Wrapped in red tape, Chinese startups are giving up on their dreams in the mainland – e-RUPI Guide

Like many ambitious The Chinese who graduated from a university abroad in the 2010s and aspired to become the next Jack Ma or Pony Ma, Lucas returned to his homeland to build his own internet startup. However, two years after he ran the company, his enthusiasm has waned. The regulatory risks and compliance costs affecting his business have become too high to justify building a China-focused product, forcing him to look abroad for growth.

(Lucas is the founder’s pseudonym due to the sensibility of discussing regulations. We can’t specify what his company does because that would compromise his identity.)

In recent years, China has introduced a litany of policies to gain more control over its internet sector. Verticals from fintech, social media, gaming and e-commerce to live streaming increasingly come under regulatory scrutiny for their unscrupulous growth and the social problems they cause. That research is propelling startups who thought they had a future for financing and growth in China to go abroad.

Observers argue that the crackdown on consumer internet giants such as Alibaba and Didi is intended to encourage domestic innovation in “hard” technology, such as semiconductors and industrial robots, allowing China to compete on the global stage. Beijing wants to curb the power of internet giants, especially those that create structural problems, such as lending products that put young consumers into debt, games that cause addiction and online education services that widen the wealth gap.

Such policies may have initially been intended to rein in the internet giants, but they have also crippled the growth of fledgling startups like Lucas’s, which face rising compliance costs and operational hurdles in China.

Three other China-based consumer internet startups who spoke to e-RUPI Guide said they were also lagging behind the Chinese market due to increased regulatory uncertainty. Four investors told us that portfolio companies targeting online education, fintech and video games are making a similar hub to target international users.

As web3-focused entrepreneurs from around the world race to revolutionize the digital space, the industry has fallen out of the picture in China, where strict censorship and a sweeping ban on cryptocurrency has limited the potential for decentralized services, core, have eliminated from web3, to thrive. The fear that a new vertical threat will face is looming large in the Chinese startup community.

Tightening grip

Regulations targeting tech companies are nothing new in China, but for years many policies were vaguely formulated or not enforced. “The authorities kept one eye shut when it was more lax,” says Lucas.

For the vigilant entrepreneurs, Beijing’s suspension of Ant Group’s IPO in 2020 was the first alarm bell, signaling that the era had ended when Chinese internet companies were given the green light to grow at breakneck speed. The suspension came as the government made “major regulatory changes for fintech”, which subsequently led to a restructuring at Ant and put it under strict financial regulation.

Last year, a government investigation into Didi for his cross-border practice of sharing data again underlined Beijing’s determination to tighten control over what it once considered its “Internet treasures.”

Smaller startups are also feeling the impact. Internet platforms of all sizes now face heavy fines and even suspension of services if they fail to implement the required content censorship and data storage mechanisms, which can easily cost up to several million yuan (1 USD = 6.4 yuan) per year for an early stage , data-rich startup, two founders told us.

It’s not just compliance costs that hinder growth. The unpredictable nature of censorship – phrases or images tolerated one day may be considered political and illegal the next – puts enormous pressure on young, cramped companies to define the boundaries of what is acceptable online.

“Venture capital firms in China, especially USD funds, didn’t care in the beginning whether a startup was making money or not. As long as the company experienced prodigious growth, it could generate revenue later on. But this formula doesn’t work anymore because any app can be uninstalled at any time,” says Lucas.

Tencent-backed Jike, a social network popular in the Chinese VC and startup community, was abruptly shut down for a year before relaunching in 2020. The reason for the suspension was never disclosed, although many speculated that it was because of censorship.

For many Chinese entrepreneurs, going public in the US, which is home to the world’s largest exchanges, is the ultimate goal, ultimately allowing them to make money and generate more capital to scale up. But that route also looks vaguer. In December, China’s cybersecurity regulator said Internet platform operators with data on more than one million people [within China] must undergo pre-IPO assessment before being listed abroad. If the regulator decides that the platform poses a threat to national security, the IPO will be halted.

At about the same time, the Chinese Securities Authority suggested that a company, regardless of where it is incorporated, must go through an application process with the Chinese government if the central management is mainly composed of Chinese nationals or executives residing in China and whose main business activity is in China.

To help startups bypass potential restrictions on their search for foreign offers, mall VC firms in China are now advising their portfolio companies to enter international markets instead. Some even provide foreign citizenship applications for entrepreneurs as part of the post-investment service, we learned from a founder and an investor.

The success of a startup, Lucas lamented, now partly depends on its founder’s ability to predict and follow the direction of Chinese policy. “We entrepreneurs should not be expected to be political scientists. We need to be left alone to focus on building the product.”

Going to the sea

With regulations becoming increasingly stifling, young companies in China are finding it more difficult to emulate the success of their predecessors like Alibaba and Tencent, which started two decades ago. Some have no choice but to give up on their Chinese dreams. But on the bright side, consumer internet models that have proven successful in China, such as bike sharing, virtual gifts, social commerce and grocery delivery, also provide a handy playbook for the rest of the world.

“We believe that many Chinese, pioneering or popular business models with technology are better suited to emerging markets, much more than models coming from the United States,” said Ben Harburg, managing partner at MSA Capital, which invests in global startups inspired . by the Chinese technology industry.

“I think everyone would like to be some variation of Ant Group in terms of money markets, loans, payments, merchant-to-peer, peer-to-peer [services]the investor added. “Everything within the China mobile-first fintech ecosystem is an example for the rest of the world.”

Chinese startups going global, or what’s called “chuhai,” literally “going to the sea,” have undergone several transformations over the past two decades. They went from exporting cheap electronics, creating a foreign version of something successful in China like Tencent’s mobile game Honor of Kings, to building services and products designed to compete globally from day one.

“Companies in the past would globalize based on their successful model and examples in China, then take the same product overseas,” noted Rilly Chen, who previously worked on Ant’s international investment team.

“While now we see more companies building their products for international customers at the start, but the infrastructure and technical base is still in China.”

Smartphone makers Xiaomi and Oppo, and apps like selfie beautifier Meitu and TikTok, are notable players of the earlier generations, while fast fashion perfume Shein exemplifies the latter category of companies operating mainly from China and serving international customers.

Going to the sea is no mean feat. The TikTok saga in the US, where the Trump administration wanted to force a sale of the short video app, shows how a Chinese app with huge global success can become entangled in geopolitical tensions. Strict privacy regulations in developed regions, such as the European GDPR, also pose new challenges for Chinese founders with little exposure to compliance practices abroad.

The current wave of Chinese startups going global mostly has Western-educated, bilingual founders born in the 1990s, like Lucas. As they move into new frontiers, they bring with them lessons from home, potentially helping to evangelize China’s tech business models and culture. At the same time, their home market is missing out on the service and creativity of these young, ambitious entrepreneurs chased by the country’s regulatory storm.

“I think [Chinese companies globalizing] is quite positive, but at the same time I also want to warn that there may be a brain drain in China, especially in sectors where Chinese entrepreneurs have found it difficult to navigate the vague rules of the regulation,” Chen said.