Moving on: What do the next 10 years have in store for venture capital and consumer growth across Asia?
Consumer-focused venture capital and growth strategies have gained significant traction across Asia’s markets over the past decade, generating some stellar returns. But what will the next ten years bring?
Unlike many other markets where buyout capital dominates the private equity space, Asia-Pacific has seen the greatest growth in venture capital and growth investments over the past decade. The relative amount of assets under management demonstrates this perfectly: as of September 2020, buyout AUM in Asia-Pacific stood at US$250bn, while for venture capital, the figure was more than double, at US$574bn, and for growth, US$433bn, according to Preqin. Combined, growth and venture capital account for 77% of the region’s private equity AUM, compared with 32% of the global industry.
Much of the growth in these segments has come from disruptive technology, with consumer-focused strategies leading the way in many markets such as China. “Chinese venture capital has done spectacularly better than global VC over the past ten years,” says Vish Ramaswami, Managing Director and Head of Asia Private Investments at Cambridge Associates. “The moment in time when the internet migrated from the PC to mobile saw massive adoption in China and that led to a leapfrogging in areas such as online payments. The stars aligned in that moment for some incredible returns at the portfolio level.”
More unicorns
Such rapid adoption of new technologies has led to significant growth in the number of Chinese unicorns. The US still accounts for the largest proportion – half – of the world’s unicorns, but China sits in second place, at 20%, according to CB Insights’ September 2021 figures. China is also home to the world’s most valuable private company – video sharing social network developer and TikTok owner, ByteDance, which reached a valuation of US$140bn in March 2020.
Meanwhile, more recently, India has also seen a number of new unicorns emerge, with 31 created in the year to the beginning of October alone, according to The Economic Times, as online business models have taken root in the economy. “The cost of data has collapsed in India over the past five years,” says Brian Lim, Partner and Head of Asia and Emerging Markets at Pantheon. “That has really driven internet use and the penetration of e-commerce. It has spawned the creation of businesses that relied on scale – something they have achieved very quickly.”
Ramaswami agrees. “The Indian market has become a lot more interesting over the past 12 to 18 months,” he says. “Consumer businesses have scaled up quickly and there have been some onshore exits. There is a more stable pantheon of investors there and we’ve seen better, more proven business models generate liquidity.”
Beyond consumer
Yet over the past few years, Chinese venture capital firms, along with those in other Asian markets have started looking further afield for opportunities as the entrepreneurial ecosystem has developed and broadened. “We’ve seen a move away from the consumer app-based models and towards greater offline omni-channel capability over the past three or so years in China,” says Ramaswami. “We’ve also seen a trend towards investing in more enterprise-based solutions, B2B, artificial intelligence, deeptech and semiconductors.”
Ramaswami points to more specialisation among Chinese funds in a bid to take advantage of these new opportunities. “We are seeing more specialists,” he says, “but they tend to offer several sectors because, as we’ve seen, regulations can change quickly and so a single sector focus can still seem a little risky.”
There are a number of shifts playing into this new focus. In China, for example, increased labour costs are leading many companies to look to enterprise software to increase efficiency, while in India, a history of offering outsourcing services to large companies has led to strong local capability in enterprise solutions. “India is a little behind some markets,” says Mingchen Xia, Managing Director and Co-Head of Asia Investments at Hamilton Lane. “But there is a lot of potential there as it has a long tradition of helping to upgrade business process outsourcing for global corporates. It is in the Indian economy’s DNA to provide services and technology solutions to corporates.”
In Japan, meanwhile, the venture capital industry is more nascent, but growing fast. Venture capital investment more than doubled in three years, according to Preqin, from US$1.7bn in 2017 to a record US$3.6bn in 2020. Corporate venture investors still make up around 50% of the start-up funding capital, but new firms are springing up. “Japan is an interesting market,” says Xia. “It is similar to China in some respects because of its large consumer market and strong manufacturing capability, but it’s on a much smaller scale. We’re seeing some SAAS and semiconductor opportunities spring up there. For now at least, most of these companies are focused on the domestic market for language and cultural reasons. I do think, though, that the market is strong because corporate customers in Japan are now at a stage where they want to pay for solutions. It’s a similar story in China.”
New skills required
However, the shift away from consumer apps will require VCs to seek out team members with different experience than previously. “For the direct-to-consumer models, VCs really need more skill and supply chain capability,” says Ramaswami. “Even the most established consumer-focused funds have recognised they need to re-tool themselves to build teams that can achieve more insight and dive more deeply into the technology. That’s a trend that was already apparent pre-COVID because of commercial or regulatory tailwinds, but the pandemic has accelerated it.”
Business-focused models are also not the same as mass consumer plays. “Enterprise is very different from consumer,” says Pamela Fung, Executive Director and Portfolio Manager for Asia Pacific at Morgan Stanley Alternative Investment Partners. “You need to have corporate relationships and to understand the corporate buying process – you can’t just take consumer VC and plug it into an enterprise-focused fund.”
This will also have implications for VC and growth returns across Asia. It may even be that the days of significant outperformance are numbered. “Enterprise technology is not a winner-takes-all market,” says Xia. “There is room for more companies to become leaders. The risk-return profile is very different. In consumer, you can reach very high multiples – perhaps in the region of 50X to 100x – and you can grow from start-up to unicorn in a very short period of time. Enterprise start-ups have a much longer timeframe and won’t reach such high multiples, but once you reach cash flow and profit, those profits are very sticky. The absolute return is smaller, but on a risk-adjusted basis, it’s an attractive market.”
Overall, it looks as though venture capital and growth investments across Asian markets are entering a new, more mature phase, which means LPs will need to be more selective about the managers they back. Yet, as Xia notes, it remains an attractive market for many, just with potentially different fundamentals. “The consumer-oriented phase has plateaued, especially in China,” says Ramaswami. “There are new opportunities emerging and any one of these may surprise us, although it’s hard to imagine a 25x or 50x fund coming out of these as we saw in some Asian funds in the last 15 years. It’s now more important than ever for investors to assess teams on whether they have the right capabilities for the next 10 years, not the last decade.”
