Series A bullshit: why China’s startups are peddling lies

Report what you’re told, or report nothing at all. That’s the harsh reality of covering the increasingly hefty investments landed by China’s startups. I know that not everyone is telling the truth and there might be some embellishment here and there, but until recently I was not aware of the scale of how Chinese startups intentionally misrepresent their funding rounds.

“Startups do it quite frequently, and I would say anecdotally it is the great majority – over 50 percent,” says Rui Ma, 500 Startups’ venture partner in greater China, who focuses on early-stage startups. “I can’t really prove this as I don’t [conduct due diligence on] every number. However, I can’t recall any number that I thought was kind of fishy that hasn’t turned out to be wrong.”

Ma says it’s typically the startups who are responsible for the fudged numbers, but Michael Zhu, the Shanghai-based partner at Gobi VC, says young Chinese venture capital firms also bear some of the blame. “It is relatively common, especially with venture capital firms who may be new to the scene and are trying to carve out a name for themselves,” he says.

The trend isn’t disconcerting just because of the large proportion of startups that lie, but by how much they misrepresent. Ma and Zhu both believe that, on average, funding figures are exaggerated by a factor of two to three (yes, double to triple), and occasionally by a factor of six (RMB swapped out for USD) or even 10 (funding swapped out for valuation).

“When startups are completing financing rounds that would exceed a theoretical initial public offering, there is likely something fishy going on,” Zhu says. “Rounding up to the nearest sum externally is fine, such as writing a US$19-point-something-million as a US$20 million investment – this is understandable. However, when a company raises US$100 million and reports it as US$200-300 million, it is a credibility issue.”

An unhealthy habit

In an industry where “everybody’s doing it” and with no immediate, direct consequences, exaggerating funding amounts – and thereby the company valuation – has become a normal part of most Chinese startups’ strategy.

“I think mainly to appear stronger than they are, which helps with securing partnerships and recruiting, and generating initial investor interest,” Ma says.

“For some startups, exaggerating the numbers may be a way that they can scare off the competition or make a big splash in the news,” Zhu explains. As for investors, he says, “Sometimes the company may act on their own to get the numbers out, while other times in the case that there are multiple investors, one investor may go rogue and announce inflated numbers that are contrary to the facts and against the wishes of other investors.”

In the long run, however, the dishonest practice harms the startup, the investor, and the startup ecosystem as a whole. Zhu adds:

In Chinese, there is a common saying: ‘pulling out the sapling to help it grow’ (拔苗助长) – and that’s what these inflated figures do. They think it will help the startup out, but ultimately, it will hurt the company by putting it in a position where it is not able to achieve sustainable growth. Any positive effects for startups from inflated figures and valuations are fleeting and the real numbers will be exposed to investors in later rounds, then written clearly in black and white when they file with the SEC.

Zhu says that once the real numbers come out, “the effects of exaggerating funding rounds or valuations earlier on will come back to bite hard as their credibility with customers, investors, and the market takes a hit. […] For other companies, when there is a mass proliferation of inflated figures in the industry, they feel like they have to pump up their numbers as well. It creates a ‘keeping up with the Joneses’ mentality.”

Ma agrees, saying it’s “totally unhealthy because naïve entrepreneurs use these numbers as benchmarks and it also adds irrationality to an already, I believe, overheated market. It sets unrealistic expectations for both investors and entrepreneurs, and then more jump in for the wrong reasons.”

The trend has no doubt contributed to growing startup bubble that is now being called out.
David Zhang, co-founder of Matrix Partners China, and Ran Wang, CEO of ECapital, both warned of a bubble on separate occasions. At a founders’ meetup event later on, Ran Wang called on investors and startups to report real figures in 2015.