funds become available to make these investments and more groups are formed to manage the invested capital and funds. It is not unusual today for established venture capital firms to manage one billion dollars or more.
Venture capital is invested in early stage, privately held companies in hopes of gaining a windfall profit when such company becomes publicly listed or is merged with another company whereby the acquiring company pays handsomely for their equity stake. It is very important to keep in mind that venture capital investments depend on clear-cut route to being able to liquidate their investments. Most high tech start-ups, as many as 4 out of 5, fail and the investment is written off. However, a successful venture capitalist will manage to make at least one investment that brings a return to more than make up for the losses. Because of the risky nature of these investments, venture capitalists rarely make investments in profitable but slow growing businesses. Such businesses take a long time to go public and do not offer a big enough potential return. Rather, venture capitalists look for companies with the potential of outstanding return on investment. In Silicon Valley, this potential is often referred to as having an anticipated revenue stream of a hockey stick. Companies engaged in developing high tech breakthroughs are more likely to experience the hockey stick phenomenon than say a chain of fast food restaurants. This is why venture capital goes to where high tech breakthroughs are being made.
While the need to make huge return on investments explains the attraction of venture capital to the high tech industries, it does not explain why Silicon Valley can attract such a disproportionate share of the venture capital. To understand that, it is necessary to examine the culture and other characteristics of Silicon Valley.
The Silicon Valley culture and infrastructure
In many ways, Silicon Valley is unique even within the U.S. No other place is as diverse as Silicon Valley. Silicon Valley has room for people from all over the world and they all come, attracted by the pleasant weather and the diversity of people. Diversity is crucial in high technology because diversity automatically ensures many different ways of thinking and looking at problems leading to a host of solutions. Only in this manner can the best solution be synthesized out of contending ideas and emerge as the commercial winner. In a way, high tech innovation is similar to Darwinian survival of the species. Namely, endangered species bordering on extinction suffer from narrow gene pools while healthy species enjoy wide and diverse gene pools. In Silicon Valley today, as one indication of its inclusive diversity, over 30% of the companies are founded or managed by immigrants from China, Taiwan and India.
The best and brightest are attracted to Silicon Valley not only because of the inclusive nature of this place--certainly overt discrimination because of someone’s skin color and other differentiation has largely disappeared. The other reason is that entrepreneurs in Silicon Valley can readily find others of like mind to band together and approach venture capital investors with business plans and proposals. In Silicon Valley, venture capitalists do not refuse to invest on someone just because the particular entrepreneur comes from a failed venture. Since most ventures do fail, the investor gives the entrepreneur credit for having gained valuable experience even if the previous venture failed. This tolerance for failure is crucial in encouraging entrepreneurs to take risks and start companies. The importance cannot be over emphasized. In Silicon Valley, “it is OK to fail.” No other place has quite the same open-minded attitude.
With the success of high tech industries and the growth of venture capital in Silicon Valley, the economic infrastructure also expanded and became part of the environment. Infrastructure needed to support high tech companies include law firms and accounting firms to help them form proper legal structure and organized to meet Securities Exchange regulations with proper stock ownership incentive programs for not just the founders but also for employees joining the high tech enterprise. The legal and accounting firms also help the venture capital firms structure their investments and keep track of their gains and losses. Other parts of the total infrastructure include public relations and advertising firms that serve the marketing and communication needs of high tech companies. Investment banks help the companies with initial public offering and follow-on secondary offerings in the equity market and propose mergers. Specialized commercial banks and leasing firms were established just to serve the high tech companies that more traditional banks dare not touch because the latter did not understand the nature of high tech companies and were frightened by its high mortality rate.
An entire profession emerged that called themselves “free lance technical writers.” These writers contract their services to high tech companies to help them write user’s manuals, technical brochures and a host of documents to help the companies convey what they have developed to the public. Human capital firms helped high tech companies set employee hiring policies and help locate and recruit people with the needed skill sets. Successful entrepreneurs often retired from active management and became consultants and advisors to venture capital firms and to other start-ups. Arguably the trend to outsourcing gained impetus from Silicon Valley because young start-ups have limited resources and most in need of outside assistance. Most models of Macintosh from Apple Computer, for instance, were designed by independent product design services and made by contract manufacturers.
Frequently overlooked but a vital part of the Silicon Valley infrastructure is the widespread presence of professional associations. These associations organized along industries or common interests meet regularly. Ostensibly, these meetings feature speakers and topics of general interest to its membership. Equally important, these gatherings offer opportunities for professionals to meet regularly with each other and form friendships, to network and exchange ideas and resumes and to assess the potential of each as a future co-founder of the next new start-up enterprise. The Churchill Club meets frequently hosting panel discussions on high tech development and regularly draws an audience of 4-500. AAMA, the oldest Asian American organization in Silicon Valley, draws 1-200 in their monthly dinner meeting. AAMA used to be known as Asian American Manufacturers Association but since not much was being made in Silicon Valley nowadays, the name was recently changed to Asian American Multi-Technology Association. Younger organizations such as Hua Yuan Science & Technology Association and China Information Networks Association tend to organize their events on weekends and can draw over 1000 young Chinese professional to their events. The Indus Entrepreneurs was organized as network for immigrant professionals from South Asia and widely recognized for not just their conferences but as a breeding ground for many successful high tech enterprises founded by Indians and Pakistanis. There are many other networking organizations and associations in Silicon Valley that space do not permit listing here. The important point is that the success of Silicon Valley is dependent on an environment where people can mingle and ideas cross-pollinate.
In summary, the success of Silicon Valley begins with its open environment where all comers with the skills and drive to succeed are welcome. Venture capital then followed to invest in this concentration of entrepreneurial energy. The spectacular returns from these investments in turn spawned a host of supporting professions that made Silicon Valley the high tech capital that it is today. A frequently asked question from foreign visitors is: “What should the government do to encourage the birth of other Silicon Valleys?” The flippant retort from most denizens of Silicon Valley is: “As little as possible.”
Government’s role in Silicon Valley
Most Silicon Valley entrepreneurs regard the government as more of a hindrance than help. For example currently a heated debate is going on between the venture capitalists and entrepreneurs on the one side and the Security Exchange Commission on the other. The SEC wants to force all companies to account stock options as a real expense. Silicon Valley companies argue that stock options are vital incentives for people working in young companies and cannot be accurately valued when the success of the company is still in doubt. If companies are forced to expense stock options, the worry is that then stock options would cease to be a preferred method to motivate the employees. At present, engineers and others join young companies for the excitement of starting something new and toil long hours at below market wages because they are motivated to see their company succeed and their wealth realized through stock options.
Silicon Valley companies also resent the export control policies of their federal government. They regard such policies as unreasonable and arbitrary and directly impact their competitive position. As a spokesperson from Semiconductor Manufacturing International Corporation recently pointed out, SMIC can buy equipment from European supplier and expect delivery in two weeks, from Japan in two months and from the U.S. the delivery is uncertain and may take 6 months or more, most of that time spent getting necessary government clearances.
However, the U. S. federal government also plays a vital role in at least two major respects to ensure the continued development of high tech industries. The most important is in promulgating clear and transparent regulations that govern the equity market. Other than making sure that the rules and regulations apply to all companies equally, the government stays out of the way. Whether a company is ready for a public listing in the stock market is controlled only by the market conditions. When the market is strong and many investors are participating, even some of the inferior companies can go public because of high public demand for new issues. When the market is weak, even the best companies have difficulty getting a listing.
Letting the market decide when and if their investee companies can become publicly listed is extremely important to the venture capitalist. When they make an investment, they hope to liquidate in three to five years. Best way to liquidate is to list their portfolio company in the stock market. The venture capitalist watches the stock market with care, constantly comparing the reception of the stock market to how their portfolio company might be worth. They are in regular conversation with the investment bankers to determine when to best offer a portfolio company to the initial public offering (IPO) process.
The federal government also plays a vital role as the provider of funds for research and development work that no venture capitalist would contemplate underwriting. These R&D work tend to be fundamental in nature with no certainty of outcome and no practical applications in sight. Best examples that come to mind would be research grants from National Institute of Health to various university research labs that led to breakthroughs in genetic engineering. Then a host of companies were funded by venture capital and other private capital sources to convert the laboratory discoveries with additional downstream development into commercial successes. The discoveries from the labs at the medical schools of Stanford and University of California at San Francisco led directly to the formation of Genentech and Chiron and the San Francisco bay area now hosts the largest cluster of biotech firms in the U.S. Advances in modern medicine and therapy would not have been possible without government support. Government funding in military defense and space exploration also led to commercial successes in the private sector. The Internet and many advances in electronics and materials can be directly attributed to original funding by the federal government.
Thus the role of the government can be simply summarized. The primary responsibility of creating a fair, open and regulated environment for the equity market is vital to maintaining the confidence of the investor public and ensuring a clear path of liquidity to the venture capitalist. No professional venture capitalist can operate in an environment where he cannot see a path to liquidating the investment. Secondly, government funding is essential to generating basic technological advances. Only the central government can assume such risks and technological advances drive innovations with commercial implications.
The venture investing process
In Silicon Valley the venture investing process has more or less evolved into a standard procedure. Some firms specialize in investing in the first round of funding where the risk is highest but the potential return is also highest since the amount invested can be relatively small for the equity stake comparable to later rounds of investment at higher cost. Other firms prefer later rounds of financing; some even invest only in the round just prior to the company going public. By and large, venture capitalists never consider themselves as passive investors but claim to help their investments succeed by being active investors. They add value by serving on the board of the investee companies, by acting as advisors to the management team, by helping to recruit needed executives, by introducing the investee company to other companies for the purpose of forming alliances and by introducing the company to the financial community (Wall Street). Not all venture capital firms are accorded with the same regard. Entrepreneurs pursue blue ribbon firms that consistently enjoy above industry average returns not just for their money and their connections. Having such famous venture capital firms as investors imply endorsement and validation of the company and its business objectives.
It should not be surprising that venture capitalists place highest importance in the character of the people they are investing in. The venture capitalist needs to know if the team of entrepreneurs has integrity, can get along with each other and can work with the investor. Their worst nightmare is to invest in a dishonest team who will stop communicating with the investor after funding and run the company without input from the venture investor. In Silicon Valley the due diligence process is rigorous. Usually the venture capitalist after extensive analysis and deciding that interest exists in investing in the company will offer a term sheet outlining the boundaries of the deal. Such term sheets are always subject to verification of representations made by the entrepreneurs in the due diligence process. There are even professional service firms to perform the due diligence investigations. A typical claim by many venture capitalists is that out of every 100 business proposals and plans they review, only about 10 are invited to face to face meetings resulting in 2-3 term sheets and only about half or less of those conclude in actual investments.
Despite the emphasis on technology, Silicon Valley venture capitalists are rarely dazzled by just the technology. They do not invest in “solutions looking for problems to solve.” They look for and ascertain that there will be markets for the products being proposed by the entrepreneur. In other words the business potential is more important than the novelty of the invention. They are fond of saying if they must have an “A” and a “B,” then they would rather have an A team for marketing and a B team for R&D than the other way around.
While venture capital has played a vital role in transforming Silicon Valley into a high tech capital, only about 25% of the Silicon Valley start-ups receive professional venture capital funding. Others start by their own bootstrap, or funds from family and friends. I have not seen a comparison of the survival rates of the two kinds start-ups but not all professionally funded companies survive and non-professionally funded enterprises can also grow into major companies. The most famous example of the latter was Hewlett-Packard, which was started by the two founders long before there was a Silicon Valley and venture capital. Cisco was founded by a husband and wife team and grew for a long time without venture capital.
Conclusion
In the final analysis, high technology development depends on having skilled and motivated people in an open environment where ideas can be freely tested. Entrepreneurs with the best ideas are more likely to attract professional investments. The best managed companies and sometimes the luckiest companies are most likely to reach the critical mass and become an attractive investment for the investing public or as a target for acquisition. Venture capitalists with the best record of making successful investments will have the least problem of raising new funds to invest in new companies. As they become successful, they become better known and are likely to be introduced to superior ideas from more proven entrepreneurs. The quality of their deal flow improves and thus increases the probability of their making more profitable investments. Such accelerating cycle applies to both the proven entrepreneur and the successful venture capitalist. The market forces determine the fate of their efforts.
Another question sometimes asked is: “How to attract premier venture capital firms from Silicon Valley to operate in places like China?” The answer is: “With a great deal of difficulty.” Venture capitalists are hands-on investors. They need to be near their investee companies and they need to be able to help their portfolio companies succeed. To most venture capitalists, with selected exceptions, China is far away and is a place they do not understand and can offer little added value. The exceptions are those individuals that are familiar with both sides of the Pacific, knowledgeable in both environments and can help their investee companies bridge the gap and gain an advantage by establishing cross border alliances. They can make astute investments on both sides and gain leverage by introducing companies from one side to work with the other.
The future is bright for China to develop high tech industries because China has plenty of human talent and entrepreneurial energy. As soon as the path to liquidity can be clearly defined, more and more professional venture investors will come to China with funds to invest. Let the snowball roll down the mountain!
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