Venture Communism How China is building a startup boom

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By Michael Schuman
The New York Times

HANGZHOU, China—In Dream Town, a collection of boxy office buildings on the gritty edge of this historic city, one tiny company is developing a portable 3-D printer. Another takes orders for traditional Chinese massages by smartphone. They are just two of the 710 startups being nurtured here.

Anywhere else, an incubator like Dream Town would be a vision of venture capitalists, angel investors or technology stalwarts. But this is China. The Chinese Communist Party doesn’t trust the invisible hand of capitalism alone to encourage entrepreneurship, especially since it is a big part of the leadership’s strategy to reshape the sagging economy.

Which is why the government of Hangzhou—a former royal capital that has been a major commercial hub for more than a millennium—built Dream Town and lavishes resources on startups. The businesses here get a slate of benefits like subsidized rent, cash handouts and special training, all courtesy of the city.

Chemayi, which offers car repair services through a smartphone app, is staying rent-free at Dream Town for three years and is applying for as much as $450,000 in subsidies from city authorities to help pay salaries and buy equipment.

“From the central government all the way down to local governments, we have seen a lot of warm support,” said Li Liheng, co-founder and chief executive of Chemayi.

For much of China’s long economic boom, young people flocked to manufacturing zones for jobs making bluejeans or iPhones. But today China is trying to move beyond just being the world’s factory floor. Policymakers want the next generation to find better-paying work in modern offices, creating the ideas, technologies and jobs to feed the country’s future growth.

Premier Li Keqiang frequently calls for “mass entrepreneurship.” In March at the National People’s Congress, he bragged that 12,000 new companies were founded each day in 2015.

The entrepreneurial embrace comes with lots of financial support. Across the country, officials are creating investment funds, providing cash subsidies and building incubators.

“Without these kinds of subsidies, you only rely on private money, and you wouldn’t see so many technology startups happening today,” said Ning Tao, a partner at Innovation Works, a venture capital fund in Beijing. “Without quantity, you cannot have quality.”

But the heavy spending is adding to worries about an inflating bubble in the world of China’s tiniest companies. Along with the government funds, venture capital money is flooding the country. About $49 billion in deals were made last year, making China second only to the United States, according to the accounting firm Ernst & Young.

Some economists and entrepreneurs are concerned that the government is helping fuel a frenzy that might ultimately result in failed businesses, wasted resources and financial losses. Just one city, Suzhou, near Shanghai, has announced it will open 300 incubators by 2020 to house 30,000 startups.

Beijing’s policymakers have a long history of giving favored companies easy access to loans and subsidies to propel certain industries, with both good and bad consequences. Though that tactic lubricated the nation’s industrialization, it also contributed to the excess that has buried the country in empty apartment blocks, mothballed cement plants and sputteri ng steel mills—all of which threaten the economy’s stability.

“I think the subsidies shouldn’t be a long-term policy,” Jin Xiangrong, an economist at Zhejiang University in Hangzhou, said of the startup support programs. “They can lead to overcapacity like the kind we see now in China’s manufacturing sector, which is largely a result of government support.”

Hangzhou city officials turned down requests for interviews.

The Children of Alibaba

At Dream Town, Li, 39, frets more about his own business. He got the initial idea for Chemayi in 2009 after a car accident. To find a trustworthy mechanic, he searched online, asked friends for advice and visited repair shops.

But Li found it difficult to judge who was reliable. A car culture—and all the services that come with it—is relatively new in China.

Aiming to fill the information void, he and three friends set up Chemayi in 2013 with 5 million renminbi (currently $750,000) of their own money. For an annual fee, Chemayi sends out staff members to help fix flat tires, paint scratches or repair broken-down engines.

“Henry Ford is gone for so many years, but we are still driving his cars,” Li said. “I felt that I also must pursue a cause that will persist after I’m gone.”

Chemayi beat out more than two dozen other startups for a coveted space in Dream Town in a 2014 competition. Another co-founder, OuYang Feng, delivered a 40-minute presentation to a panel of judges who peppered him with questions about Chemayi’s business model and future prospects. The provincial governor watched over the grilling.

In the end, the committee awarded Chemayi a 3-foot golden key that symbolically opened the doors to Dream Town.

Chemayi now has 284 employees in four cities, with plans to reach 1,000 by the end of the year. Li said his company had raised $22 million in private money and turned a profit of about 10 million renminbi last year.

“A lot of Chinese people want to be successful. They want to initiate change through innovation,” Li said in his spacious corner office, while fussing with a traditional Chinese wooden tea-making set. “That is a formidable power.”

Hangzhou is a natural center for China’s startup fever. After China embraced capitalist reform in the 1980s, Zhejiang province, of which Hangzhou is the capital, emerged as a leading base for the export industries that fueled the country’s rapid growth. Factories pumped out products like socks and plastic Christmas trees.

Now that zeal for commerce is being channeled into technology startups. Hangzhou is home to China’s most famous internet company, the e-commerce giant Alibaba, which has become a training ground for would-be entrepreneurs.

The neighborhoods near Alibaba’s sprawling campus, once a poorly developed area on the city’s outskirts, now make up a budding tech center with newly built office parks like Dream Town, dominated by ambitious college graduates, angel investors and venture capitalists. The local restaurants have become hangouts to exchange ideas and gossip over fried squid and stewed pork and eggs.

Feng Xiao is typical of this new breed. Feng, 39 and a Hangzhou native, spent 11 years at Alibaba, mainly in sales and marketing.

“There is a Chinese proverb, ‘The soil is too rich,’” Feng said. Alibaba “offered you a lot of opportunities. It was easy to have a sense of success. But I wanted to be able to start from scratch.”

His startup was born in Alibaba’s cafeteria, where he ate meal after meal. “I really missed Mom’s cooking,” he said. He figured that many other people, trapped working for long hours far from home, felt the same.

Feng and two other Alibaba employees left their jobs in 2014 and opened a food delivery service, Mishi. Their plan was to connect people willing to prepare homemade meals with on-the-go professionals who were too busy to cook. They set up shop in a friend’s empty house, decorated with secondhand furniture and photos from home.

Along with raising $19 million from private investors, Mishi caught the eye of the Hangzhou city government. In 2014, district officials awarded Mishi 5 million renminbi to help pay the bills. Its rent in a Hangzhou office park is also subsidized.

“The most important thing on the part of the government is whether they are open” to new types of businesses, Feng said. “We are glad to see they are aggressively supporting us.”

Hangzhou represents what Chinese leaders see as the nation’s economic future. The country used to generate astronomical growth rates by depending heavily on low-cost exports and extremely high investment in apartment towers, factories and highways. China built so many steel mills that it can produce 10 times as much steel as the United States.

But today, costs are rising, eating away at the competitiveness of many export industries. The long investment boom has saddled the economy with too many factories and a mountain of debt.

Instead, policymakers are encouraging a shift to new growth engines, like services and high-tech.

The entrepreneurial focus is providing an economic boost for Hangzhou.

The city’s gross domestic product rose 10.2 percent in 2015, compared with the 6.9-percent national growth rate. Hangzhou’s service sector, which includes many startups, was the main engine of that strong performance, surging 14.6 percent.

“The Chinese know that state-owned enterprises are not going to employ everybody,” said Hans Tung, a managing partner at GGV Capital, a venture capital firm that operates in both Silicon Valley and China. “They need young people to create jobs for themselves, so they are encouraging them to try something new.”

Mishi  has created 100 full-time jobs, and has bolstered the incomes of more than 10,000 home chefs.

Cai Liangen, a retired businessman turned Mishi cook, learned about the startup when a marketing team visited his apartment complex seeking to enlist new chefs.

In November, he and his wife began making local specialties in their kitchen, including a sliced pork dish prepared with “my mother’s secret recipe,” Cai said. They now receive 40 orders a day and earn 5,000 renminbi a month, increasing their total income 70 percent.

“We do it because we love to cook,” Cai said, “but the money is good to have, too.”

A Swell of Subsidies

After submitting a 10-page proposal in 2014 to join a Hangzhou incubator, Ai Binke sat nervously before a committee of tech industry executives who questioned his future prospects. His software company, Yun Ran Internet of Things, had only four employees, and its business deals had been small. But his startup, Ai explained to the committee, had great potential.

That was sufficient for the judges to award him 100,000 renminbi in subsidies. The bulk, roughly 70 percent, was instantly transferred into his corporate bank account. “As long as you run projects that are encouraged by the Hangzhou government, you can get the subsidies,” said Ai, 29. “It’s not very difficult.”

Local governments around China are spending heavily on startups. In Shenzhen, authorities are offering to subsidize up to 70 percent of rent for “creative” startups. Local officials in the southwestern metropolis of Chengdu are setting up a 200-million-renminbi “entrepreneurship and innovation development fund” and promising subsidies of up to 5 million renminbi.

Officials in Guangdong province in China’s south will cover part of a startup’s losses. Even the lesser-known city of Yingtan, in an area of Jiangxi province mainly known for its ancient Taoist temples, is planning to build an incubator.

Hangzhou’s government has been one of the more active. Officials are forming a venture capital fund of 4.7 billion renminbi , with contributions from companies, according to the city’s website. This year, Hangzhou announced that it would give 100 million renminbi to help startups pay expenses.

But governments historically have a spotty record of using state-directed money to generate business success stories.

During Japan’s high-growth decades, its bureaucrats tried to “pick winners” by selecting certain industries for support. Though they nurtured a few internationally competitive industries (shipbuilding and steel), they also had significant failures (chemicals and computer software). The Obama administration got a black eye for its financial aid to the solar technology firm Solyndra, which sank into bankruptcy.

In China, government efforts to assist new businesses have often led to waste and excess. Too much investment pours into favored industries, spawning poorly conceived projects in areas like hotels and solar panels. By trying to spur startups, the state is also engaging in a high-risk business that even for the most experienced venture capitalist is prone to produce more failures than successes.

Hangzhou officials are trying to avoid such pitfalls. At Dream Town, the financial aid is often linked to a startup’s performance. The amount of free rent depends on how much private capital a company can raise. Cash handouts are tied to revenue targets or top-selling apps.

Government officials also enlist professionals to help allocate the city’s money. The committee that judges applicants to Dream Town is usually made up of tech executives, financiers and academics.

Ye Feng, a manager at another incubator who has sat as a judge on three occasions, said she quizzed the contenders on their technology, business plan and even product pricing.

Usually about 30 startups appear at each competition. No more than four make the cut to enter Dream Town. “The competition is quite fierce,” Ye said. “Sometimes it’s hard to make a decision.”

But some in Hangzhou fear that the government is doling out too much money, and it is flowing to startups with weak business plans and feeble prospects. Ai of Yun Ran said that two neighbors also received city subsidies. One, a robotics startup, failed to attract private capital and closed, while the other, a mobile game company, is struggling to stay afloat as its business withers.

The government money, Ai said, often cannot replace the private capital necessary for startups. “Without financing, it would be very hard for them to survive,” he said.

Image Credits: BM Graphics: Ed Davad