Recently, Cao Yi, CEO and Founding Partner of Source Code Capital, shared his “Reflections from Six Years of Entrepreneurship and Investment at Source Code Capital” with the guests present at the 2020 Code Class Investor Conference and Smart Manufacturing Summit. Based on his own experience and feedback, he shared the story of the on-going journey to become the most entrepreneurial investment firm, praising and showing high respect to the tenacious and courageous entrepreneurs whom he had the honor of travelling together with.
Looking back at the past six years of entrepreneurship, building Source Code Capital, Cao Yi believes for most, “the past six years of Source Code would appear to be just six years of making investments. But for me, the past six years represent six most meaningful, fascinating, and thought-provoking years of entrepreneurial exploration in our investment industry.” “During this period, I grew from being an individual sniper to becoming captain of our team; from being a pure investor, to becoming an entrepreneur myself, participating in, and shaping our asset management industry.”
At the same time, Source Code Capital gradually developed. It started as a small team, to later becoming a cross-regional organization with nearly 80 team members and offices located in Beijing, Shanghai, and Shenzhen. Concerning its own internal organization development and innovation, Source Code Capital believes in institutionalization. Its “Special Forces” now include both early stage Venture and Growth stage investment teams, and its “Arsenal” includes professionals from its post-investment and platform teams. Together they are able to achieve real-time and multidimensional collaboration, which in return creates new synergies and increases company efficiency. This resulted in various improvements in Source Code Capital’s organization. Source Code Capital has also been fortunate enough to find itself on multiples awards lists at home as well as abroad. These achievements would not have been possible if without the firm resolution of entrepreneurs and the strong support of LP investors.
The pyramid model of investment institutions
Since its establishment in 2014, the total funds under management at Source Code Capital have now reached a grand total of USD $1.5 billion and RMB 8.8 billion. A large number of new members, such as ByteDance, Meituan, KE Holding and Li Auto, have now started to take the lead in the development of China’s new economical wave. From Cao Yi’s perspective, he believes that if we want to summarize the past six years, we should start from the premises of each investment, and first answer three questions: “Why” do we do what we do, “what” it is we hope to do, and “how” to do what we hope to do.
If we are to define the “why, what and how” of an organization from an investment perspective, the answer will present itself as an orderly pyramid model. The bottom layer would be the initial intention of investment, which not only answers the initial “why” question, but also lays the foundation for the subsequent superstructure. Cao Yi believes that “if the initial intention of an investment institution is not clear and firm, it might be difficult to achieve excellent returns in a sustained manner, due to China’s strong competitive landscape. Swayed by constant considerations on gains and losses, you will end up exhausted both physically and mentally.
There is a derivative and progressive relationship between the “initial intention of investment” and “investment philosophy, investment strategy, investment logic, and investment judgment.” Among them, the “investment strategy, investment logic, and investment judgment” answers the “how” for an institution. For example, since its inception, Source Code Capital has been following is investment roadmap, the “Three Fundamentals Drivers.” using “Internet+,” “AI+,” and “Global+” as its main investment lines, allowing the company to keep moving forward. This is by far what is the most easily perceived by the outside world.
In order to understand the “what” of an organization in depth, we need to focus on the middle layer of this pyramid. This is where we find the answers to one’s investment philosophy. Investment philosophy can be understood as a value proposition, which is analogous to a person’s values. “A gentleman should do some things, he shall not do certain ones.” Investment institutions are faced with trade-offs. Compared with a concrete investment strategy, investment logic or investment judgment, the values of an institution are more general, more abstract and basic.
For Cao Yi, “there are too many opportunities in this world. You must try to keep things simple: what do I believe in, and what do I believe is valuable?”
The Investment Philosophy and Value Proposition of Source Code Capital
Focus on Big Changes
Before founding Source Code Capital back in 2014, Cao Yi spent many years in China’s top-tier venture capital institutions. During that time, he travelled abroad many times, especially in the Silicon Valley, in order to learn how to communicate and exchange. His now, deeply rooted investment philosophy of paying attention to big changes, was gradually developed over time. This is what naturally became one of Source Code Capital’s main value propositions.
Since its inception, Source Code Capital regards information technology as the most fundamental change with constant technological innovations, which push and drive forward commercial and social changes. Those will be subject to multiple evolutions through the integration of various industries and information technology, such as “Internet +” and “AI +”.
Investing in big changes can help us focus our limited time on the big picture, therefore allowing us to ignore medium-and small-scale changes. This is why, Source Code Capital, conscious of this narrow time window, wants to target major company growth and major technological innovations.
Since its reform and opening, China has really grasped the information technology revolution tide. During the period of opportunity created by the transition from PC Internet to mobile Internet, a large number of enterprises issued from the new economy have achieved leapfrog development. The accompanying local venture capital institutions were also paying attention to the “changes in the middle layer and the application layer brought about by these infrastructure changes,” thus allowing fir rapid development in recent years.
“Investing in great changes is very challenging,” Cao Yi explained. “Because you can also choose to invest in small or micro changes. This is also a valid investment logic. Investing in small changes is more certain, and the return period may be shorter, and thus it is not all that difficult to judge.” Investing in great changes means longer return periods and brings more uncertainty. Any subsequent change in the direction or in the development speed will bring unknowns. Therefore, grasping great changes requires more capabilities from investment institutions, one of them and not the least being having a firm idea: the capacity to believe in great changes and to accept the challenges and difficulties associated with them.
Emphasis on Innovation
With Cao Yi’s explanation, we can now see that Source Code Capital’s understanding of innovation is actually multidimensional.
The first of which is to choose technological innovation. Before the new economy, there was a market that tended to replicate already mature business models from Europe and the United States in China. It relied heavily on China’s low production costs and demographic surplus to become cost efficient. These products more than often not did not require much technological innovation. Let’s take an investment in the microchip industry as an example. At the moment, there are two popular investment options: one is domestic substitution, and the other is microchip research and development. Source Code Capital will strongly opt for the latter option. Even if the new products of microchip giants cover new possible applications, there will be “intersections” during development. Those “intersections” will include both innovation breakthroughs and domestic alternatives, which is the technological innovation Source Code Capital is looking for.
In addition to this, Source Code Capital also emphasizes on the need for the integration of technological innovation within model innovation. “Innovative enterprises must have good model novelty in order to exert the power of technological innovation, therefore accumulating resources and profits gain thanks to a robust business model. After, they can invest more efficiently in technological advancement by making deeper and longer-term investment in the related underlying technologies.” When model novelty and technology innovation are able to create this virtuous cycle, the growth potential development of said company will also increase.
The other is management innovation, or organizational innovation. This is particularly critical when population increment bonuses disappear and competition in domestic and international markets becomes increasingly fierce. For Cao Yi, today’s leading Internet enterprises in China, such as ByteDance, have begun to lead some organizational management innovations on a global scale. ByteDance currently manages a team of about 100,000 people around the world. The problem of organizational development is particularly complex. At the same time, there are facing globalization challenges. “How to manage top-down and bottom-up internal innovation? There must also be strategic guidance, flexibility and so on. These problems put a lot of pressure on ByteDance’s organizational system.” In order to meet those challenges brought by organizational change, ByteDance established the Management Research Institute. Lark, an enterprise communication tool that improves efficiency, started playing an important role in the process of transforming a hierarchical-based organization into a more organic one.
Faced with three types of innovations, technological, model based and in management, investment institutions and start-up companies alike need to keep an open mind, be willing to try and even actively embrace uncertainty. In Cao Yi’s eyes, “there has never been a still domain in this world. If there is one, it is also short-term and local. When we start considering things on both a larger scale and a longer time period, there is going to be wave after wave of innovation. No one can hide, lay low and rely solely on brand power and network efficiency to enjoy success.” The increasing anxiety felt by all major companies today also means that constant innovation iteration is becoming an unavoidable issue. What investment institutions can do, is to invest in innovative enterprises in order to find their own place in this ever-changing situation.
Invest in Qualitative Change
In the investment world, the standard practice is to invest in quantitative change, or iterative consistency. In that case, what remains unchanged is a relative tremendous demand and an already established supply chain. However, there is some adjustment in this quantitative change theory that appears in a more linear form. For example, leading companies might achieve a double-digit growth in both market shares and profit rates through better business model. At its core, this investment philosophy is based on the belief that some elements of this world are rather permanent.
For Cao Yi, if “Source Code Capital invests in qualitative changes over quantitative ones, it is because we believe that some parts or elements of this world are in fact nonlinear and transient. Therefore, some qualitative changes are needed in order to transform or evolve.” Source Code Capital hopes to detect some of those relatively determinant long-term megatrends earlier, because those often offer qualitative investment opportunities where potential returns and room for investment are also more extensive.
When having to consider between investing in quantitative change or in qualitative change, Source Code Capital tends to choose the latter, investing in stages 0 to 1 and 1 to 10. Even with Source Code Capital’s current investments that are still in growth stage, we believe that those companies still have the opportunity to carry out a qualitative change transition. For example, Lianjia to KE Holding, or ByteDance to TikTok, in which both quantitative and qualitative changes intersect.
Situated at the Frontier, Our Desire to be Vanguards
At the moment, it is easy for many companies to develop, following the mainstream “trends” in the market, quickly achieving a consensus, catching the eyes and attracting most funds of this industry. Source Code Capital strongly emphasizes its refusal to slide into this “short, stale and fast” inert channel. “Short” reflecting its short-term effectiveness; “stale” referring to its commonness, that is, do as the other do, which leads to mediocrity in the investment industry; And finally, “fast” which would be this constant search for those rapid in and out opportunities. Cao Yi explained, “it is in Human nature to be naturally drawn towards mainstream ideas. If there is no strong emphasis on some beliefs, philosophies or principles, it is then easy to fall into this apathetic stream of the industry, but it is very difficult to come out of it.”
The approach of Source Code Capital is to invest into early stages of development. That means even if there is no consensus in the industry at the time, even if there are no short-term investment opportunities, and even if only a few people are looking at this particular matter. What Source Code Capital should do, in this particular situation where 8 out 10 people will not be enthusiastic about a seemingly marginal company, is to become the other 2, the ones best prepared for when this edge will become the new norm.
In order to empower the belief in this “edge,” Cao Yi believes you need some romanticism and idealism, and he tries to look at the world from the perspective of future “science fiction.” Self-driving, AR, VR, brain-computer connection, and numerous robots are in reality already described at length in older science fiction movies. “Remember that in the movie “Iron Man,” the most successful company in the world is a robot company. As for now, in our world, the biggest company is a mobile phone company, but one day it might be a robot company. Some romanticism is needed if new things are to appear in the future.
Finding innovation on the edge of any industry brings with it an obvious advantage: you are a step ahead of everyone else. During this time period, it is easy to gain noticeable advantages by focusing on investment, research, post-investment and network resources, which will in return diminish the chances of clashes between venture capital institutions. Conflict might not be totally avoided, but on a larger scale, Source Code Capital wishes to use positional or ambush warfare, and gain significant advantages by deploying early. Therefore, when the open conflict starts, you will be in a stronger position.
Surround Yourself with and Partner with Visionary Entrepreneurs
As an old saying goes, “Men are afraid of going into the wrong business, women are afraid of marrying the wrong man.” But both of them should be afraid of the Investment industry. With all the great entrepreneurs that we have now, every investor may feel under pressure, afraid of not being able to keep up the pace, but it is this pressure that will lead to more growth.
After many years of investigation and research, Cao Yi and Source Code Capital believe that the best entrepreneurs are usually a collection of multiple contradictions. But they can integrate those multiples contradictions and make the best of them, such as being pragmatic and romantic at the same time. In the eyes of Source Code:
Excellent entrepreneurs know when to stand up and when to lay low. Standing up refers to their ability to compete fiercely when needed; laying low attests to their patience, building strong foundations in order to be able to reach the top.
Good entrepreneurs are both infinitely outward and infinitely inward. Infinitely outward means that they know no boundary, and they participate to enlarge business scope, scale, numbers and market value. At the same time, they are infinitely inward, which helps promote internal transformations at greater speeds. In Cao Yi’s view, “excellent entrepreneurs start a company to connect more extensively with social development as well as to create value. At the same time, it is also a path of self-cultivation. The two combines to achieve a very high inner state, therefore they are both infinitely outward and infinitely inward.”
Accomplished entrepreneurs are both emotional and rational. A good number of internet and technology companies’ entrepreneurs can sort things out logically and systematically. However, they are also very sensitive to human nature. “When things cannot be grasped by logic and rationality, they do not ponder about whether or not they do in fact really exist, but instead, approach them with perceptual perspectives and empathy.”
“Like contemporary rock stars, today’s entrepreneurs experience different states and feelings, like love, idealism, but also paranoia, loneliness and raw power,” Cao Yi said with much feeling and emotion.
The Original Intention is the Future
Investment strategy, logic and judgment are based on an investment philosophy, which is itself founded on the initial investment intention, which come from the source of the original animus. At the end of his speech, Cao Yi said that the initial intention of Source Code Capital is to be the most entrepreneurial investment institution, creating real lasting value, helping entrepreneurs to realize their dream of starting a business, helping them to change their industries, to later change the world.
At the present, the total funds under management at Source Code Capital has reached a new stage. Internal organization continues to innovate and iterate, post-investment services capabilities are steadily improved on, IT data value is emerging, and the external Code Class ecosystem is proven with unique value. These different aspects of optimization and growth all come from the strong identity developed at Source Code Capital.
Six years later, Source Code Capital has partnered with nearly 200 companies, covering all aspects of China’s new economy. Source Code Capital and its portfolio companies are becoming a new force to help promote China’s ascension. “Through our investments, we believe 2C companies are making people’s lives better, and 2B companies are making businesses smarter.” Source Code Capital will continue to work hand-in-hand with visionary entrepreneurs, remaining true to our original aspiration, to create real lasting value.
