Views from a partner in an emerging startup ecosystem
The venture capital industry is going through some patchy times; some managers say these are challenging times. Well, let's call it what it is: it has been a rough year so far. That being said, and being a forever optimist, I also see plenty of room for opportunity.
Photo credit : Mun Kong
Over the past 10 months, I have interacted with limited partners, general partners, and founders across the US, Europe, Asia, and the Middle East. There were several interesting observations. The statistics show that deal count across Asia is down by at least a third (between China, India, and Southeast Asia). Fund managers have overall slowed down their deployment pace (first checks and follow-ons). Especially compared to some all-time highs in 2021. A number of factors caused the slowdown. There is no lack of liquidity amongst venture capital funds. Still, the heavy discounts on secondaries, lack of sizeable exits, and more focus on investing in financially sustainable businesses had impacted the pace of investments across the board.
The other uncertainty venture capital fund managers face is extended fundraising cycles for their flagship funds. Limited partners, although continuing to allocate capital to the venture capital asset class, are cautioning. The current macroeconomic environment severely impacts exit markets for tech companies. IPOs in the technology sector are sporadic, and it's still being determined when the IPO- window will be fully open again. While some funds might still sit on significant paper gains, the name of the game in today's market is realized returns or DPI. Realized returns allow limited partners to re-up their existing portfolio of fund managers or invest in emerging managers. The search for DPI has impacted the way fund managers look at returns. More often than not, fund managers in emerging markets are open to secondary trades, which opens a new possibility for secondary buyers, such as dedicated secondary funds, PE funds, and family offices. With the current growth in secondaries, I foresee a lot of opportunities for limited partners, secondary buyers, and fund managers. The secondary trades in emerging markets need to solve two main issues.
The information gap on single assets needs to be closed. Acquiring shares in single assets in emerging markets can be challenging. Understanding local or regional regulation, the size of the markets, cultural nuances, market share, and scalability opportunities can be problematic if you operate in a different market.
Secondary buyers expect late-stage growth companies to have sight of profitability. In the years prior, the focus was on forecasting growth and market share. More is needed in current times. At the time of investment, late-stage investors and secondary buyers want clear visibility on a sustainable financial model and at least cashflow profitability. Secondary buyers want an exit horizon of maximum 3 years, and profitable companies give them a path toward a successful IPO or acquisition.
Is it all bad? No, but there are a few things to take note of.
Fundraising across the board will take longer, and there is a clear need for capital to get into the private markets (from early stage to pre-IPO).
Current conditions have proven to build resilient founders raising capital at sensible valuations. There are more cross-border opportunities for founders and venture capitalists than ever before. New growth markets are emerging both from geographical and sector standpoints. From a Morgan Stanley report: "The region [the GCC] has continued to grow remarkably resiliently throughout 2022 when every other market around the world, barring Africa and parts of Europe has seen sizeable corrections as interest rates have ramped up." Companies are expanding from Asia to the GCC and vice-versa.
Some venture capitalists in emerging markets are going through their first downturn and are building a more resilient fund strategy moving forward, including appropriate fund sizing for their respectable markets.
Fund managers are building diversified exit strategies, which provide more access to venture capital to different asset allocators. Mergers and acquisitions (<$500M USD) and secondary trades should be an integral part of every early-stage fund manager's strategy. According to Bain and Company: [For Asia Pacific] Initial Public Offerings (IPOs) remained the primary exit channel, accounting for 45% of the exit market, down slightly from the previous year. Trade sales represented 33%, unchanged from 2021. And secondary deals grew to 22% of the market, up from 19% a year earlier.
The coming 3 quarters will remain challenging, but there are opportunities for limited partners, fund managers, and founders. As Formula 1 teams always say, we have to keep our heads down, look at the data, and get ready for the next race.