By Bruce Einhorn
Friday, January 11 2008 11:00 AM
URL: http://www.zdnetasia.com/news/internet/0,39044908,62036461,00.htm

With the number of Chinese Internet users soaring past 160 million, many venture capitalists from the United States are rushing to fund Web start-ups providing new services for China's Net surfers.

Nowhere is this more evident than in video, one of the hottest sectors around. IDG Technology Venture Investment based in Framingham (Massachusetts), for example, has invested in a video-sharing site, an online movie site, and a mobile-phone video site and Quan Zhou, IDG's managing director in Beijing, said that they all have great potential.

But there is one nagging problem: So far, none of these companies is licensed to show videos in China. However that does not seem to bother Zhou. "That's venture capitalism," he said. "You take some risk."

Venture capitalists like Zhou and the Chinese entrepreneurs they are backing are now facing what could be their biggest risk-tolerance test yet. On Jan. 31, the government will implement new regulations that potentially could put China's nascent Internet video industry out of business.

Under the new rules, a company showing online videos from inside China will need a license, and only a state-owned or state-controlled Chinese company will be eligible to receive one.

That is causing big worries among China's private-sector Internet start-ups. "A lot of people are very concerned," said Gary Wang, the founder and chief executive officer of Tudou, a Shanghai-based YouTube-like site backed by IDG and several other venture-capital firms. "If you take [the regulation] literally, it means the Chinese state has to own the whole Chinese Internet," he said.

Big backing from venture capitalists
Until now, start-ups like Tudou have benefited from growing interest among foreign VCs looking for the next big thing in China. For instance, on Nov. 26, Beijing video-sharing site Youku announced it had raised US$25 million from Brookside Capital, an affiliate of Bain Capital, and three existing investors--Sutter Hill Ventures of Palo Alto, Farallon Capital of San Francisco, and Shanghai-based Chengwei Ventures.

Youku rival 56.com has raised an undisclosed sum from investors, including Silicon Valley heavyweight Sequoia Capital and Steamboat Ventures, the VC arm of Walt Disney. And last April, Tudou raised US$19 million from IDG, General Catalyst Partners of Cambridge, Massachusetts; Jafco in Tokyo, and Granite Global in the Silicon Valley.

The financiers are keen to replicate the success of Chinese Net stars like Baidu, the Google-beating search engine that dominates the Chinese market and has had its stock price increase over 11-fold since its 2005 Nasdaq initial public offering, or Alibaba.com, the online marketplace for small and midsize businesses that raised US$1.5 billion through its initial public offering in Hong Kong last November.

YouTube not a player in China
One reason investors have been so eager: the absence of the biggest player in the industry, YouTube. Chinese Internet users can gain access to sites from YouTube's U.S.-based servers, but those sometimes get blocked by the Chinese government.

The Google subsidiary last fall launched services in Hong Kong and Taiwan but has nothing based in the mainland itself and is unlikely to in the near future.

The Jan. 31 regulations make clear that the government expects China's YouTube wannabes to censor all video clips with anti-Beijing content. Reporters Without Borders, the international organization that lobbies in favor of journalists worldwide, on Jan. 4 condemned China's "unprecedented censorship measures."

Adds RWB in a press statement: "Under the pretext of developing China's media industry, the authorities are stepping up their control of online content, especially in the run-up to the Beijing Olympics."

However the entrepreneurs running the sites inside China contend that they have already been censoring their videos. They are now hoping that their willingness to follow Beijing's censorship rules will make it easier for them to find a way out of the latest regulatory quagmire.

Encouraging statistics from Nielsen Online
Chinese Internet companies have experience coming up with creative ways around the country's quirky regulations. For instance, since the government requires Chinese ownership for companies that operate most Web sites inside China; and since many of the country's top VC-funded Internet companies are officially not Chinese, but rather are based overseas (in the U.S. or in tax havens like the British Virgin Islands); they have formed partnerships with local companies to provide them with all the content they need to operate the Web site.

Something similar might happen now, said Victor Koo, Youku's CEO. "If you look at the overall history of China's Internet development, the government has always had a pro-development stance," he said. Koo and others are hoping that history holds true this time as well.

In the meantime, he said, he is focusing on building the business. Today, for instance, Youku announced that a survey by Nielsen Online, the Internet research arm of A.C. Nielsen, reporting that Youku shows 100 million videos a day--equal, Koo said, to the amount YouTube showed when it was acquired by Google.

As for the licensing woes, Youku's legal team is on the case. "Our lawyers will let us know what to do," said Koo.