Recent moves by the Chinese government on intellectual property rights and consumer spending have encouraged venture investors to dive into China’s software and internet sector. Dave Keating reports.

There are many differences between Chinese and American cultures, but one of the starkest may be the difference in how the two nations save. The thrifty Chinese have made saving an art form, whereas over the past decades Americans have spent their way deeper and deeper into debt. Last year China saved about half of its gross domestic product, whereas the US saved only 13 percent of its national income. In the same year the personal savings rate for individual households in the US actually dipped into the negative, at -0.4 percent, whereas Chinese households stashed away about 30 percent of household income.

Both of these extremes are bad news for their respective countries, but the Chinese government is working to change this trend. One of the major planks of its new five-year plan is to discourage the Chinese propensity to save and to promote internal consumption. This hasn’t escaped the notice of venture capitalists, who are eyeing the sectors where Chinese citizens are most likely to first spend their money. That sector, they’re willing to bet, is internet and software companies.

Ollie Curme says China is fostering venture interest.

“The Chinese government is trying to promote consumption,” says Ollie Curme, a general partner with Battery Ventures who specializes in Chinese investment. “As it goes from a very small consumption society to a very big one, people are hoping that it sort of skips all the retail stores and goes straight to internet commerce. That’s got a lot of people tremendously excited.”

Chinese software and internet companies have become a magnet for both foreign and domestic venture capital firms. According to the venture capital research and advisory company Zero2ipo, fund raising by venture capitalists for investments in China hit a record $4 billion in 2005, and much of that money is eyeing the internet sector. There were 56 internet deals in China last year, raising $223 million. High profile IPOs such as that of China’s leading search engine have received a lot of attention from US venture capitalists. The wildly successful Alibaba, which now owns, and Yahoo! China, is reportedly close to an IPO of its own. And China’s biggest online book seller Dang Dang, often called the Amazon of the East, has been raising increasing amounts of venture investment in successive rounds.

Some of the most recent venture entrants into the field have included Menlo Park-based Doll Capital, which has said it plans to invest $500 million in China over the next ten years, and Siemens Venture Capital, which has said it plans to close deals in China over the next twelve months. Intel has established a $200 million venture capital fund that will invest in Chinese hardware, software and service companies. And last month Beijing-headquartered Oak Pacific Interactive, an internet content and communications provider, received $48 million in financing from a group of private equity and venture capital firms led by General Atlantic.

The Chinese government has had no small role in attracting the attention, as they’ve instituted tax breaks for high-tech companies and instituted plans to make the formation of venture capital management companies easier. In response, many Chinese companies have started their own venture capital operations. Companies such as Stone Group Corp, Start, Legend, Tsinghua Tongfang and Haier have all set up their own venture capital firms or partnered with existing ones.

There actually are pretty good laws, it’s just that they’re not very strictly applied. If they can do this you’ll see a market emerging much more rapidly.

GSR Ventures’ Richard Lim on intellectual property laws in China.

The government is also instituting plans to spur the growth of the software sector. At the recent 10th Annual China International Software Exposition earlier this month, Ding Wenwu, deputy director with China’s Ministry of Information Industry, said China’s software industry is expected to keep an annual growth rate of 30 percent from 2006 to 2010, by which point it will be worth 1.3 trillion yuan ($162.5 billion). He added that software exports would reach $12.5 billion by 2010, more than triple the $3.59 billion for 2005. He said this growth would be achieved through changes in government regulation and a crackdown on intellectual property rights violations, which has been a major concern for years.

“The Chinese government can begin to enforce more issues about piracy, or really the ability to not get prosecuted,” says Richard Lim, a managing director with GSR Ventures. “There actually are pretty good laws, it’s just that they’re not very strictly applied. If they can do this you’ll see a market emerging much more rapidly.”

Of course there are still major concerns. International bodies have noticed that enforcement of intellectual property rights varies greatly from area to area, with Shanghai being a much better enforcer than Beijing, for example. But Curme says a much bigger issue in China is the lack of experienced managers.

“Private industry has really only grown up in the past 10 or 15 years,” he says. “So you have a lot of high-growth companies, but the managers are learning on the job. It’s hard to hire an experienced CFO or marketing people. You don’t have the resource base in China that you do in the US.”

Few investors doubt, however, that there is big money to be made in China’s emerging software and internet sector.