New Fears for China's YouTube Wannabes

Starting Jan. 31, any company showing online videos in China will need a license, and only state-owned or state-controlled outfits qualify

by Bruce Einhorn

Video-sharing site Youku has raised millions in November from western venture capitalists

With the number of Chinese Internet users soaring past 160 million, many venture capitalists from the U.S. are rushing to fund Web startups providing new services for China's net surfers. Nowhere is this more evident than in video, one of the hottest sectors around. Framingham (Mass.)-based IDG Technology Venture Investment, 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, says 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 doesn't seem to bother Zhou. "That's venture capitalism," he says. "You take some risk."

Venture capitalists like Zhou and the Chinese entrepreneurs they're 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 startups. "A lot of people are very concerned," says 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 says.

Big Backing from Venture Capitalists

Until now, startups 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 $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 (DIS). And last April, Tudou raised $19 million from IDG, General Catalyst Partners of Cambridge, Mass.; Jafco in Tokyo, and Granite Global in the Silicon Valley.