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Chinese investors financing startup, early stage companies

February 27, 2010

Never underestimate the power of a market void.

Indiana entrepreneurs weary of hitting dry holes with angel investors and venture capitalists are turning to Chinese investors who are eager to diversify their portfolios, latch onto American innovations—and take advantage of a federal visa program.

Few deals have been consummated—possibly no more than a dozen statewide in the past year or so, say financiers and other professionals familiar with the investments.

Still, it’s a small miracle that investment is flowing to fledgling companies at all. And now that the spigot is cracked open, the same observers expect funding to continue for as long as the investors realize good returns.

“We’re on the front end of a curve,” said Jason Farmer, managing director of Indianapolis private equity firm BlueTip Investments LLC. “As the investments prove out, those relationships will only get stronger.”

David Millard Millard

Barnes & Thornburg partner David Millard, who has seen five term sheets detailing potential Chinese infusions, said, “If you’re a citizen of the global economy, you’d say, ‘Thank God that some of the wealth that has been created in China is being put in United States companies as an attractive investment.’

“Those U.S. companies desperately need that capital to grow and thrive.”

Angel and venture capital investors are slowly beginning to emerge from a hiatus of more than a year.

Angels pulled back because steep stock market losses suddenly tilted their personal portfolios heavily toward startups. Most angel investors aim to allocate about 10 percent to the risky angel activity; in some cases, their portfolios moved to 20 percent or more.

Venture capitalists went AWOL because they didn’t want to ask their investors, such as university pension funds, to put in more cash at a time they were hurting and might not be able to deliver.

Chinese interest in young local companies is part of a broader move by Chinese investors into the United States. In 2008, the latest year for which figures are available, foreign investment by China climbed to $50 billion—twice the level of the prior year, according to Washington, D.C.-based Washington Institute for International Economics.

A big drawing card is the EB-5 federal visa, which leads to permanent resident status for foreign investors who invest at least $1 million in an American business that will employ 10 or more full-time American workers. Another way to qualify is to pump at least $500,000 into a business in an area with high unemployment.

After three years, the investors stand a good chance of becoming U.S. citizens; thus, their children also gain citizenship.

The program was fairly obscure until recently, but now is spawning a cottage industry to help Chinese investors operate in the United States.

Behind the scenes

The scope of Chinese investment in Indiana companies is not well understood. Government agencies don’t track it at the local level, and companies and their advisers hide investor identities to accommodate requests for anonymity and, in some cases, avoid tipping off employees who may fear their jobs moving overseas.

Who are the investors? Mostly businessmen and wealthy families enriched through China’s recent adoption of capitalism.

The United States is attractive because the value of the dollar is low, making yuan-denominated investments go further. Chinese investors also are drawn to American innovation, particularly the cream of current Yankee ingenuity—alternative energy, health care, biotechnology and advanced manufacturing. A few are setting up distribution networks for Chinese-made goods.

Cutting-edge technology is coveted not only for its potential for big returns, but also because much of it is easy to transfer to China to meet needs of its burgeoning economy.

The investors almost always scout for opportunities through intermediaries who can help navigate American culture and ensure their investments are protected.

Like many other Asians, Chinese investors are slow to warm to strangers and prefer building relationships over long periods.

Deals struck with Chinese investors are little different from those landed through local angel investors or, for that matter, California venture capitalists. Depending on the maturity of the company and risk, the Chinese in Indiana are committing $1 million to $10 million and seeking 20-percent to 40-percent ownership stakes.

They seldom demand controlling interests or active roles in day-to-day management. However, they usually require sign-offs before such major decisions as raising capital or a sale of the company.

Most go it alone as investors to boost their level of control. They also sail alone because they can: They’re so wealthy they don’t need partners.

“They’ve got the capital,” said BlueTip’s Farmer.

An exception has been with the riskiest technology companies, where $1 million injected into a “science experiment” is only marginally safer than placing a bet at a casino. In those scenarios, Chinese investors don’t seem to mind joining with even several partners.

Eye-popping savvy

Most entrepreneurs are surprised by the savvy and sophistication of Chinese investors.

Farmer said roughly half the Chinese investors he’s worked with are U.S.-educated; they primarily hold MBAs, or graduate degrees in science or engineering and other technologies.

“Impressive isn’t even the right word to use,” he said. “There’s a reason they’re such a powerful nation right now, particularly from a capitalist perspective.”

Trent Decatur, an Indianapolis native who runs a Hong Kong investment bank called Asia Capital Management Ltd., said Chinese investors aren’t necessarily looking to buy Indiana companies and move the operations to China.

They primarily want to make solid investments and broaden their knowledge of business, Decatur said. Inner workings of Silicon Valley, Calif., seem to hold particular intrigue for Chinese investors, which is one reason California is far ahead of Indiana in building Chinese connections.

Millard said some Hoosier entrepreneurs, while thankful for the Chinese investment, are uneasy with how their new backers will react to surprises that crop up with virtually any young company.

The investments are so recent that there’s little to no evidence of Chinese investors reacting adversely.

“There is an underlying thinking they will make business decisions differently,” Millard said. “Whether that’s valid or not, only time will tell.”

Here to stay

Chinese investors are expected to stay active in Indiana long after recession clouds clear and prosperity returns.

Their arrival in Indiana is not so different from the period in the 1990s when networks of angel investors began to form. Already, attorneys, investment experts and other professionals are organizing alliances to tap pipelines of Chinese capital.

In the short term—perhaps the next year or so—Chinese investment is on a trajectory to increase.

Chinese investment might never amount to a big portion of all investment in startup and early-stage companies. But it’s an alternative that’s likely here to stay.

“You just say it’s the global ecosystem at work,” Millard said.•

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