Pando

Why most of the Valley was plain wrong about Asia (To the tune of some $15b)

By Sarah Lacy , written on July 27, 2015

From The Money Desk

Back in 2009, while writing a book about entrepreneurship in the emerging world, I spent 40 weeks traveling through Africa, Asia, and South America.  

When I came back to Silicon Valley between trips, I heard a lot of smart people saying very stupid things about the places I’d visited.

Incredibly savvy Valley investors would argue that countries like China or India were best at producing copycat versions of Valley companies, and weren’t capable of much “innovation” beyond that. Some would even claim that, because many of these places were still in the process of building the infrastructure that the Western world takes for granted, developing countries simply weren’t ready to start innovating when it comes to, say, the consumer Web.

Under their worldview, innovation in emerging markets would happen at the same pace as it did in the West. It hadn’t seemed to occur to them that innovation can happen in parallel -- that highly innovative companies can still be built while the cables are still being laid in the ground.

Sure, most VCs have had their Chinese branches or their Indian offices for a while. Some, like Sequoia Capital, have been among the most active investors there year-on-year. But the latest numbers on second quarter global investing show clearly just how “ready” Asia is for capital and who is driving investment there in the wake of Silicon Valley’s continuous “are you in or are you out?” ambivalence.

First let’s talk about volume, per KPMG and CB Insight’s report released last week:

  • In the second quarter, Asian companies raised more than $10 billion in capital, growing year over year by 45%.
  • There were nine new Asian unicorns and the average late-stage deal was nearly $200 million. (Bigger than in the US)
  • Asian companies have raised some $15 billion in the first half of this year.

$30 billion in a year would have been a good amount for total US fundraising a few years ago. And the trend of pre-IPO mega deals and unicorns is as novel here as it is in Asia – this was not how the venture capital world developed back in mid-century USA.

Like most things China has done since it’s warm embrace of Capitalism, it has sprinted before it’s walked. And India is surging this year too, with a similar mega-deal trend. Flipkart is one of only seven companies to have raised $1 billion in a single round.

“Sure, but that’s just a bubble,” many say, particularly about the overheated Chinese market. Probably. But just like bubbles in Silicon Valley history, a bubble doesn’t mean that large companies and massive returns won’t result from a period of frenzied deal making. Consider the dot com bubble: A period we remember as so irrational it has haunted the dreams of a generation of tech workers and entrepreneurs. And yet that period-- while it caused a lot of economic and job devastation-- also yielded Amazon, Yahoo, Google, eBay, PayPal and many other tech powerhouses.

One interesting aspect is who is investing in Asia. Sure, there are some of the usual Valley players like Sequoia and Accel, and there are some good homegrown Asian firms. But gigantic Asian corporates are responsible for some 32% of the deals-- with US hedge funds and mutual funds also swarming the market.

The numbers are greatly skewed by mega deals-- the top six deals in Asia accounted for $4.2 billion or nearly 30% of all funding. But it’s not just folks coming in and cherry picking top deals: The average Asian Series A price also hit a five-quarter high in the second quarter.

The Asian corporates dominating the game include Alibaba, Tencent, Baidu, Rakuten, and others that the Silicon Valley spent years pooh-poohing as mere copy cats until they emerged as gigantic international forces of users and cash. (They are investing, in turn, in some of the hottest US mega-deals too, like Snapchat and Lyft.)

The dominance of Asian corporates in local deal-making has profound ripple effects in the way these ecosystems will continue to emerge. Yes, corporates have always been a factor in the US-- participating in one-fifth of the deals here, versus one-third in China. But in the US, corporates don’t tend to lead deal-making, and are seen as a mixed blessing.

Many entrepreneurs in the US view corporates as dumb money, and eye them suspiciously, wondering what their true intentions are. Terms like a “right of first refusal” to acquire a portfolio company can hurt a startup’s options down the road-- either by limiting who can buy it or signaling to other would-be buyers that they’d only be stalking horses in someone else’s deal. Some VCs downright hate investing with them.

The best investors typically aren’t working inside a corporate because intra-company politics mean they won’t get compensated anywhere near where they could at a VC firm, and a giant company’s priority is never going to be its startup portfolio. One of the most successful corporate VC firms in the US is Intel Capital -- and that’s because its commitment doesn’t wax and wane with its public market valuation. And because it invests for return first, and strategic importance second.

But in Asia, corporates seem to be a bonus in deals. Because of the relative youth of the tech market in Asia, these companies may provide more potential for mentorship and help with hiring senior management than some young VCs-- or VCs who only understand the US. And they have just massive, massive amounts of capital.
Consider a case I wrote about recently: Uber’s competitor in China, Didi Kuaidi. Even Uber can’t compete with Softbank, Alibaba, and Tencent’s ability to fundraise.  

In cases like this one, the rise of corporates is very bad news for US investors looking to face easy competition overseas. US Internet companies have never been good at competing in China-- mostly due to a culture they didn’t understand and their own arrogance. Now they have sophisticated management teams and pockets deeper than their own to add to the challenge.

As I wrote then:

I’ve never seen a battle like this, where all the cash is coming from Asia to try to dominate Asia and a surging US company is doing so many concurrent battles with such sophisticated local backers who ultimately have a home field advantage. I can’t imagine Uber’s usual tactics of buying state legislatures, bullying journalists, styling its corporate image like an American presidential candidate, and whipping up faux grassroots fervor to put pressure on regulators is going to play the same in Asia. If it’s going to win, it’s going to need to do it in a different way and against harder competitors than it’s faced anywhere.

Silicon Valley was never good at Asia, and Asia has gotten way harder in recent years. It’s difficult to believe even the all-powerful Uber will be able to break the Valley’s Asian losing streak.

That said, Asian entrepreneurs will have to be wary of a lot of the same factors the US faces with corporate investors. What are their intentions? Are incentives aligned? Do they really want new powerhouses to emerge that may one day steal their market thunder, or is this just the same kind of outsourced R&D that hobbled big company formation in the biotech and pharma world? And what will happen if their stocks collapse? Investing isn’t any of these company’s core business the way it is for a venture firm. Then again, incentives beyond just returns might encourage these very deep pocketed giants to take more risks-- a win for ambitious startups.

It’s hard to know the answer to these questions for the precise reason I mentioned at the very top of this piece: These markets aren’t simply a US do-over. That may be the only certain fact in any of this.