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Creating a Web Startup in China – The Yunio Way

CHINA | Not many foreigners are brave enough to start a company in China, especially an internet business. Willing to try are the people of Yunio (??), who have created a cloud storage service much like Dropbox, but with an advantage the competition doesn’t have: access to the Chinese market. I recently had the pleasure of meeting Yunio’s Founder Chris Mathews and Operations Director Joey Gu in their office here in Shanghai.

“If you were to put the creation of an internet startup into a video game, setting up in Silicon Valley would be like playing on ‘normal’ mode while creating a company in China is like playing on ‘difficult’ mode,” according to Chris, who has experience doing both. “Every aspect of a tech startup is tougher in China than in the United States – from the regulatory environment to the inherent limitations of the Chinese internet backbone – and you are doing it all on your own.”

The creation of Yunio started with an idea that was first developed into a prototype in the comfort of Chris’ own apartment in Shanghai back in 2010 alongside cofounder Rick Olson. With the prototype, Chris and Rick went looking for (and found) a Chinese angel investor who supplied them with the angel investment. They are now set to launch version 2.0 in the next few months. Great for all cloud-savvy “laowai” out there is that this new edition will include an English version. To come to this point, the company had to solve some normal startup problems as well as some China-specific ones.

Chris himself is an American with an ethnic Chinese background who came to China to be rooted and because he knew this was where he wanted to be. Early on in his time here, Chris decided to conduct an MBA at Fudan University to connect with local like-minded individuals. He’s also taken the time to learn and appreciate the local culture, and his first point of advice was that learning Chinese is essential if you want to do business here.

“Would you ever go to America and do a startup without speaking English? Probably not. The same applies to China; you just HAVE to learn Chinese,” Chris says.

With over 450 million netizens and a forecasted e-commerce market of US$311 billion by 2015, the Chinese online environment has great potential for startups. The hurdles to enter and succeed in this market, however, are equally tough to overcome.

 

Setting up a web company

Although China’s 12th Five-Year Plan includes measures to strengthen the Chinese service industry, the regulatory reality still doesn’t offer any easy entry into the market. It’s always advisable to have a holding company outside the Chinese mainland in Hong Kong or Singapore, for example, since it makes handling certain things like share transfers much easier and might also offer tax advantages. The process is easy and cheap and normally strongly outweighs the disadvantages.

On the other hand, setting up the Chinese subsidiary is not always as straightforward, since the internet market is still quite restricted for foreign companies. Generally speaking, it is easily possible for foreigners to offer non-commercial services as well as goods online, but they are currently not allowed to offer commercial services. This means that a service business can advertise online (without making profit through the website) and a physical shop (e.g. a foreign-invested commercial enterprise) can offer their goods online in addition to their physical store, however it is not possible for foreigners to register real web startups offering services for a fee in China.

So how did Yunio do it? They did this by registering a Chinese company with Chinese citizens as the registrants, because ICP licenses can only be issued to companies that are wholly Chinese-owned. Chris and his partners then own shares of this company via separate agreements with the registrants. If you want to offer online services in China, the only way to do that is with a Chinese partner – either as a joint venture or otherwise with a proxy holding your shares in the company.

However, regardless of the solution you choose, it is a double-edged sword. Your Chinese partner will in any circumstance be in the stronger position and might try to turn the cards in his or her favor. It’s therefore only advisable to work with Chinese partners that you can trust completely – 100 percent.

Of course you can make profit sharing agreements, yet often Chinese courts consider them to be illegal since their purpose is to evade the current law. They therefore tend to not be enforceable and will not offer you any legal protection.

Joint ventures give you a maximum of 50 percent control of the company, yet it’s still hard to get the necessary license from the Ministry of Industry and Information Technology to operate commercial services. One requirement is a high amount of registered capital. An example for this is Groupon, who formed a joint venture with Tencent in order to enter the Chinese market, yet the Groupon example also shows the dangers that such joint ventures entail. One of the mistakes the company made when entering into a deal with Tencent was not to include “non-competition” articles in the contract. This is why Tencent is pushing their own group buying platform with much more dedication than they did with “GaoPeng.” This should be another reminder that the most important thing in China is a trustworthy partner. The demise of Groupon’s “GaoPeng” is also one example that even companies with funding, branding, and a proven record of success outside of China are not a guaranteed success.

There are semi-legal ways around it, but it is important to notice that those ways tend to come back to haunt you in the later stage of your business, especially if your business becomes successful. As a rule of thumb, you could say that if a court will not enforce your contracts and interests, it’s probably unwise to go on with the project you’re doing. Yet even a written contract might not save you from bad experiences. Only building strong relationships with your customers, suppliers, employees and other stakeholders can really help your China business succeed. For people who like to get things done quickly and prefer a structured environment, this can be very frustrating.

It is possible to register patents and trademarks in the name of individuals or foreign companies. If you decide to have a joint venture or a proxy holding your shares, this might be one way to secure leverage on your side. You can register the company in the name of your Chinese partner, but register trademarks and patents in your name, which would give you at least some leverage. It could be also possible to get key elements of your source code out of the reach of your partner. Try to do as much as possible to balance your legal stand towards your Chinese partner, even if you trust him or her completely.

 

Understanding the Chinese customers and your product

As a foreigner, you will not be able to succeed in China if you only come for the market. You have to come for the love of China as well as with interest in the culture and people. It’s important to notice that a market gap in China might not turn out to be a market demand. This doesn’t necessarily mean that you have to lose your identity, but it definitely means that you have to adapt your product to the local tastes, much like KFC and Pizza Hut have done with tremendous success in China.

The Chinese market is unique in its form and taste, which makes it necessary for entrepreneurs to understand ....

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Source: Posted on June 27, 2012 by China Briefing, by Jochen Schanbacher

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