Accel Partners beat three other “major” venture capital firms in a heated competition to partner with IDG Ventures on a new VC fund focused on China.
IDG was the first foreign venture firm to set up shop in China and may be the most successful venture investor in that country. After word leaked out four months ago that IDG was considering a proposal by an unnamed VC firm to do a China joint venture, seven other firms put their names in contention for the deal, says Pat McGovern, founder and chairman of International Data Group, the parent of IDG Ventures.
“The others heard there was a discussion going on; there’s either a spy network out there or some lateral vision going on,” McGovern says with a laugh.
McGovern declined to name all the suitors, except to say that four of them were “major” VCs. IDG spent about three months talking to those four firms and “decided that Accel was the most appropriate and qualified partner,” McGovern says. It didn’t hurt that McGovern has been an Accel LP and has known Accel Managing Partner Jim Breyer longer that Breyer can remember. Breyer’s father, John, once worked for McGovern and has been an advisor to IDG’s two China funds since the first one was set up in 1992. “Pat tells me that he’s known me for 40 years,” jokes Breyer, who turns 44 this week.
IDG and Accel last Tuesday announced the launch of IDG-Accel China Growth Fund, a $250 million fund that will invest in maturing Chinese startups in the IT, health care and consumer technology sectors. Unlike IDG’s previous two funds, which focus on seed and Series A rounds that range from $500,000 to $2.5 million per investment, the new fund plans to invest $4 million to $8 million in companies that are in expansion mode. The typical company will have an established management team, a fully developed product and annual sales of about $5 million in sales, McGovern says.
The capital for the new fund will primarily come from Accel’s existing limited partners, who are expected to contribute $200 million. The remaining $50 million will come from IDG and Accel, which will put up $25 million apiece. Accel’s portion will come from three sources: personal investments from the firm’s general partners; an investment from its most recent U.S. fund, $400 million Accel IX; and an investment from its first European venture fund, $509 million Accel Europe.
Accel expects to start fund-raising after Labor Day and hold a final close in either Q4 or early Q1 2006.
LPs are already jockeying to get in. About two-dozen LPs called to get details about the fund in the two days following the announcement, Breyer says.
It’s not surprising that so many U.S.-based VCs wanted to partner with IDG. Its two China funds have a combined IRR of about 46%, McGovern says. They have collectively invested in about 140 Chinese companies and have exited from 37 of those investments (seven through IPOs on U.S. or Hong Kong stock exchanges).
IDG portfolio companies that have gone public include Ctrip.com International Ltd. (Nasdaq: CTRP), an Internet portal for booking hotels and airline tickets; China Finance Online (NasdaqNM: JRJC), an online provider of public-company data; and Sohu.com Inc. (NasdaqNM: SOHU), a portal that offers content, advertising and e-commerce service through various websites.
IDG’s return on the Ctrip IPO was 20X, while its returns on China Finance and Sohu were 13.5X and 12X, respectively, McGovern says.
IDG has also made a killing on sales of portfolio companies. For example, EachNet.com Ltd. was bought by eBay for about $220 million in 2003, producing a return of 19X, McGovern notes.
IDG set up its first fund in China, an $80 million vehicle, as a way to reinvest profits from its technology publishing and exposition businesses. It put another $250 million into a second fund in 1999. The two funds are managed by IDG Technology Venture Investment LLC (IDGVC), which has 10 general partners. That same team will manage the IDG-Accel China Growth Fund.
Accel has been studying China intensely for the past two years. Doing the deal with IDG was one of three possible routes it considered taking into the heated market. One option was to start from scratch, as it did in Europe, by opening an office and hiring local talent. Another was to co-sponsor a fund to be raised by Chinese VCs and/or entrepreneurs.
“Everything we considered was with Mainland Chinese entrepreneurs and venture capitalists,” Breyer says. “We wanted to work with people who understood the local market at a depth that we knew we never could. It’s important to know what you don’t know.”
Breyer adds that partnering with IDG was “the first and best choice possible,” because of the strength of its investment team in China, track record, “consistency of vision and Pat McGovern, specifically.”
Going with experts who know the local market also helps to mitigate some of the risk. “There are political risks, cultural risks, fundamental company-building risks – everything from IP protection to finding executives who can work with founders and scale a business,” Breyer notes. “That’s enough to keep me up at night, but at same time, there are very compelling long-term reasons why, over the next decade or two, that it’s critical to make thoughtful investment s in China.”
Breyer says his colleagues in the United States are hot on his heels. “I am certain that you will see several top-tier venture firms over the next few months announce strategies for China,” he says. “Over a 10-year period, there will be a lot of money made and a lot of money lost in China by U.S. venture firms.”