Three weeks ago in the Industry Standard, I wrote that Silicon Valley venture capitalists' confidence had hit a four-year low, based on the results of the quarterly survey I have conducted since Q1 2004. Silicon Valley VCs primarily expressed concern over deteriorating macroeconomic conditions. Confidence had been declining since Q4 2007, and their sentiment proved telling: Q2 2008 turned out to be the first quarter in 30 years that not a single venture-backed firm completed an IPO.

While venture capital markets have become increasingly integrated nationally and internationally over the last decade, there are still regional differences that impact the local availability of capital and the health of the high-growth venture environment. To capture some of these differences in one of the strongest investing environments outside of the United States, I have surveyed (with co-author Ling Ding) China-based venture capitalists' confidence in their national high-growth venture environment. For Q2 2008, China VC confidence remained near a three-year low. (The graph below shows this trend data.)

China-based VCs, like their Silicon Valley counterparts, expressed concern over deteriorating macroeconomic conditions. For instance, one China-based venture capitalist attributed his low confidence to "the high inflation environment and tight credit policies."

Unease over issues specific to the venture market in China was also articulated. Another VC respondent indicated that "valuations are still way out of line and [price to earnings ratios] are too high." This anxiety may be due to the rapidly growing influx of capital. According to the Zero2IPO China Venture Capital Report Q2 2008, 40 new venture capital funds raised a total of $3.02 billion. This is a new record of capital inflows for one quarter to the venture industry in China. Among the new funds, 31 are domestic funds with more than $1.2 billion, and seven are foreign funds with more than $1.7 billion.

With money from both international and domestic sources pouring into Chinese venture funds, an imbalance could occur between available capital and attractive new ventures which might lead to unsustainable valuations. Holding this view, one China-based VC expressed worries about a bubble:

"While the China entrepreneurial environment has come a long way, the 'anything goes' style is unhealthy and unsustainable. In the short term, you will see a lot of high valuations and so-called success stories; this will build up into a false bubble with dire consequences."

 

 

Other VCs saw positive trends. Tony Luh of DFJ Dragon Fund China said "We continue to see strong growth and government backing of entrepreneurship." Jessica Mak indicated that while "inflation and the global economic downturn remain, tight credit provides an advantage for VC [and private equity] to pick deals in China." Further, the exit market for Chinese ventures was healthy in Q2, with 10+ venture-backed firms completing an IPO, compared to zero U.S. venture-backed firms during the same period (Note: Several sources indicated a different number of venture-backed IPOs from 10 -- 18 in Q2.).

So what are the takeaways from this data? Well, it seems that despite the steep declines in the public financial markets in China this year, there is still a strong appetite for investment in new Chinese ventures. And, the increased capital inflows to China venture funds from the U.S. and elsewhere ensure sufficient capital availability and confirm the increasing links in the venture industry across national boundaries. Still, the upcoming Beijing Olympics notwithstanding, uncertain legal and regulatory issues remain for venture investing in China.

How can entrepreneurs maximize the upside potential of the China market and minimize the associated risks? Entrepreneurs operating in the U.S. may be wise to incorporate a China strategy in their new ventures -- allowing them to enjoy the U.S. regulatory environment while standing ready to seize upon the growth opportunities in China. Keeping abreast of China-based VC confidence and