Two years ago, it was one of the hottest areas in tech investing. Venture capitalists were lining up to throw money at it. But now, after disappointing IPOs, investors are fleeing.
Social networking? Nope. China.
In the past few years, virtually every venture shop worth its salt set up operations in the Middle Kingdom, home to one of the world's fastest-growing economies and a billion-strong consumer marketplace. Defying the decades-old maxim that venture capitalists wouldn't invest outside a 30-minute drive of Menlo Park's Sand Hill Road, firms here and elsewhere rushed to join Chinese venture houses or send homegrown partners to China.
But last year, venture capitalists largely abandoned China, in large part because of underwhelming stock offerings by Chinese firms on both domestic and U.S. exchanges.
Consider: Thirty-eight Chinese firms went public in 2010 in the United States. The following year, just 15 did so, and last year's number was only two, said Jeff Richards of GGV Capital, a specialty firm with dual headquarters in Shanghai and Menlo Park.
"In 2010, investors were paying a premium for Chinese IPOs," said Richards. "Some of those IPOs have not performed well, and there's not much enthusiasm right now on the part of some of the momentum funds to invest in more startups there."
And while many Silicon Valley venture firms made money in the United States amid Wall Street's IPO doldrums through a robust startups. Compare those numbers with 2011, when venture investment in China peaked at $6.3 billion spread across 362 deals.
"VC ardor has cooled around investments in Chinese companies," said Andrew Chung, who leads China efforts for Menlo Park-based Khosla Ventures. Like others, he cited uncertainties about the Chinese economy, the dearth of initial public offerings and the rise of "copycat" companies that some say simply ape ideas from Western tech darlings. "There's too much capital chasing too few deals."
What's more, some Silicon Valley venture firms have grown wary of China's often opaque regulatory environment and loose approach to intellectual property laws. "We're skeptical of the environment," said John O'Farrell of Menlo Park's Andreessen Horowitz, a firm not known for being risk-averse. "The deck is stacked against foreign companies."
But some firms — ranging from powerhouses like Sequoia Capital and Accel Partners to specialty shops like GSR Ventures and Richards' GGV — are convinced the Chinese market remains ripe for cleantech, mobile and other deals.
"You can't ignore the kind of opportunity in China," Chung said. "In cleantech, for example, the government plans to invest $80 billion per year for the next 10 years."
A Khosla-backed startup called EcoMotors just inked an agreement with a Chinese auto-parts conglomerate to fully fund a $200 million factory in the country that will build what Chung calls cheaper and more efficient internal combustion engines.
While investor appetite for cleantech has been spotty in the United States, Chung said Khosla will continue to be "opportunistic" in scouting similar partnerships in China.
Richards of GGV said competition for deals has also lessened now that many "tourist investors" have dropped out.
"I used to meet people all the time and they'd say, 'Hey, I'm heading over to Shanghai to make an investment,' " said Richards, whose firm raised a new fund last year.
VCs that are staying the course salivate over statistics like the 240 million smartphones that were sold in China last year, according to a recent estimate by mobile advertising company Velti.
In December, Silicon Valley legal heavyweight Wilson Sonsini Goodrich & Rosati opened China offices, sensing a vast opportunity to broker future tech deals. Meanwhile, valley venture veterans such as Gary Reichel of Mobius Capital and Erik Lassila of Clearstone Venture Partners have decamped for China full time in recent years. And in a coals-to-Newcastle twist, Beijing-based investment firm WestSummit Capital last year opened a Palo Alto office.
But it's not for the faint of heart: GSR's Richard Lim, for instance, admits that he can't publicly identify some of his portfolio companies, much less make payouts to his investors, because of the arcane laws that govern foreign investment in China.
Because of Beijing's restrictions on foreign ownership, most U.S. investments in Chinese companies pass through joint venture arrangements that can slow the time before investors can reap profits, he said. And authorities on both sides of the Pacific are still wrestling with how those partnerships should be taxed, Lim added.
"Although China is a tremendously enticing opportunity, there are a whole lot of things you need to know," Lim said. "It's probably kept some people on the sidelines."
Still, he and Richards both note that the two most recent Chinese companies to go public, YY and Vipshop (the latter backed by Menlo Park's DCM) have seen their stocks gain altitude of late. That has given veteran China hands reason for hope.
"We meet in China or here in Palo Alto at least four times per year to develop our investment strategy," said Jim Breyer of Accel, which has raised billions of dollars to invest in China with a firm based in that country.
"We have 11 partners in our Beijing and Shanghai offices," Breyer said, "and we remain very committed and optimistic."