There are a lot of hot start-ups in China right now. But the industry's reputation took a blow recently after media reports reveal that several well-known start-ups grossly exaggerated how much money they had raised from venture capitalists and other investors. Experts say the practice has become commonplace among start-ups. Although exaggerating funding can boost a start-up's profile among investors and the public, critics say the practice has the potential to do a lot of damage to the industry in the long run.
As the 19th century English novelist Charles Dickens wrote in the Tale of Two Cities, "it was the best of times, it was the worst of times." Dickens' words might also suit this era of Chinese start-ups.
Over the last year or two, China's entrepreneurs have been eagerly throwing themselves into the overflowing tide of entrepreneurship. In the resulting frenzy, some entrepreneurs and their start-ups have found themselves pursued by venture capitalists and admired like movie stars by the media.
However, this image has taken a beating recently after media reports revealed that many start-ups had lied about how much capital they had raised - a practice that is something of an unwritten rule in venture capital circles.
Inflated numbers
One recent disturbance involved ele.me, a Shanghai-based online platform for ordering takeout food.
On August 28, the company announced that it had raised $630 million in its latest round of fundraising, bringing its total fund to $1.1 billion.
The amount would have been the most ever raised in a single round of fundraising by an online platform for takeout orders. The announcement was widely questioned by the public and the media.
On Friday, VentureBeat, a U.S.-based news site focused on technology and business, reported that ele.me had actually raised less than $400 million.
Other controversial cases involved some closely watched start-ups, such as lamabang.com, a Shenzhen-based online social platform for mothers that claimed it had raised $100 million in total funding.
On Tuesday, Web portal tech.qq.com reported that the actual amount was closer to $30 million.
The report also questioned the veracity of the funding amounts claimed by the group-buying website 55tuan.com, the e-commerce giant JD.com Inc and other prominent companies. It said many start-ups exaggerated their fund raising amounts by three to five times.
Experts said such exaggerations have become commonplace among start-ups, with some inflating these amounts by as much as 10 times.
Reasons to exaggerate
So, why are these start-ups so willing to exaggerate how much money they raise? Reputation is one reason, an insider close to the matter, who refused to be named, told tech.qq.com.
A company that can raise a lot of money from investors benefits from a halo effect of sorts, said the insider.
Also, it makes it easier for a company to raise money from venture capitalists in the future, the insider noted.
In addition, fabricating funding amounts can hurt the competition, said Gui Shuguang, founder of Beijing-based Landscape Angels.
It can disrupt competitors' expansion plans and make it more difficult for them to recruit employees, raise additional funding and expand its user base, Gui said.
For investors, who should know how much money these companies have actually raised, there are few incentives to ferreting out the truth. Market analysts say higher funding amounts usually translate into higher future valuations, which increases the return on investment for venture capitalists who get in early.
Although the public and the media might be aware that some companies lie about how much money they have raised, there are few ways for them to figure out the truth.
There are no laws or regulations that require start-ups to disclose how much money they have raised, or other details about their finances, so it is nearly impossible for the media to verify these amounts.
Furthermore, the media's survey requirements are also usually refused by these companies, which use confidentiality agreements with investors as an excuse.
Start-ups in the US have also been known to brag how much money they have raised from investors. However, US start-ups usually won't exaggerate funding by more than two folds, an investment manager told tech.qq.com, who prefers to be anonymous.
The manager said that US start-ups have more discipline and don't face as much competition as start-ups in China.
In the U.S., there are some authoritative websites that specialize in disclosing inside information, which helps keep start-ups honest, analysts said.
Long-run risks
Although fabricating fundraising amounts can benefit a start-up in the short term, it can hurt in the long run. The practice makes start-ups and their competitors anxious to achieve quick success and gain instant benefits, leaving a lot of necessary work for them to make up in the future, according to experts.
Moreover, the fundraising bubbles make it difficult for start-ups to raising money in the future if the capital market cools down. In these situations, investors become more cautious about what they invest in, and start-ups can go bankrupt when the easy money dries up.
Famous Chinese venture capitalists Xu Xiaoping and Wang Ran have long called for companies to stop fabricating how much money they raise. They worry it will cause great harm to the industry.
But the market generally believes that the fabrications will continue because they have yet to cause any serious harm to the industry, and represent more of a moral problem than a legal one.
