China Heartland Province Earmarks $81 Billion to Seed Startups

(Bloomberg) -- China’s next billion-dollar startup could have backing from an investor with more money than Warren Buffett and a knack for promoting spicy duck-neck delicacies.

The Hubei provincial government is armed with 547 billion yuan ($81 billion) earmarked for investments that can diversify a job base dependent on steel, mining and cars. And the bureaucrats in the heartland region along the Yangtze River are letting professionals do the work -- allocating the money to investment houses Sequoia Capital LLP, TCL Capital and CBC Capital.

Local governments across China are getting into the venture-capital business, deploying a combined 3 trillion yuan as the Communist Party resolves to modernize the economy and reduce debt-fueled spending on infrastructure. The money is meant to spur development of biotechnology, internet and high-end manufacturing companies that can replace the stumbling heavy industries sapping economic growth.

“Our focus is more on the sector than the return,” said Wang Hanbing, who oversees $6 billion as chairman of the Yangtze River Industry Fund, one of several using Hubei government money. “We encourage people to bring real jobs back to Hubei.”

China is grappling with a profusion of economic difficulties such as declining exports, surging home prices and skyrocketing corporate debt. Gross domestic product grew 6.7 percent in the third quarter from a year earlier, maintaining the slowest expansion since 2009.

For QuickTake explainer on China’s economic pain points, click here.

The State Council signaled last month it had a bigger appetite for venture capital, urging local administrations to play a leading role and promising to level the playing field for foreign VC funds.

Policy makers want to curb the proliferation of borrowing by regional authorities to pay for infrastructure projects that prop up growth. Local government financing vehicles borrow on behalf of governments, which often are barred from doing so.

Through September, the debt issued by more than 1,600 such vehicles soared 47 percent from a year ago to 1.5 trillion yuan, according to Bloomberg Intelligence.

Incubating startups also can create more landing spots for the 7.7 million college graduates expected to join the workforce this year.

“You want the government to have some skin in the game so they will promote more progress and disruption,” said Hans Tung, general partner at GGV Capital in Menlo Park, California, and an early investor in smartphone maker Xiaomi Corp. “If the government doesn’t benefit from disruption, it’s not going to be good for innovation.”

More than 780 local government funds are vying to seed the next multibillion-dollar startup like Xiaomi, online emporium Alibaba Group Holding Ltd. or drone maker SZ DJI Technology Co. China is pushing to build at least one Silicon Valley in most of its 30-plus provinces.

The Yangtze River organization chose to be a fund of funds. By using investors with a track record of hit-making, it wants to avert the pitfalls of nepotism and state-directed spending, Wang said. To minimize risk, the fund is banning investments in real-estate or infrastructure projects.

“The government will not interfere with the investments of the teams, and the government will not recommend any projects to us,” Wang said. “Our fund needs to play by the rules of the market.”

Even with good intentions, China’s resume is populated with government initiatives that went awry. Real-estate policies helped send home prices to their highest in six years, and massive infrastructure spending created a hodgepodge of ghost cities.

Putting public money into venture capital can be risky. More than 75 percent of 2,000 private startups studied by Shikhar Ghosh, who teaches management practice at Harvard Business School, never returned cash to their investors, he said. And the infusion of government money often distorts markets.

“There’s a skewing of incentives,” Ghosh said. “The thing that people get really good at is: ‘How do I extract money from the system?’, and those are really different skill sets than what you need to build a company that will change the world.”

Government-backed VC funding also is being tried in such U.S. states as New York, Illinois and Minnesota, and in Europe.

Hubei is home to about 60 million people, the Three Gorges Dam and the Wuhan spicy duck-neck dish made famous in the movie “Life Show.” Hubei’s economic anchors include Wuhan Iron & Steel Co. and Dongfeng Motor Group Co., which operate factories there. Its $81 billion war chest is more than double the amount of investing by venture capitalists in China all of last year.

The province envisions the Yangtze River fund amplifying its technology sector, where more than 200 software companies generated about $2.5 billion in revenue through August, according to government statistics.

The fund is overseen by 40 shareholders, including some of the nation’s biggest financial institutions -- China Development Bank Capital Corp. and CCB International Holdings Ltd.

So far, the Yangtze River fund is in the process of working with eight institutions, pledging an average of about $75 million to each with the intent they can leverage it to entice more investors, including banks and other VCs or funds, Wang said. The fund has an investment cycle of 10 years.

One benefactor is TCL Corp., the Chinese electronics maker with an investment arm managing 20 billion yuan -- including money from Hubei. Half of that will be put into projects based in, or with ties to, the province.

“The government guidance funds are more focused on nurturing local industry growth and attracting funds to their localities,” said Yuan Bing, chief executive officer of Shenzhen-based TCL Capital. “This is a bit different from how Sequoia might usually invest.”

Sequoia is focusing on early- and growth-stage companies in media, health care and biotechnology, said Pu Xiaoyan, a fund partner based in Beijing. She didn’t name them, but Sequoia’s website lists investments in Jinri Toutiao, a news distribution app with 135 million active users a month; and drug maker Betta Pharma.

Wang told the investment houses that the Yangtze River fund wouldn’t meddle with decisions, and it doesn’t require the startups to be based in Hubei -- though being able to generate more jobs and growth in the province would mean higher management fees.

“We hope that after our initial investment, more famous funds in China will feel encouraged to back these high-tech and strategic emerging industries,” Wang said.

To contact the reporters on this story: Lulu Yilun Chen in Hong Kong at ychen447@bloomberg.net, Edwin Chan in Hong Kong at echan273@bloomberg.net. To contact the editors responsible for this story: Robert Fenner at rfenner@bloomberg.net, Michael Tighe

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