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Welcome to Ymer Venture Capital’s podcast #2.

We are casting from the Victoria Peak in Hong Kong where it is raining today.

Today’s podcast is filed under the “Start-up First Aid” and the topic is due diligence.

We gets lots of emails from start-ups asking us what type of questions venture capitalist ask when interviewing the start-ups’ customers during the due diligence process.

Frankly, every VC has their own list of questions, and to be honest there isn’t a set format, but we have 13 base questions that we like to get out of the way before we ask spontaneous questions…

I think you can learn a lot about life, relationships, and investing from watching sitcoms, especially US sitcoms – no joke!

For example, I have been watching season three of NBC’s Scrubs, a hospital spoof based on the lives of young doctors and nurses coming to age. In last night’s episode, the main character, Dr. John “JD” Dorian, commented:

“…a recent study showed doctors spend an average of 15 seconds with each patient – sounds insensitive but that is all the time we need…”

Reflecting back on JD’s comment, it stirred a thought, something that I’ve been noticing/observing for quite some time now – when it comes to investing, China based VCs a vast majority of China based VCs tend to spend more time listening to the opinions of other VCs than they spend on truly understanding the business and listening to opinions of the management team. So, let’s call this phenomenon “clubbing”.

I can totally understand that there is safety in numbers and that there are some benefits in building a syndicate (i.e. leveraging diverse relationships, experiences, and portfolios) but these spoils only go to the gold standard start-ups (i.e. those companies who fit the “Valley” venture model).

But this is China and as of yet there isn’t an acid test that is applicable to a majority of investments. The fact of the matter is that the VC environment in China is not only immature, but also untested (i.e. no serial entrepreneurs). Ultimately, lots of hidden gems fall through the cracks because their composition/profiles buck the conventional wisdom of what is an “A” team v. “C” team.

In my view, this is the time VCs should be backing less traditional ventures (i.e. anti-gold standard), when the market is less defined and investors are more accepting of China’s raw environment.

Turning back to our sitcom, Scrubs, (and yes, like all formula based sitcoms, there is a lesson here) JD recognizes the flaws associated with a 15 second diagnosis – let’s read what he has to say:

“…the problem with only listening for 15 seconds is sometimes you don’t hear everything, and when you finally figure out what they were trying to say you might have lost them forever…you can never underestimate the importance of listening…ultimately it keeps you in the moment so you don’t miss the things that really matter…”

A bit corny, we totally and unapologetically recognize this but, nevertheless, this is relevant to the point we are hoping to make…

Today, I had lunch with Roger Evans, Greylock, and Steve Williams and Hank Horkoff from Chinesepod.com — we had an interesting discussion about what VCs look for when meeting an investee for the first time. Roger is a Partner at Greylock and has over thirty-years of experience as both an entrepreneur and an investor – below are just some of his sage advice:

(1) Business focus – “what separates the men from the boys is focus, knowing what your core competencies are…what your addressable markets are…and being disciplined enough not to cross those boundaries…”

(2) Defend your territory– “once you’ve staked out your core competencies, how defensible are they?”

(3) Thought process – “the way you have thought through your business strategy/model…what factors did you take into account…where did you get this information from…”

(4) Motivation – “what gets you up out of bed each day?”

Today’s Financial Times (FT) reports South Korean gamers are ganging up on Chinese gamers, whom they view as greedy and rude.

In Lineage, which has more than 3m subscribers, players in the form of knights, wizards and elves chase monsters who drop money and other valuable items that increase players’ strength, such as swords and medicine. These items can be sold for real money through online trading sites.

However, there is an etiquette to be followed: players interact along the way, but you are not supposed to take things dropped by someone else’s monster. Many young Chinese are joining South Korean matches because that is where the most items are traded and where the most money can be earned. But players say they do not follow the unwritten rules.

There have been reports of Chinese [parlors] where gamers play for hours to earn money using South Korean identities. More than 220,000 South Koreans have had their online identities stolen in connection with Lineage, NCSoft said yesterday.

We haven’t fully thought through the medium to long-term implications of this, but it can’t be good, especially because Chinese gaming companies license a majority of their MMORPG from South Korea. One thing is clear, it brings to light both the opportunities and the pitfalls associated to worldwide networking…

A Technorati search reveals over 500 blog links to the phrase “under-promise, over-deliver”

We bring this up because, well, it seems to be the catch phrase of the month — 9 out 10 entrepreneurs prefer to “under-promise, over-deliver” — this mindset worries us greatly — when it comes down to it, we want to know an honest assessment of what you are capable of doing and where you believe the company will be in x number of months.

Otherwise how can anyone truly make an informed decision — from both an operational (resource requirement) and investment perspective…

Man-o-man have we received a ton of b-plans pitching video sharing sites over the past couple of weeks. By last count there are no fewer than 50 such sites in the US alone; and since barriers to entry are so low making a move in this space is challenging. However, here are four criteria we want to see even before we will consider your venture:

(1) Destination – #1 spot, #1 spot, #2 spot (if you also own the #1 spot)

(2) Captive audience – size does matter (“super size me”), but so does their length of time on the site

(3) Rich content – audience contributes content as much as they consume

(4) Control – clear, functioning copyright and mature content control/policy

What kills me about China’s Internet companies, even listed, well capitalized companies, is their lack of attention to details. For example, today I called Beijing based travel agent e-long to book a ticket from Shanghai to Hong Kong using the company’s “In Mainland China Number: 400-810-1119”

Here is my conversation with e-Long’s travel agent:

Ymer: “Hi, I would like to buy a ticket from Shanghai to Hong Kong”

e-Long: “Are you calling from Beijing?”

Ymer: “No. I’m in Shanghai…”

e-Long: “I’m sorry, you can’t use this number to book a ticket from Shanghai, you can only use it in Beijing…”

Ymer: “So, why, on your website does it inform customers in mainland China to use 400-810-1119”?

e-Long: “I don’t know…”

Ymer: “Don’t you think that is a little strange? I can’t be the first person to bring this up…have you ever asked your manager why this is the case or made a suggestion that customer service should try and clarify this?”

e-Long: “…(silence for 30 seconds and then there was laughter and a gulp)…do you want the mobile number of my boss to ask him yourself?”

I get it that people in Shanghai like to talk to other Shanghainese (strange phenomenon in China), but this is easily solved by using a web based PBX software – there really isn’t any excuse for this sort of service.

At the very least there should be a feedback loop from the front line agent to her immediate boss whereby suggestions are made and executed upon. Japanese automotive manufacturer, Toyota, did this famously, whereby they called it Jidoka:

…It refers to the ability to stop production lines, by man or machine, in the event of problems such as equipment malfunction, quality issues, or late work. Jidoka helps prevent the passing of defects, helps identify and correct problem areas using localization and isolation, and makes it possible to “build” quality at the production process.

Maybe we need to come up with a similar process – we can call it “Zhong-doka 2.0” and start evangelizing it to China’s web-based community?

From Oriental Morning Post via Pacific Epoch:

According to a recent survey by Chinese career consulting firm CBP Career Consultants, 52% of white collar workers in Beijing, Shanghai, Guangzhou and Shenzhen have their own blogs and 28% more will launch their own blogs soon, reports Oriental Morning Post. According to the survey, white collar bloggers update their blogs every 3 days on average, and Shanghai’s white collar workers update their blogs every 4.5 days on average. The report said that 41% of white collar bloggers use MSN Space because it is only open to friends.

I don’t like to give out too much advice on what to do and what not do if you are a start-up, largely because I think there are smarter people out there with better insights than me. However, today, I want to touch on a subject that has been running around in my head for several weeks: CEO Secession.

For the past six months, I’ve been working very closely with a Shanghai based technology start-up. As a result, I believe I’ve built an honest, trusting and open relationship with the CEO (Harvard MBA) and her management team. Typically, I’m wearing my “vc hat” however in this case I’m wearing both my “vc hat” and “team hat” which makes things a bit difficult as the investor inside of me must remain cold and calculating, while the team member inside is pulling for the company.

In this case, we are in the process of closing a second round of financing with a seasoned US/China based VC — one of the outstanding question marks is whether or not the CEO in place is the “right person for the job”? And if the answer is, “no, she is not” then at what point do you replace her?

In some ways (“vc hat”), I think it is wonderful that this question is coming to the forefront early on, rather than 6 or 9 months down the road — the reason being that: (1) the investors are passionate about this investment and are doing their homework, and (2) at least we have time to plan for a contingency strategy rather than going into crisis mode when the shit hit the fan.

However, in the same breath (“team/vc combo hat”), I’m a bit disappointed that this is even an issue so early on — perhaps this isn’t a simply a “CEO issue”, perhaps the issue is more a result of poor market conditions (too early), limited resources (more head count and funding needed), and/or basic early stage hiccups. In which case this is a “structural issue” common in almost every single early stage company I’ve even been involved in. Isn’t this why we (the venture capitalist) is in this game – to add value, to be hands on investors – supporting entrepreneurs is our sweet spot (and if we do it right, we make some nice change to boot).

Putting all my hats away, I’m left resolving the best way to directly address this issue with the CEO so as to not shake her confidence while eradicating any grey area as to what the core issue is: “Can you take the company to the next level and if so, how do you plan on doing this”?

Never too shy to “ping” a complete stranger for help, I emailed Garage Ventures MD, Guy Kawasaki, this morning seeking some insights into this matter; Guy was cool enough to quickly reply:

I wish I had a magic solution for you, but I don’t. You’re just going to have to discuss this openly with the CEO. A good CEO will recognize that the company comes first, not his own needs. Also, there is a chance he could grow into the position–believe me, VCs don’t know everything about how someone will grow into a job.

I shared this email with the CEO, we chatted at length, and resolved this matter (with the support of her advisors) rather quickly. I’m really proud of this lady; her response was neither aggressive nor condescending (i.e. I’m local Chinese, therefore I know best how to run a company in China); in fact she totally agreed that her interest must never get in the way of the company. And with that, she went about mapping out an execution game plan for the next 3, 6 and 9-months and at each milestone highlighted specific, measurable, and tangible results that she would ultimately be solely responsible for. Furthermore, a contingency plan in is the works, which includes key/replacement hires. In my book, that is a responsible, fundable leader (especially in China where it is extremely difficult to find an entrepreneur with this quality).

Only time will tell how this pans out, whether the milestone and accountability stick – for if they don’t, it will be as much the responsibility of the CEO as it is of the “value-add” investors (myself included)…

As a side note, Guy Kawasaki wrote a very nice article called, “The Art of Execution” – totally worth a read for start-ups going through similar situations.

BBN Technologies launched Podzinger, which uses speech technology to convert to text the contents of 60,000-plus podcasts. Since it can search through the text of podcasts, it can better determine the relevance of search results to help you find what you’re looking for.

There are several China-based blog search engines that do very basic searches, such as feedsearch, 8fang, feedss, and Bokee’s Booso.

However, none of these blog search engines have the capability of searching podcasts, which is unfortunate as Podzinger is an English only podcast search engine.

USAToday reports that Toshiba, a Japanese electronics company, has developed mobile-phone technology that searches for product reviews on up to 100 Web journals, or blogs, in 10 seconds.

Although, there might be issues of trust (commentary) and accuracy (data), we like this concept very much and will be following its development closely.

In the same breath, there is a small Shanghai based venture called Kaible.com that is backed by Dragon Venture that does something similar, however its offering focuses on price comparison.

We are not a big fan of Kaible’s model as it’s less dynamic (real time pricing) and completely dependent on the participation of merchants providing reliable, truthful data. Furthermore, we don’t see the value in it for the retailers — why would they want to reveal pricing to their competition. And finally, anyone who has shopped in China knows plenty well that haggling (over the price) between customer and clerk is more the norm than the exception – how does Kaible account for this?

(One approach might be to encourage consumers to SMS/Email Kaible with price information in return for loyalty points, or a chance to with gift certificates – however the most powerful driver would be community.)

New York Times reporter Joseph Khan reports on comments made by Liu Zhengrong, Head of Internet affairs for the information office of the Chinese State Council, regarding China’s control over the Internet:

“If you study the main international practices in this regard you will find that China is basically in compliance with the international norm,” he said. “The main purposes and methods of implementing our laws are basically the same.”

“Major U.S. companies do this and it is regarded as normal,” Mr. Liu said. “So why should China not be entitled to do so?”

AOL launched its new Chinese portal over Chinese New Year targeting Chinese living in the US – we tried the search feature from Beijing and there doesn’t appear to be any blockage of information.

The timing of the launch is interesting – perhaps a marketing ploy set at distinguishing themselves from Google, Yahoo! and MS – the difference being, AOL servers seem to be hosted State side. No street cred there, AOL.

Most of the commentary we’ve read applauds AOL’s open search, proclaiming “…companies have choices…despite what they may claim…” but this is just ignorant and misses the bigger picture – AOL can’t make it in China and they realize this (otherwise, why they are targeting US based Chinese when ever other US portal/search is in China?)

First rule of doing business in any foreign country (for example, China) is localizing, working within the system, sticking out performance wise, yet remaining under the regulatory radar (as much as possible). AOL recognizes that if they rolled out a meaty China operation (not as Time-Warner, but as AOL the Internet play), such as Yahoo!, Google, and MS have, odds are extremely good that their search parameters and content would echo that of the big three.

(on the soap box)

We aren’t here to defend China, but rather to provide some perspective – which, by being on the ground for over a decade, is somewhat clearer than pundits across the pound. China is an amazing, frustrating, backwards, confusing, quagmire of conflicts, resolutions and more questions but at the end of the day what truly separates the success stories from the failures is sustainability and adaptability (i.e. frequent trial and error) to China’s evolving landscape and power plays. That is why a quality/gritty/grounded management team is more important than the size of the market or uniqueness of IP – other investors feel differently, but we don’t.

(off the soap box)

We have tried very hard to avoid talking about the “Google & China Issue” but in light of last night’s USA Today article about the new bill drafted by US Representative Chris Smith (R-N.J.) we couldn’t hold our tongue any longer.

Rep Smith seeks to…

…force Internet companies including Google, Yahoo and Microsoft to keep vital computer servers out of China and other nations the State Department deems…

We don’t understand the fallout over this issue — the rules of doing business in China have not changed in decades — why the sudden drama!?

If you think about it, is there any difference between what China is asking Google to do and what this new congressional bill seeks to do?

To be honest, we think the US would be better served if Congress worked to protect US corporate IP…

First, the creator of the MillionDollarHomepage went to ebay to auction off the last 1,000 pixels which sold for US$40,000

And, now it is RocketBoom’s turn…

Back in November 2005, Nokia Greater China customer service and marketing SVP Zhao told Beijing Star Daily that Nokia was considering a move into TD-SCDMA handsets. Yesterday, Sohu.com reported on Nokia’s 2006 China Strategy, specifically noting Nokia’s move into manufacturing TD-SCDMA handsets.

Obviously, this isn’t earth shattering news (Motorola and Siemens have already moved in this direction), however it does provide another piece to the 3G “when will we get a decision on licensing” puzzle — in other words, if Nokia has spent the past four months chatting up their TD-SCDMA handsets then it is a good bet they had some “information” others might not (i.e. we might be closer to 3G “go” time then we think). As such, we’re revising our 3G licensing decision timeline from Q107 to Q306.

A small ancillary benefit from Nokia’s move into TD-SCDMA is that it should expedite the development of TD-SCDMA handsets with their massive R&D teams and experience in commercializing new technologies.

It will be interesting to watch what comes out of the 3GSM World Congress over the next several days regarding the 3G licensing decision in China.

UPDATE (2/14):
Today, Sina.com noted the 3G royalty negotiation between the Chinese government and Qualcomm has run into a stalemate. This negotiation is carried out by the Ministry of Information Industries on behalf of all Chinese vendors, covering TD-SCDMA, WCDMA, and CDMA 2000.

Chris Early, Studio Manager for Microsoft Casual Games Group talks with gaming blog Joystix about challenges facing casual gaming and how MS is working to bridge the gap between console players and PC players.

One of the big challenges that–not just Microsoft–people have been working on for years in the online community space is “how do you allow consumers to differentiate themselves? “Because you and I, when we both log in, we are essentially the same, right? In that digital world we’re just a collection of bits.

How do we begin to establish different identities and differentiating ourselves becomes a key element to the community? One of the ways is by allowing people to pick their own avatar and self express in some forms. But another way is to allow people to earn and achieve those differentiators and have that be part of something you can be proud of and show of:

“In fact I am different because even though we may have picked the same avatar and remarkably similar name, I am clearly a much better Geometry Wars player or pick the game player because my score’s higher or I’ve earned more badges or because whichever method you want to go to.” Differentiation ends up being key.

Steve Rubel is SVP at NYC based PR firm Cooperkatz agrees with us that RSS is the New New Thing in direct marketing:

That’s all folks. The door has officially closed on email marketing. Maybe this will drive more companies to start up opt-in RSS feeds and blogs that facilitate dialogue.

And so does Polarman:

Fred, please change the business models from email to RSS. It’s time Email gives way to RSS. Everything that a email delivered service can do should be done by RSS.

But, Elliott Ng, an Executive at Intuit, gave us a different opinion:

I think RSS itself is a feature, but the larger story is about how customers and companies engage with each other, and how companies have a difficult time managing those dialogues.

Regardless where you stand on the RSS v. Email marketing debate (if in fact there is one and we aren’t making a mountain out of a, well, non-issue) one thing is certain: RSS marketing will have a major impact in China where two of the largest email service providers, 163 and Sina, already block thousands of smaller email servers — some good (permission based marketing) and some evil (spammers) — getting your company off their black lists and onto their white lists reeks of favoritism…

A couple days ago, HBO (Home Box Office) petitioned the FCC (Federal Communications Commission) in the United States to prevent consumers from recording their content (Subscription Video On Demand) – either with a VCR, DVD, or TiVo device. Sure this doesn’t have a direct impact on those of us living in Hong Kong and China – where HBO doesn’t have the traction it has in the US – yet HBO is representative of the losing battle the incumbents (broadcast networks) fighting – and losing dearly.

My general thesis is that all content will be free in the very near future and that DRM (Digital Rights Management) is not a sustainable technology. I’m not supporting piracy; I just believe it will be very difficult to generate any revenue from content alone. Where the money will be made is on product placements and side promotions, for example. Listed companies, such as Tom.com are spending a lot of money in rights to content that they won’t be able to control – in other words, their business strategy is dead wrong.

The companies that will be the winners, the next Google, will be the companies that develop technologies to harness, distribute and monetize this free content. Yahoo, for example, if a big buyer of networks and page views (note its purchase of Flickr’s 8 million users); yet they are not a buyer of technology…

The reason I believe this sector (e.g. BitTorrent) is a massive opportunity for start-ups is simply because there is: (1) demand, (2) users, (3) exits. The “demand” and “users” are clearly defined, but the “exits” – how will they come? I believe “exits” will come from the major portals, such as Baidu, Sina, and Tencent. The reason is simple: these listed companies can’t develop this technology in-house, but it isn’t because they don’t have the capability, it just that they can’t be seen publicly supporting file sharing, for example.

This is why technology start-ups (in this space), especially in China and Hong Kong, are so attractive (at least to us) and why we believe the next MONSTER company will come from this space.

From my hometown, Boston (USA), comes “WiFi Pulse Points”, the Boston Globe writes:

They allow individuals [with wireless] to connect to a network, but not to the Internet or e-mail. Rather, these Pulse Points connect individuals to their location—and each other. They create a “situational community” of people who are connected simply because they are in the same place at the same time.

Content, content, content…

Some amazing developments in video blogging (vblog) over past year. We’ve mentioned vblogs a couple times in the past months, including China based Toodou.com — the following two sites are worth mentioning:

FireAnt (it’s a portal that syncs to almost any device)

ApolloPony (suggest watching Game: On Mashima)

In fact, one vblog out of New York City, RocketBoom, has moved from the web to the TV, or rather, to TiVo

And then again, this shouldn’t be all that much of a surpirse given Yahoo’s partnership with TiVo back in November 2005…

To all the China-based entrepreneurs — we are putting you on notice: The learning curve is moving quickly, as are expectations — this time around there will be no room for excuses, such as “we are a developing country…”