China’s startups are lying to you, and there’s not much anyone can do about it

It doesn’t really matter which Asian market you’ve been watching – over the last few years, funding rounds (and by extension) valuations have soared. Startups are raising more money, and the industry is growing. That growth is real – nobody in the industry could doubt that. But those massive funding rounds you’ve read about? Many of them are fake.

That’s the allegation put forward in a report from Chinese news site Tencent Tech, which says that 80 percent of the country’s startups are lying about their funding rounds. The article quotes famed Chinese investor and Zhenfund founder Xu Xiaoping as saying that phony funding numbers are “a new kind of tacit understanding in the industry.”

“I’m totally not surprised at the 80 percent number being thrown around by that writer,” 500 Startups partner Rui Ma told Tech in Asia, “although I didn’t realize it was getting worse as they contend.” Chinaccelerator director and SOSV partner William Bao Bean agrees, telling Tech in Asia it’s “pretty common practice” right now for startups to exaggerate the size of their funding. “It’s a psychological warfare tactic designed to scare the competition and to scare VCs away from funding the competition.”

If you’re a longtime Tech in Asia reader this may come as no surprise to you – my former colleague Paul Bischoff wrote about the problem earlier this year. But the Tencent Tech article, unlike previous investigations into the issue, names some names. And that means we can now take a closer look at the kind of exaggeration that seems to be happening – and how it happens.

Following the paper trail

Generally speaking, it’s very difficult for the media to verify whether or not a startup is telling the truth when it has raised a funding round. But verification of earlier rounds can be possible when a Chinese company lists on the American stock market because the US Securities and Exchange Commission (SEC) requires them to disclose several years of securities issuances history. Since lying about the numbers there could derail your entire IPO and legal status in the US, companies are unlikely to do it. That means that SEC filings are a source of accurate, verifiable information about how much companies really raised in previous rounds.

The Tencent Tech article used this approach to name a number of companies whose announced rounds don’t seem to line up with the paperwork. An independent investigation by Tech in Asia found that while in some cases Tencent Tech had made mistakes or the situation wasn’t entirely clear, several major US-listed Chinese tech firms do have major discrepancies between the fundraising they announced and the funding they reported to the SEC.

Wowo CEO Xu Maodong at the company’s NASDAQ IPO.

For example, there’s the Chinese daily deals company Wowo (previously known as 55tuan). Major Chinese tech sites including Sina Tech and Tencent Tech reported in 2011 that the company had officially announced a funding round of US$200 million, which was one of the year’s largest China tech deals. But the company’s SEC filings – for example Form 424(B)4 page 163 – indicate that that round couldn’t have been worth much more than US$65 million. In Wowo’s history of securities issuances, the company reports that in the entirety of 2011, it accepted a total of around US$66 million in investment.

Chinese video and downloading service Xunlei’s filings seem to have similar holes. The company publicly confirmed that it raised a US$50 million round in 2012, but its SEC filings – like Form F-1 page 202 – state that the company raised only US$37.5 million in that round.

Sometimes, the disparity is not so large. Chinese travel site Tuniu announced a US$60 million round in September 2013 on its official weibo account, but its SEC filings – like Form F-1 page 144 – state explicitly that the company raised US$50 million. Of the 2013 round, Tuniu’s own SEC filing states: “The net effect as a result of these transactions is that Esta Investments Pte Ltd. purchased a total of 18,142,893 series D preferred shares for an aggregate price of US$50.0 million (RMB308.3 million).”

Tech in Asia contacted Wowo, Xunlei, and Tuniu for clarification or comment about these discrepancies last week, but has not received a response from any of them.

Although none of these companies have responded, the discrepancies are apparent proof that the publicly-reported funding numbers are wrong. A US Securities and Exchange Commission official told Tech in Asia that foreign companies, like domestic companies, must disclose information on all securities sold for cash or any other considerations within the past three years in accordance with Item 701 of Regulation S-K.

Media mistakes