By Jochen Schanbacher
Jun. 27 – Not many foreigners are brave enough to start a company in China, especially an internet business. Willing to try are the people of Yunio (云诺), who have created a cloud storage service much like Dropbox, but with an advantage the competition doesn’t have: access to the Chinese market. I recently had the pleasure of meeting Yunio’s Founder Chris Mathews and Operations Director Joey Gu in their office here in Shanghai.
“If you were to put the creation of an internet startup into a video game, setting up in Silicon Valley would be like playing on ‘normal’ mode while creating a company in China is like playing on ‘difficult’ mode,” according to Chris, who has experience doing both. “Every aspect of a tech startup is tougher in China than in the United States – from the regulatory environment to the inherent limitations of the Chinese internet backbone – and you are doing it all on your own.”
The creation of Yunio started with an idea that was first developed into a prototype in the comfort of Chris’ own apartment in Shanghai back in 2010 alongside cofounder Rick Olson. With the prototype, Chris and Rick went looking for (and found) a Chinese angel investor who supplied them with the angel investment. They are now set to launch version 2.0 in the next few months. Great for all cloud-savvy “laowai” out there is that this new edition will include an English version. To come to this point, the company had to solve some normal startup problems as well as some China-specific ones.
Chris himself is an American with an ethnic Chinese background who came to China to be rooted and because he knew this was where he wanted to be. Early on in his time here, Chris decided to conduct an MBA at Fudan University to connect with local like-minded individuals. He’s also taken the time to learn and appreciate the local culture, and his first point of advice was that learning Chinese is essential if you want to do business here.
“Would you ever go to America and do a startup without speaking English? Probably not. The same applies to China; you just HAVE to learn Chinese,” Chris says.
With over 450 million netizens and a forecasted e-commerce market of US$311 billion by 2015, the Chinese online environment has great potential for startups. The hurdles to enter and succeed in this market, however, are equally tough to overcome.
Setting up a web company
Although China’s 12th Five-Year Plan includes measures to strengthen the Chinese service industry, the regulatory reality still doesn’t offer any easy entry into the market. It’s always advisable to have a holding company outside the Chinese mainland in Hong Kong or Singapore, for example, since it makes handling certain things like share transfers much easier and might also offer tax advantages. The process is easy and cheap and normally strongly outweighs the disadvantages.
On the other hand, setting up the Chinese subsidiary is not always as straightforward, since the internet market is still quite restricted for foreign companies. Generally speaking, it is easily possible for foreigners to offer non-commercial services as well as goods online, but they are currently not allowed to offer commercial services. This means that a service business can advertise online (without making profit through the website) and a physical shop (e.g. a foreign-invested commercial enterprise) can offer their goods online in addition to their physical store, however it is not possible for foreigners to register real web startups offering services for a fee in China.
So how did Yunio do it? They did this by registering a Chinese company with Chinese citizens as the registrants, because ICP licenses can only be issued to companies that are wholly Chinese-owned. Chris and his partners then own shares of this company via separate agreements with the registrants. If you want to offer online services in China, the only way to do that is with a Chinese partner – either as a joint venture or otherwise with a proxy holding your shares in the company.
However, regardless of the solution you choose, it is a double-edged sword. Your Chinese partner will in any circumstance be in the stronger position and might try to turn the cards in his or her favor. It’s therefore only advisable to work with Chinese partners that you can trust completely – 100 percent.
Of course you can make profit sharing agreements, yet often Chinese courts consider them to be illegal since their purpose is to evade the current law. They therefore tend to not be enforceable and will not offer you any legal protection.
Joint ventures in the internet services industry give you a maximum of 50 percent control of the company, yet it’s still hard to get the necessary license from the Ministry of Industry and Information Technology to operate commercial services. One requirement is a high amount of registered capital. An example for this is Groupon, who formed a joint venture with Tencent in order to enter the Chinese market, yet the Groupon example also shows the dangers that such joint ventures entail. One of the mistakes the company made when entering into a deal with Tencent was not to include “non-competition” articles in the contract. This is why Tencent is pushing their own group buying platform with much more dedication than they did with “GaoPeng.” This should be another reminder that the most important thing in China is a trustworthy partner. The demise of Groupon’s “GaoPeng” is also one example that even companies with funding, branding, and a proven record of success outside of China are not a guaranteed success.
There are semi-legal ways around it, but it is important to notice that those ways tend to come back to haunt you in the later stage of your business, especially if your business becomes successful. As a rule of thumb, you could say that if a court will not enforce your contracts and interests, it’s probably unwise to go on with the project you’re doing. Yet even a written contract might not save you from bad experiences. Only building strong relationships with your customers, suppliers, employees and other stakeholders can really help your China business succeed. For people who like to get things done quickly and prefer a structured environment, this can be very frustrating.
It is possible to register patents and trademarks in the name of individuals or foreign companies. If you decide to have a joint venture or a proxy holding your shares, this might be one way to secure leverage on your side. You can register the company in the name of your Chinese partner, but register trademarks and patents in your name, which would give you at least some leverage. It could be also possible to get key elements of your source code out of the reach of your partner. Try to do as much as possible to balance your legal stand towards your Chinese partner, even if you trust him or her completely.
Understanding the Chinese customers and your product
As a foreigner, you will not be able to succeed in China if you only come for the market. You have to come for the love of China as well as with interest in the culture and people. It’s important to notice that a market gap in China might not turn out to be a market demand. This doesn’t necessarily mean that you have to lose your identity, but it definitely means that you have to adapt your product to the local tastes, much like KFC and Pizza Hut have done with tremendous success in China.
The Chinese market is unique in its form and taste, which makes it necessary for entrepreneurs to understand the things that netizens think are cool, or lame, or plainly what the users are capable of understanding. If you look at the overall demographics of internet users in China, the market seems endless; however quantity and quality are two rather different things. Also, be aware of environmental differences. Bandwidth in China is much more expensive than in the West, and while you can serve the whole world with your servers in the West, it’s currently not even possible to serve the whole of China with a server in one location due to a lack of infrastructure.
One of Yunio’s best features is the ability to use a keyboard shortcut to transfer a JPG screenshot directly into Yunio. Also great is the 5GB free storage space (which is double the amount of Dropbox) and the extremely user-friendly interface. Yet, the biggest issue Chris and his team are facing is the education of the market. Many of the 400 million or so netizens are mainly using the internet for communication and do not yet understand the concept of cloud storage or the syncing of files. This is why Yunio’s Version 2.0 will strongly focus on sharing functionalities.
IP and innovation
With a great idea comes great competition and infringements on intellectual property – yet you better accept that there is not much a young startup can do about it. You can, however, minimize potential mistakes by ensuring that your brand is registered in China and by focusing on the product and the customer.
A common mistake is to think that registering your brands and patents in China is not important since others will infringe on them anyway. This is absolutely wrong. While registering your property will not completely get rid of infringements, it will nevertheless give you legal protection and leverage when they do occur.
As Chris puts it “in China you don’t compete on innovation, but on execution,” meaning you not only have to have the talent onboard, but you also have to have an efficient and streamlined process in place.
“Competing on execution is just that: Execution,” Chris explains. “It’s about being damn good at what you do and it usually it comes down to who can do it faster and more efficiently.”
The broad and self-learning focus of a Western education might give you an edge in execution – as it tends to be more efficient for the establishment of good procedures and gives you the confidence in your work. The benefits might not be visible right away, but better execution will give you a competitive advantage in the long run as your service will be more reliable and offer better customer satisfaction.
With more than 6 million fresh Chinese university graduates every year, there seems to be a huge pool of young, intelligent people to pick from for a startup. The war for good talent, nonetheless, is not weaker than in Silicon Valley. Contributing to this situation is a culture that is mainly driven by income and reputation. The best people want to work in big state-owned or international companies with a good reputation and high employment security – not in small startups with high risk.
But even without these issues, there is a lack of creativity and self-confidence with most of these graduates. This is something often said by many companies operating in China, and is especially true for startups which survive on the sole fact that their people are more creative and dedicated than their employed counterparts.
Chris tells us the secret of Yunio: “We don’t underpay our staff, we create a fun working environment and we hire the right people.” These elements together are the foundation of Yunio’s success in China. This means that if you can’t compete on job security and prestige, you have to find your own niche that gives your employees the satisfaction they can’t find somewhere else. A great working environment with mutual respect, a high degree of responsibility, and freedom for the individual might be one way to go. But as Chris states, it all begins with hiring the right people and creating a thorough hiring-process where expectations on both sides are clear.
“I’m always looking for a personality that fits our own culture,” says Chris. “I make sure to ask candidates if they have friends because people who don’t tend to have problems working with others and are not likely to be team players.”
The financing market in China is extremely tough and recent headlines featuring entrepreneurs running away due to immense debt serve as a sign of the inherent problems within Chinese financial markets. There are several ways to get funding in China for start-ups, but save your time if you are thinking about going to a bank.
The government has set up funds for high-tech startups and has built innovation centers where startups can rent offices cheaply. However, these benefits are hard to come by most of the time and foreign entrepreneurs will find it nearly impossible to access them. In the current system, the Chinese government is only interested in guaranteed successes and has very little interest in projects with a high degree of risk. However, the funds that are distributed are huge and might be interesting for some startups, especially if you have a Chinese partner with a good local network.
The option that probably yields the highest success is to look for a private investor. There are a lot of them as well as a bunch of international funds on the lookout for great investment opportunities. To get a meeting with them is relatively easy, but the scrutiny of your business plan can be unexpectedly high. The level of investor-competence varies strongly and you may have to spend quite of bit of time drinking baijiu and going to KTV if you want to gain the trust of a Chinese angel investor.
If you are thinking about getting funding from outside of China, it is important to note that it can take several months to get the government’s approval for transferring foreign currency into China. This time is added to the time you have to spend to find international funding.
Chris and his team at Yunio had to make a lot of cold calls to angels and VCs, but they were able to find a Chinese angel investor who was willing to invest RMB10 million. After they developed the demo, it took Yunio six months to get the funding, which is pretty much in line with the situation internationally.
The right personality
An entrepreneur in China needs to be committed not only to his or her startup, but also to the Chinese culture. As Chris puts it “you have to love being part of the change that is happening in China.”
Without this interest, you will not be able to cope with the immense difficulties you have to face here. Not only do you have to solve your business issues, but you also have to be able to cope with cultural issues. This makes doing a startup in China particularly hard, and the relationship culture of guanxi makes “getting things done” painstakingly slow. Also, as mentioned earlier, you have to speak Chinese. The Chinese authorities will not always help you succeed (no matter how good your idea might be); and once the proven concept is there, copycats will pop up everywhere. If you can adapt and deal with this kind of pressure, you might be able to succeed in the Chinese environment.
Jochen Schanbacher works with the business advisory division of Dezan Shira & Associates and is the founder and organizer of Startup Weekend Switzerland. He is a St. Gallen University graduate and has been active for several years in the Shanghai tech and startup scene. Jochen has spent time working with both multi-national tech companies as well as venture capital firms.
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