For venture capital fund managers who are out in the market raising their debut vehicles, the timing could not have been worse.
The COVID-19 outbreak, which continues to tighten its vice-like grip across the world, has altered the fundraising landscape for first-time managers often seen as more vulnerable compared to storied investors on the trail.
“When I raised my first fund in 2012, we did not have COVID-19,” says Deepak Shahdadpuri, founder and managing director at DSG Consumer Partners. “We did not have the whole world upside down or the economy shutting up. Mine was a story about being a first-time fund manager.”
DSG Consumer Partners was aiming to be Southeast Asia and India’s first consumer fund. Shahdadpuri no track record, zero pipeline, and a completely unproven strategy. In the end, he took over a year to fully close his $12 million debut fund, mortgaging his home to plug in 20 per cent of the corpus during what was a comparatively calm economic climate.
“If you overlay what’s happening with COVID-19 today, it’s going to be very tough. Raising any first-time fund is hard. It takes a long time and a lot of conviction on limited partners (LPs) to believe a new strategy,” shared Shahdadpuri.
In Southeast Asia, there are at least 19 venture capital firms raising capital for the first time. These same funds are also the ones likely to be experimenting with a new strategy, exploring an underserved market or an underrated sector, putting risk capital where risk is deemed the greatest – until COVID-19 burst into the scene.
The coronavirus pandemic continues to claim thousands of lives across the world. Closer to home, Southeast Asia’s governments are barely grappling with what are just-right policy manoeuvres to preserve the future of their economies, while saving the lives of their own citizens within the constraints of a tight fiscal budget.
The ensuing global restrictions on cross-border travel mean venture fund managers have a drastically shrunk pool of LPs to reach out to directly. This is leading to fewer in-person meetings, a narrower chance of scoring a strong suite of investors, and an even unlikelier chance of securing an anchor LP or two, if they are so lucky.
“Raising overseas capital is going to be tricky,” shared James Tan, founding partner of early-stage Southeast Asian venture firm Quest Ventures.
“It doesn’t matter how well-known we are out there, a face-to-face meeting will still be required. This isn’t just a meeting with one or two people. Our entire investment team needs to go there, say hi and shake their hands. All that is going to be impossible in this climate.”
Quest Ventures was initially aiming to raise at least 80 per cent of its $50 million debut fund from institutional investors, including regional corporates and family offices. Today, Tan anticipates this to shift slightly, with newer capital coming from Singapore, especially corporates which will have more funds to deploy at this moment.
1982 Ventures, a newly formed early-stage fintech fund, is aiming to keep things flexible – both in terms of fundraising and deployment.
“Fortunately, our LPs have stayed committed and we have not been impacted on this front. However, LPs which have not made decisions are probably delaying their investment decisions in the short term,” said Herston Powers, managing partner of 1982 Ventures.
“Our timeline hasn’t changed but we have to be flexible with regards to LPs and when founders are ready to close their fundraising rounds,” he added.
First-timers rough it out
Others are in less enviable positions.
At least two first-time funds DealStreetAsia spoke with said that some of their LPs have either dropped out completely or placed their commitments on ice. One Southeast Asian early-stage venture firm had planned to launch its debut $30-50 million fund in March. The fund is already suffering delays.
“COVID-19 is such a b***h,” grumbled a senior executive at this venture firm.
Its high net worth individual LPs have reversed gear, choosing to break up with the GP due to souring businesses in mainland China. Meantime, the global market rout has created attractive buying opportunities in equities and real estate. Why lock money away for 10 to 12 years when you can make a quick buck in the next few months?
The larger, more established LPs — these typically include sovereign wealth funds, endowments and multinational private equity firms — are usually quite unlikely to display such skittishness, but time and patience may not be on the side of fund managers if they were unable to nail a solid LP relationship in pre-COVID times.
Others are already pushing their fundraising timelines.
OBOR Capital, a frontier markets venture fund focused on Cambodia, Laos, Myanmar and Vietnam, had planned a $13 million first close for its $30 million debut fund by Q3 this year. As of mid-March, it was still unsure if it could hit this target. The firm is still searching for an anchor LP.
“I think it’s going to be postponed by a few months. That’s for sure,” said OBOR Capital founder and chairman Christophe Forsinetti.
Just two weeks ago, Forsinetti had planned to hold a board meeting in Cambodia with one of his existing LPs from France. The French investor-entrepreneur was to arrive with his directors and discuss plans to double his investment in OBOR Capital. The meeting never happened.
“He’s still in France and needs to re-assess whether it makes sense to inject more liquidity into his own business back home. So yes, the situation is changing everything and it’s going to be a whole new world after that I’m certain,” said Forsinetti.
The likelihood of LP defaults
LP defaults have already begun to surface in troubled European markets. Earlier this week, MJ Hudson, a London-based asset management consultancy, was reported by Private Equity International to have seen at least three European LP defaults, one of which was a “large pension fund.”
Corporate fund lawyers from Shearman & Sterling and DWF both say they have yet to see such LP defaults in Southeast Asia, adding that it’s still “too early to tell” if this is going to be an issue of concern.
But the fact that COVID-19 has been lingering in the Asia Pacific far longer than it has in Europe seems to point towards more bullish underlying sentiments despite the prevailing economic uncertainty. These debut funds aren’t small. According to DealStreetAsia’s data, Southeast Asia’s first-time funds can be as large as $150 million.
“We continue to see and advise on the formation of debut funds, some of which are quite significant at around $80-100 million,” said Joel Shen, partner at DWF. “One reason for this is because Southeast Asia enjoys relative political stability and strong macroeconomic fundamentals.”
“The recent stock market crashes (could also) have resulted in capital flights from the capital markets and…made its way into private equity and venture capital as investors rebalance their portfolios,” he explained.
Others say this is just disquiet before a very cold, harsh winter storm.
“We anticipate that fundraising (for Asia-based GPs) will face stronger headwinds beginning in the second quarter of 2020,” said James Clayton-Payne and Sean Murphy from Shearman & Sterling’s Asia Pacific team.
LPs and GPs have had an exceptionally busy first quarter, several of whom are rapidly accelerating fund closings which were approved prior to the onset of the pandemic. Meanwhile, LPs have already begun to reconsider or lengthen their due diligence processes for upcoming closes to buy themselves a little extra time.
“We have noticed an uptick in requests from GPs and LPs to consider building deferral mechanics into fund LPAs, which enable the sponsors to achieve an initial close but not commence the accrual of management fees and the commencement of the investment program or investment period until a later date,” wrote Clayton-Payne and Murphy.
This will enable sponsors to hold fund closings, while providing flexibility to LPs and GPs to assess investment opportunities and deployment schedules as the COVID-19 impact sinks in.
How to survive fundraising famine
During the 2001 financial crisis, DSG Consumer Partners’s Shahdadpuri tried to raise a fund and failed. After the collapse of Lehman Brothers in 2008, about 20-30 per cent of his fund LPs defaulted or were unable to make contractual payments after the close of his fund. Shahdadpuri had to spend the next one to two years selling his LP positions to other third-party specialist funds.
He expects 2020 to be similar. Many will be tossed into the crucible. First-time funds will be no exception.
“You gotta do what you gotta do, right?” quipped Shahdadpuri. “There’s always going to be an opportunity to invest.” Stay focused, re-assess the size of your fund, and make sure you have a target size in mind. Figuring out your anchor LP is going to be crucial.
“You really have to figure out who your anchor LP is. I spent a lot of my time finalising the first five LPs I wanted in my fund because it takes a lot of energy to convince people,” he shared.
But for Shahdadpuri, the single, biggest factor which helped during those gruelling months was putting in his own cash. Together with his sponsor, they contributed 40 per cent to the fund corpus, hit their first close and began deploying almost right away. This created a quick pipeline of investments for LPs to see if they liked his strategy or not. The portfolio companies which came from DSG’s first fund include names like RedMart and Chope.
“There’s no more ‘I will do great deals’,” explained Shahdadpuri. “You say, guys, I’ve done four deals. I think they’re fantastic, but you decide whether these deals are good or not. You immediately jump two hurdles here. One is conviction, the other is showing the ability to execute.”
He continued: “No matter how much you say or how well you sell, people will say they’re not convinced until you actually prove it. So get the first close as soon as you can, start investing as soon as you can, show actual traction as soon as you can – that’s my advice.”