Venture communism: China fuels a start-up boom

The Chinese government is lavishing benefits like free rent and cash hand-outs on home-grown start-ups

Employees at Chemayi in Dream Town, Hangzhou. The start-up, which offers car repair services through a smartphone app, is staying rent-free in Dream Town as part of a government’s programme. Photo: The New York Times
Employees at Chemayi in Dream Town, Hangzhou. The start-up, which offers car repair services through a smartphone app, is staying rent-free in Dream Town as part of a government’s programme. Photo: The New York Times

In Dream Town, a collection of boxy office buildings on the gritty edge of this historic city, one tiny company is developing a portable 3-D printer. Another takes orders for traditional Chinese massages by smartphone. They are just two of the 710 start-ups being nurtured here.

Anywhere else, an incubator like Dream Town would be a vision of venture capitalists, angel investors or technology stalwarts. But this is China. The Chinese Communist Party doesn’t trust the invisible hand of capitalism alone to encourage entrepreneurship, especially since it is a big part of the leadership’s strategy to reshape the sagging economy.

Which is why the government of Hangzhou—a former royal capital that has been a major commercial hub for more than a millennium—built Dream Town and lavishes resources on start-ups. The businesses here get a slate of benefits like subsidized rent, cash hand-outs and special training, all courtesy of the city.

Chemayi, which offers car repair services through a smartphone app, is staying rent-free at Dream Town for three years and is applying for as much as $450,000 in subsidies from city authorities to help pay salaries and buy equipment.

“From the central government all the way down to local governments, we have seen a lot of warm support,” said Li Liheng, co-founder and chief executive of Chemayi.

For much of China’s long economic boom, young people flocked to manufacturing zones for jobs making blue jeans or iPhones. But today, China is trying to move beyond just being the world’s factory floor. Policymakers want the next generation to find better paying work in modern offices, creating the ideas, technologies and jobs to feed the country’s future growth.

Premier Li Keqiang frequently calls for “mass entrepreneurship”. In March at the National People’s Congress, he bragged that 12,000 new companies were founded each day in 2015.

The entrepreneurial embrace comes with lots of financial support. Across the country, officials are creating investment funds, providing cash subsidies and building incubators.

“Without these kinds of subsidies, you only rely on private money, and you wouldn’t see so many technology start-ups happening today,” said Ning Tao, a partner at Innovation Works, a venture capital fund in Beijing. “Without quantity, you cannot have quality.”

But the heavy spending is adding to worries about an inflating bubble in the world of China’s tiniest companies. Along with the government funds, venture capital money is flooding the country. About $49 billion in deals were made last year, making China second only to the US, according to accounting firm EY.

Some economists and entrepreneurs are concerned that the government is helping fuel a frenzy that might ultimately result in failed businesses, wasted resources and financial losses. Just one city, Suzhou, near Shanghai, has announced it will open 300 incubators by 2020 to house 30,000 start-ups.

Beijing’s policymakers have a long history of giving favoured companies easy access to loans and subsidies to propel certain industries, with both good and bad consequences. Though that tactic lubricated the nation’s industrialization, it also contributed to the excess that has buried the country in empty apartment blocks, mothballed cement plants and sputtering steel mills—all of which threaten the economy’s stability.

“I think the subsidies shouldn’t be a long-term policy,” Jin Xiangrong, an economist at Zhejiang University in Hangzhou, said of the start-up support programmes. “They can lead to overcapacity like the kind we see now in China’s manufacturing sector, which is largely a result of government support.”

Hangzhou city officials turned down requests for interviews.

The children of Alibaba

Hangzhou is a natural centre for China’s start-up fever. After China embraced capitalist reform in the 1980s, Zhejiang province, of which Hangzhou is the capital, emerged as a leading base for the export industries that fuelled the country’s rapid growth. Factories pumped out products like socks and plastic Christmas trees.

Now that zeal for commerce is being channelled into technology start-ups. Hangzhou is home to China’s most famous Internet company, the e-commerce giant Alibaba, which has become a training ground for would-be entrepreneurs.

The neighbourhoods near Alibaba’s sprawling campus, once a poorly developed area on the city’s outskirts, now make up a budding tech centre with newly built office parks like Dream Town, dominated by ambitious college graduates, angel investors and venture capitalists. The local restaurants have become hang-outs to exchange ideas and gossip over fried squid and stewed pork and eggs.

Feng Xiao is typical of this new breed. Feng, 39 and a Hangzhou native, spent 11 years at Alibaba, mainly in sales and marketing.

“There is a Chinese proverb, ‘The soil is too rich,’” Feng said. Alibaba “offered you a lot of opportunities. It was easy to have a sense of success. But I wanted to be able to start from scratch.”

His start-up was born in Alibaba’s cafeteria, where he ate meal after meal. “I really missed mom’s cooking,” he said. He figured that many other people, trapped working for long hours far from home, felt the same.

Feng and two other Alibaba employees left their jobs in 2014 and opened a food delivery service, Mishi. Their plan was to connect people willing to prepare home-made meals with on-the-go professionals who were too busy to cook. They set up shop in a friend’s empty house, decorated with secondhand furniture and photos from home.

Along with raising $19 million from private investors, Mishi caught the eye of the Hangzhou city government. In 2014, district officials awarded Mishi 5 million renminbi to help pay the bills. Its rent in a Hangzhou office park is also subsidized.

“The most important thing on the part of the government is whether they are open” to new types of businesses, Feng said. “We are glad to see they are aggressively supporting us.”

Hangzhou represents what Chinese leaders see as the nation’s economic future. The country used to generate astronomical growth rates by depending heavily on low-cost exports and extremely high investment in apartment towers, factories and highways. But today, costs are rising, eating away at the competitiveness of many export industries. The long investment boom has saddled the economy with too many factories and a mountain of debt.

Instead, policymakers are encouraging a shift to new growth engines, like services and high-tech.

The entrepreneurial focus is providing an economic boost for Hangzhou.

The city’s gross domestic product rose 10.2% in 2015, compared with the 6.9% national growth rate. Hangzhou’s service sector, which includes many start-ups, was the main engine of that strong performance, surging 14.6%.

“The Chinese know that state-owned enterprises are not going to employ everybody,” said Hans Tung, a managing partner at GGV Capital, a venture capital firm that operates in both Silicon Valley and China. “They need young people to create jobs for themselves, so they are encouraging them to try something new.”

Mishi has created 100 full-time jobs, and has bolstered the incomes of more than 10,000 home chefs.

Cai Liangen, a retired businessman turned Mishi cook, learned about the start-up when a marketing team visited his apartment complex seeking to enlist new chefs.

In November, he and his wife began making local specialties in their kitchen, including a sliced pork dish prepared with “my mother’s secret recipe”, Cai said. They now receive 40 orders a day and earn 5,000 renminbi a month, increasing their total income 70%.

“We do it because we love to cook,” Cai said, “but the money is good to have, too.”

A swell of subsidies

After submitting a 10-page proposal in 2014 to join a Hangzhou incubator, Ai Binke sat nervously before a committee of tech industry executives who questioned his future prospects. His software company, Yun Ran Internet of Things, had only four employees, and its business deals had been small. But his start-up, Ai explained to the committee, had great potential.

That was sufficient for the judges to award him 100,000 renminbi in subsidies. The bulk, roughly 70%, was instantly transferred into his corporate bank account. “As long as you run projects that are encouraged by the Hangzhou government, you can get the subsidies,” said Ai, 29. “It’s not very difficult.”

Local governments around China are spending heavily on start-ups. In Shenzhen, authorities are offering to subsidize up to 70% of rent for “creative” start-ups. Local officials in the south-western metropolis of Chengdu are setting up a 200 million renminbi “entrepreneurship and innovation development fund” and promising subsidies of up to 5 million renminbi.

Officials in Guangdong province in China’s south will cover part of a start-up’s losses. Even the lesser-known city of Yingtan, in an area of Jiangxi province mainly known for its ancient Taoist temples, is planning to build an incubator.

Hangzhou’s government has been one of the more active. Officials are forming a venture capital fund of 4.7 billion renminbi, with contributions from companies, according to the city’s website. This year, Hangzhou announced that it would give 100 million renminbi to help start-ups pay expenses.

But governments historically have a spotty record of using state-directed money to generate business success stories.

During Japan’s high-growth decades, its bureaucrats tried to “pick winners” by selecting certain industries for support. Though they nurtured a few internationally competitive industries (shipbuilding and steel), they also had significant failures (chemicals and computer software). The Obama administration got a black eye for its financial aid to the solar technology firm Solyndra, which sank into bankruptcy.

In China, government efforts to assist new businesses have often led to waste and excess. Too much investment pours into favoured industries, spawning poorly conceived projects in areas like hotels and solar panels. By trying to spur start-ups, the state is also engaging in a high-risk business that even for the most experienced venture capitalist is prone to produce more failures than successes.

Hangzhou officials are trying to avoid such pitfalls. At Dream Town, the financial aid is often linked to a start-up’s performance. The amount of free rent depends on how much private capital a company can raise. Cash hand-outs are tied to revenue targets or top-selling apps.

Government officials also enlist professionals to help allocate the city’s money. The committee that judges applicants to Dream Town is usually made up of tech executives, financiers and academics.

Ye Feng, a manager at another incubator who has sat as a judge on three occasions, said she quizzed the contenders on their technology, business plan and even product pricing.

Usually, about 30 start-ups appear at each competition. No more than four make the cut to enter Dream Town. “The competition is quite fierce,” Ye said. “Sometimes it’s hard to make a decision.”

But some in Hangzhou fear that the government is doling out too much money, and it is flowing to start-ups with weak business plans and feeble prospects. Ai of Yun Ran said that two neighbours also received city subsidies. One, a robotics start-up, failed to attract private capital and closed, while the other, a mobile game company, is struggling to stay afloat as its business withers.

The government money, Ai said, often cannot replace the private capital necessary for start-ups. “Without financing, it would be very hard for them to survive,” he said.