Now, I should emphasize that my familiarity with venture capital is somewhat less extensive than my familiarity with private equity, infrastructure and real estate. I have some familiarity with it, having followed the sector in the trade publications and by speaking with local venture capitalists, but it was not an asset class my old firm specialized in, and accordingly I have evaluated far fewer venture deals in my career.
For the avoidance of doubt, where a company has raised multiple financing rounds during the year, I will include only the most recent round in determining which companies are in the top five.
Overview
Table 1 above sets out the top five VC financing rounds with principal place of operations, series, size of the financing round, date financing round closed, post-money valuation, and investors. China contributed three companies to the top five in 2014, a three-fold increase from 2013 when the top five consisted of two companies from India and once company each from Singapore, Malaysia, and China. The size of the largest financing round in 2014 ($1.1 billion Series E for Xiaomi Inc. (北京小米科技有限责任公司), valuing it at $46 billion) was 2.05 times larger than the largest financing round done in 2013 ($360 million Series E for Flipkart, valuing it at $1.6 billion). In fact, even the fifth largest financing round in 2014 resulted in a post-money valuation ($2 billion) higher than the largest financing round in 2013 ($1.6 billion).
The five companies included one Chinese hardware manufacturer (producing smartphones, tablets, consumer electronics, and home automation systems), three e-commerce marketplaces in China, India and South Korea, and one Chinese taxi booking app. In 2013, while there were no hardware manufacturers, three of the top five were again e-commerce marketplaces or online retailers, and the last was a financial institution aimed at serving the under-banked urban population in India. Some things, it seems, have not changed much.
The financing rounds were mostly—as might be expected—late stage financing rounds, with the exception of Meituan (美团), which was a Series C investment.
The composition of the investors in these financing rounds is also quite interesting. The corporate venture capital arms of Tencent Holdings and Alibaba Group participated in two of the financing rounds, Didi Dache (滴滴打车) and Meituan, respectively. DST Global, Yuri Milner’s investment fund, invested in three of these financing rounds. Given DST Global’s prior success in investing in a Series D round for Facebook and a Series G round for Twitter, as well as a Series B round for Airbnb, I am inclined to give it the benefit of the doubt. Singapore’s sovereign wealth funds again participated in several financing rounds, with the Government of Singapore Investment Corporation making two investments and Temasek Holdings making one.
Post-Money Valuations — A Bubble?
All five companies in 2014 were members of the “unicorn” club, i.e. companies that had achieved a valuation of $1 billion or more (as of their most recent financing round). By contrast, in 2013 only one company crossed the $1 billion post-money valuation line: Flipkart. Are we looking at a market bubble in Asia?
I think not. First, one should remember that it is incredibly hard to build a company worth $1 billion or more. These five that have managed to do so represent a very small percentage of the startup ecosystem in Asia; I would estimate (without crunching the number for the denominator, because collecting the data would almost be a full-time job) probably not more than a tenth of a percent. These five have done well for themselves, but for every Xiaomi or Flipkart, there are probably many hundreds that struggle to raise even a $100,000 seed financing round. The high profile financing rounds with staggering post-money valuations are not illustrative of the majority of startup valuations.
Second, one needs to recognize the state of the financial markets. With interest rates at all time lows—close to zero in Singapore, Japan, Hong Kong, and still fairly low in Malaysia, China, and in fact negative in almost all of these Asian countries if one account’s for inflation—the present value of future cash flows will inevitably be high. If we assume that stock in a company is a claim on all future cash flows of that company, then in a low interest rate environment our valuation of a company will be significantly higher than it would be in a “normal” interest rate environment, because our next best alternative to equity investments will be an investment with a fairly low return on investment. Like Fred Wilson, I believe that the valuations we see in the market are at least partly a consequence of macroeconomic factors, and not necessarily a sign of irrationality on the part of investors.1
Third, in many of the geographies and industries where these companies are operating, gaining an early and commanding lead over their competitors in order to lock in customers is a key element of their strategy. If we assume that the majority of the value in these markets is captured by the market leader, then it becomes a matter of life-or-death for a startup to be that market leader and do whatever it takes—including spend aggressively—to beat its competitors to that top spot.
On the flip side, however, one can say that there are some indications that valuations may not be entirely backed by fundamentals. Take a close look at the list of investors. There are quite a few investors that are not traditional venture capital firms and do not necessarily follow the same investment philosophy: corporate venture arms of industry leaders like Tencent and Alibaba, sovereign wealth funds like the Government of Singapore Investment Corporation and Temasek Holdings, and hedge funds and diversified investment managers like Tiger Global Management and T. Rowe Price. They have entered the market and have expanded the pool of capital chasing after attractive investment opportunities, thus inevitably driving up valuations. This is not to say that these investors are necessarily irrational, but their investment theses and holding periods do not necessarily match traditional venture capital firms.
One can also note that if valuations are well publicized, startup founders will be incentivized to try and join the “unicorn” club. Assuming that their startup is intrinsically valuable and has potential to take a dominant position in its market, there may exist a certain amount of leeway for the entrepreneurs to push for higher valuations (within reason, of course).
Investor Composition — Some Initial Thoughts
The entry of sovereign wealth funds into financing startups is interesting. I would be curious to see how the financing is being done, whether it is through dedicated venture arms staffed by people familiar with the venture capital industry and its investment theses and return requirements. I am also curious about the return requirements and investment theses of the diversified asset managers that have started financing late-stage venture capital rounds.
If one assumes that they are not devoting a significant fraction of their total assets under management to these deals, they may be willing to accept different return profiles (in particular money on money and IRR numbers) than venture capital investors that must aim for outsized returns in order to offset the significant proportion of their portfolio that either fail or deliver at best average (linear) results.
At this point, I would say it is still too early to say how the change in investor composition will affect the market for venture capital financing. My personal view is that these investors will remain (due primarily to appropriate “bite sizes”) primarily focused on larger, later stage venture capital rounds where they can deploy a meaningful amount of capital (relative to their assets under management) given that due diligence on a target is often the same for large deals and for small deals, in terms of time and energy spent.
Furthermore, I think the diversification of financing sources, while potentially driving up valuations (especially in later stage financing rounds), will ultimately be beneficial for startups in Asia if it allows for different time horizons on invested capital and different return profiles.