Can Silicon Dragon Really Rival Silicon Valley?

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China's tech entrepreneurial boom is already entering its second stage after only a decade.

Fueled by the world's largest mobile and internet markets, Chinese start-ups have developed into technology leaders in e-commerce, gaming, social networking and cloud computing. The tech giants Baidu, Alibaba and Tencent have cemented their lead in multiple market sectors, defeated western contenders in their local markets, and continue to gain power as they grab up more start-ups to house under their corporate roof.

Once copying ideas from the west and transplanting proven business models to the Middle Kingdom, founders of new businesses today in China are developing original concepts and commercializing new businesses. The copy-to-China phenomenon is dead. The scene has become much more local with fewer cues from Silicon Valley.

The story of China innovation today is micro-innovation, improving upon existing platforms and fine-tuning them for local tastes. Sina Weibo, China's Twitter, has more features than the original from Silicon Valley, for example.

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Venture investors too have become more localized in their approach to funding new enterprises in China. Today, they invest with locally hired partners in the yuan currency from yuan funds. They look to exit their investment in portfolio companies through a trade sale or listing - outside the once well-traveled paths of Nasdaq and NYSE.

The start-up fever in China has spread from the hubs of Beijing and Shanghai to new turf away from the biggest cities, spreading inland as far as Chengdu and Chongqing. Tech parks that can match the impressive infrastructure in the major cities have sprung up in these heartland places of China.

Meanwhile, as the entrepreneurial boom has matured in China, Beijing and its Haidian district, near the top tier Tsinghua University, has emerged as the favored spot for young graduates and Mark Zuckerberg wanna-bees to set up shop – despite the tough climate and lingering pollution. Shanghai is no longer the only place for venture capitalists to call home. Increasingly, leading investors in start-ups are moving to Beijing to be closer to the entrepreneurs they fund.

Survival of the Fittest

But challenges remain. Intellectual property protection remains an issue. In mobile internet in particular, new businesses can be copied swiftly – and are. Censorship of internet content in China continues, and probably will for some time. Chinese companies can gain the upper hand over western multinationals in this censored environment, as the Baidu and Google rivalry showed with the U.S. search giant withdrawing from mainland China.

Meanwhile, too many businesses are being set up in the same sectors, and not all can survive. With the economic slowdown in China and a parallel decline in online advertising revenue that supports internet businesses, growth rates and profitability have diminished. For many, it is survival of the fittest time as they look to stretch more limited financial resources and ride out the downturn.

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Venture capitalists that have funded these startups are also facing a shake-out. Just two years ago, the number of venture-backed Chinese start-ups listing on Nasdaq and the NYSE peaked. Now, very few Chinese companies are going public in the U.S. Accounting scandals among some listed Chinese businesses in the U.S. and a resulting stock price drop for many other public traded companies from China has put a lid on new listings. New regulations issued last fall in China have halted public offerings of Chinese companies within the domestic market. There's a backlog of nearly 800 companies waiting to go public in China.

The overall result is that start-ups have to preserve cash to keep going while waiting for the IPO (initial public offering) window to reopen. A trade sale is an alternative, but may not produce the big windfall. Venture capitalists are working with their existing portfolio companies to help keep them afloat. Funding of new start-ups is certainly not as active as two years – last year, venture capital investments declined by more than 40 percent.

On the positive side, angel investors are helping to fill the funding gap. Many of these new angel investors were founders of Chinese companies that went public or were acquired, giving the founders cash to invest in a new league of start-ups. Entrepreneur and start-up investor Lei Jun is behind several of the recent success stories from China start-ups such as smartphone Xiaomei and social communications player YY, which went public on Nasdaq last November. Fritz Demopolous, co-founder of travel search site Qunar, which Baidu bought into for $300 million-plus, is now angel investing too.

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Also on the plus side, China's tech leaders are beginning to look to new geographic frontiers for expansion. Tencent's popular instant messaging service WeChat is an example of tech innovation that is spreading now from China to the west as the service catches on as a handy communications tool worldwide.

China's startup ecosystem has matured rapidly over the past decade. We're still only at the beginning of a whole new era of China establishing its market as Silicon Dragon, a force that has the potential to rival Silicon Valley.

Rebecca Fannin is the author of Silicon Dragon (2008) and Startup Asia (2011), and a contributor to Forbes. She leads Silicon Dragon Ventures, the group she formed in 2010 to publish start-up news and host forums in the world's start-up capitals.