Venture capitalists are pouring billions into start-ups and valuations are rocketing. Are these signs of a bubble in China’s buzzing start-up sector?

2014 was a good year for Chinese start-up entrepreneurs, as venture capital (VC) investment continued to recover from the stagnant period between late 2011 and early 2013. According to Dow Jones, venture capitalists have poured $8.12 billion into VC-backed start-ups in the first three quarters of 2014 (the most recent data available), higher than the $5.44 billion they invested in the whole year of 2013. Data complied by QDaily shows that in 2014, at least 26 Chinese start-ups raised more than $100 million in a single round of financing, higher than the number of companies in the previous four years combined.

Big money has also pushed up valuations—more than a dozen Chinese start-ups are now valued at more than $1 billion, with Xiaomi leading the group with a $45 billion price tag. Financial backing from BAT (Baidu, Alibaba and Tencent, the three dominant players in China’s tech industry) has also elevated ride-hailing (and cash-burning) apps like Didi Dache and Kuaidi Dache to the $3 billion-club.

The downside of the frenzy is the worry of a potential bubble—is fundraising too easy for start-ups? Are those highly valued companies really worth the investment?

“It’ll be wrong to say that there’s no bubble at all,” says Chuan Thor, Managing Director of Highland Capital Partners in Shanghai. He believes that investment would likely cool down a little in 2015 because valuation today is already “out of control”. But Thor isn’t so worried about his own fund because he says he has been a very focused investor—since kicking off Highland’s China fund in 2006, he has only bought in 10 companies.

But among those 10, one company has made the Boston-based fund widely known in China’s start-up community—Qihoo. The internet browsing and security company went public on New York Stock Exchange in 2011, raising $175 million—the largest initial public offering by a Chinese company in the US that year. The company’s market cap stands at about $7 billion today, the fifth-largest among its Chinese peers in the US stock market.

Since then Thor has been on the search for his next big bet. And in this interview, he shares his investment ideas in China and what qualities he values the most in Chinese entrepreneurs, who he says have evolved so much in the past few years.

Q. You have said publicly that Highland only focuses on the TMT (technology, media and telecommunications) industry. Why?

A. Because companies in this sector have the most growth opportunities. And their valuation is also much higher than companies, say, in the renewable energy or retail sector.

Another reason is that this is a very fast-changing sector. In this sector, the chance of a newcomer replacing a top dog in less than a decade is higher than anywhere else. For example, Netease, Sohu and Sina were the three biggest players in the industry in the early 2000s; now few people talk about them anymore. Similarly, BAT (Baidu, Alibaba and Tencent) might not be leaders of the industry 10 years from now.

Q. The concept of online-to-offline commerce (O2O) is very hot in China. There are so many scenarios in this space. What would you focus on as an investor?

A. I think the core is “clothing, food, shelter and transportation” (or Yi Shi Zhu Xing, a Chinese idiom that summarizes basic necessities of life). Currently the very hot ride-hailing apps is a good example in “transportation”; and in “shelter”, the emergence of some online real estate brokers might be able to overthrow the traditional intermediaries; and now people can take orders on their handsets to get food delivered to their doorstep without having to pay cash—these are only possible in the O2O era.

So in general, I think the future is bright for business models that will greatly improve users’ experience and at the same time lower prices. It’s okay even though these businesses may not make profits in the first few years, as long as they are successful at getting a large number of users for their services.

Q. Some local governments in China have announced that they’ll crackdown on ride-hailing apps. What’s your opinion?

A. I think some adjustment, or regulation, is necessary, because [the taxi industry] has to do with consumer protection as well as public safety. But in terms of consumer demand, this trend [of using technology to arrange one’s commute) is huge and inevitable. I think the government and businesses would [strike] a balance eventually. It’s very unlikely that these apps will just disappear because the government wants to clamp them down.

Q. Are there other areas that you think are good bets for venture capitalists in China?

A. I’m paying attention to virtual reality technologies and UAV (Unmanned Aerial Vehicles). In terms of UAV, it’s not merely for personal entertainment; it has great potential in remote management of utilities network, mapping and other industrial uses.

I’m also looking at a broad range of smart devices, including wearables and smart home appliances.

Q. You work very closely with the management once you invest in a company. What qualities do you value the most in a team?

A. I think it’s important that members of the management team have advantages in different areas. It means that some people should be good at technologies, some should know operations and more importantly, some should understand the disruptive trends in the industry. It’s very important that team members can complement each other in terms of skillset and ways of thinking. For us, team chemistry is very important when evaluating a business as an investment.

Q. Over the past seven years, what changes have you seen in Chinese entrepreneurs?

A. I think the younger generation no longer wants to be copycats of western companies. They’re more open-minded and ambitious; and what drives them [to build businesses] is not just money—many of them do believe that they have the chance to become the next Steve Jobs.

In addition, they’re as diligent as always. Some teams I know work six and half days a week so we only have time to sit down and talk on Sundays.

In terms of technology knowhow and product development, I’ll have to say that the gap between Chinese start-ups and their Silicon Valley peers is closing. But there’s still some catching up to do for Chinese entrepreneurs.

Q. Some people say that valuations might be too high for some start-ups in China. Is there a bubble in this sector?

A. It’ll be wrong to say that there’s no bubble at all. But from an investor’s point of view, it’s important to know how to weigh opportunity against risk. So if you position yourself well, even if there’s a bubble and it bursts, it doesn’t mean that you’ll lose everything.

I think in general, there may be an adjustment this year [in VC investment in China]. Investors are probably going to be more cool-minded.