Chinese venture capital firm Unity Ventures is preparing ammunition for its first $100-million US dollar fund as it foresees heightened investment into early-stage technology startups following Beijing’s listing reforms that will make exits easier for their investors.
Beijing-based Unity Ventures, which primarily bets on startups at the angel and pre-Series A stages, already reached the first close for the debut dollar fund at tens of millions of US dollars before the Lunar New Year. Limited partners (LPs) include China’s Wu Capital, a family office that manages money for real-estate tycoon Wu Yajun.
The new vehicle kicked off fundraising in late 2019 and is expected to close in the second half of 2020 at $100 million.
China’s Nasdaq-style STAR Market and Beijing’s proposed reform of the ChiNext board will make it “substantially easier for investors to exit from their high-tech portfolios,” said Shaw Wang, founding partner of Unity Ventures in a phone interview with DealStreetAsia.
Investment interest in Chinese technology startups at Series A round and after will increase with the formation of exit alternatives. This will contribute to “a less difficult development path for high-tech companies that rely heavily on massive capital and talent investment to grow in the early stage,” he said.
The venture capitalist, formerly a founding member of Nasdaq-listed Chinese search engine giant Baidu, created Unity Ventures in September 2011 and anchored four RMB-denominated funds with nearly 2 billion yuan ($281 million) in assets under management (AUM).
After deploying about 1 billion yuan ($141 million), the company has formed a portfolio of over 200 startups predominantly at angel round and Series pre-A round, as well as a fraction at Series A round.
Unity Ventures posted a track record of over 40 per cent in average internal rate of return (IRR) in its previous three yuan funds, in what Wang referred to as a symbol of maturity for his investment team to manage a dollar fund with a larger capital pool.
“USD-denominated funds are of crucial importance since about 60 per cent of subsequent investments in our portfolio companies are from dollar funds,” said Wang. “We are able to get a hold of their preferences, which makes it logical for us to run a U.S. dollar fund of our own.”
Shaw Wang shared with DealStreetAsia the fundraising updates of Unity Ventures’s first dollar fund and investment strategies, as well as his insights into a transition of consumer behaviours amid the COVID-19 outbreak, and how Beijing’s IPO reforms are shaping up exit potential for investors behind Chinese technology companies. The interview was conducted in Chinese. Below are the translated and edited excerpts:
Could you walk us through the funds and assets currently managed by Unity Ventures, as well as updates of the new U.S. dollar fund that the company is raising? How much of these funds have been deployed so far?
Unity Ventures is an early-stage technology investment company created in September 2011. Launching a new fund around every two years, Unity Ventures currently manages four RMB-denominated funds with nearly 2 billion yuan ($281 million) under management. Our portfolio consists of more than 200 early-stage technology startups, primarily in the angel round and Series Pre-A round, as well as some in Series A round.
In late 2019, we started the fundraising work for our first USD-denominated fund. The dollar fund, which we target to raise $100 million, has reached the first closing at tens of millions of U.S. dollars before the Lunar New Year. We have received capital commitments from previous LPs, as well as new family offices and strategic investors. We’re now looking for more LPs and are expected to close the new fund in the second half of 2020.
What are the major considerations of setting up Unity Ventures’ first U.S. dollar fund? What does it mean for the company’s investment strategies?
Unity Ventures started as an RMB-denominated fund manager so we are more familiar with the fundraising path and development process of yuan funds. After the track record of previous four funds, I think it’s the right time for our investment team to raise and manage a U.S. dollar fund of a larger capital pool with Unity Ventures’ more mature and quality investment capabilities.
In terms of the [Chinese] investment market, USD-denominated funds are of crucial importance since about 60 per cent of subsequent investments in our portfolio companies are from dollar funds. We typically inject capital into startups at angel round and Series Pre-A round while their following Series A and B rounds are supported by dollar funds, so we are able to get a hold of their preferences, which makes it logical for us to run a USD dollar fund of our own.
Will you be able to name some LPs of the new fund?
I can share a few. [In the first closing of the new fund,] I committed $4 million as the GP. Longfor Group’ Wu Capital invested $5 million. There is one strategic investor who poured $10 million, apart from capital injections from several other individual investors.
(Note: Beijing-based Wu Capital is one of China’s biggest family offices, managing money for the family of real-estate tycoon Wu Yajun, the chairwoman and largest shareholder of Longfor Group. Wu and her family have a net wealth of $12.6 billion, according to the Forbes Billionaires List 2020.)
How will the investment focus of the dollar fund be different from Unity Ventures’ previous yuan funds? What are the sectors you will be mainly looking at in the second half of 2020?
Previously, we focus more on startups at angel round and Series Pre-A round, including a fraction of companies at Series A round. The dollar fund will finance more startups at Series A round, predominantly from the technology field that covers the segment of consumer Internet.
Unity Ventures primarily makes investments in three areas: First is “new technologies,” which include companies that leverage advanced technologies like AI, machine learning, and 5G to develop chips, operating systems, and intelligent platforms, as well as companies specialized in Platform as a Service (PaaS) and Software as a Service (SaaS).
Our second focus is “new industries.” Hereby I refer to companies that use new technologies and new models to empower traditional industries, serving as an infrastructure platform developer or corporate service provider. We also look into “new services” as our third focus. China’s commodity consumption market has become very much saturated, but products and services related to insurance, education, healthcare, and provision for the aged are still gaining traction. We consider these new services as an important space to invest in.
About half of the new capital pool will be used to re-up investments in our portfolio companies, while the remaining part will be used for deals at Series A round in [the technology industry] where we have expertise. But we may need to adjust the 50-50 proportion along the way.
Geographically, our investment focus will still be China. But we will also look into startups created by Chinese entrepreneurs in overseas regions such as India, Africa, and Southeast Asia amid a trend of “going-overseas” among Chinese businesses.
We don’t have a specific plan in terms of the proportion of dry powders to be deployed in the overseas market, but I estimate it to be somewhere between 10 per cent and 20 per cent. Essentially, Unity Ventures’ investments will be centred around Chinese entrepreneurs.
Could you illustrate more on the investment performance of the previous four RMB funds, including prominent exits and the average internal rate of return (IRR)?
We have so far invested approximately 1 billion yuan ($141 million) out of 2 billion yuan ($282 million) managed across the four RMB funds. Since we just started deploying capital for the fourth fund, it would be more accurate to share the average IRR of the previous three funds. Their average IRR is somewhere between 40 per cent and 50 per cent.
China’s investment market has notably embraced a hit from the novel coronavirus in the first quarter. Boston-based management consultancy Bain & Company tracked a 55 per cent drop in deal value and a 7 per cent decline in deal volume in Q1 2020. Has the pandemic more or less influenced Unity Ventures’ investment plan in the quarter?
We made about 10 transactions into portfolio companies and new startups in Q1. The number is slightly lower than usual since we also have perceptions and some degree of sensitivity of a market downturn. But generally speaking, Unity Ventures has maintained our investment routines and directions. And personally, I don’t consider entrepreneurial opportunities to be very closely aligned with the capital market environment.
The pandemic only accelerates the transition of certain user behaviours in fields like online conferencing and cloud documentation, rather than influencing the way they develop.
As an early-stage investor, Unity Ventures has not changed much of our overall investment decisions and routines [amid the coronavirus outbreak]. Because when people began to notice the development of certain sectors, their window of investment opportunities have already passed for us. We invested in Shimo (a Chinese startup that provides real-time docs collaboration solutions like Google Docs) about five to six years ago and laid out investments in the online education field two to three years ago. Now we focus more on budding opportunities instead of areas that have obviously entered into the fast track.
That being said, many companies do benefit from the accelerated transition of user behaviours during the pandemic. In the field of online education, for instance, our portfolio company Path Academics has enjoyed significant growth in March and April, booking a record monthly revenue of about 50 million yuan ($7.04 million).
Do you expect the revenue spike and consumers’ behaviour shift to endure for a longer-term? What do you think startups should be aware of if the market demand returns to normal post the pandemic?
I expect the surge in consumer demand to fall a bit after the pandemic, but to remain at a level higher than a pre-virus world. Increased user demands [for the aforementioned online education, remote work solutions, and others] will retain because these services and products are practical and adaptive to actual market demands.
I have three suggestions for startups: Firstly, companies should take good advantage of the change in consumer behaviours to promote the brand, increase consumer retention, and enhance their industry reputation to leave a deep impression on customers. Secondly, companies should increase investment in brand building and talent recruitment, while speeding up their fundraising pace since it’s easier to bargain for a higher valuation when there is visible revenue growth. Thirdly, for companies which have entered a faster development state, they will need to further lift their operational capabilities and expand offerings.
There is a saying among some Chinese investors that it’s actually a better time to make bets in a market downturn because the price is cheaper despite risks brought by the pandemic. Do you agree with this opinion?
Yes, I do. Venture capital investment is closely related to the price of startups… [What we seek for is] a balance between the company price and value. It would be difficult for us to invest in a startup if they price themselves too high yet we only find their value intermediate. We are kind of in a market trough, which is a suitable time [to source deals as] to purchase stocks. But apparently venture capitalists wait for a much longer-term to maturate their investments and focus more on the industry development potential of the portfolio.
Of course, I think it wouldn’t be very feasible to discuss if the company valuation is reasonable or not without giving a specific example. Because we really need to look into the company value, which is largely reflected in their future development potential that bears many uncertainties and vary from one company to another. There will always be startups that are reasonably priced even under a much better market condition.
Take the market as a whole, the valuation range of Chinese startups has moved lower to be more reasonable and lucrative for VC investments. Since there are fewer investors and ammunition in the market, there is more room to bargain for a lower price.
Apart from the pandemic, we have seen some US-listed Chinese firms involved in alleged misdeeds of posting exaggerated revenue numbers. What does it mean for Chinese early-stage investors? Are you seeing increased concerns for future exits among investors who have China-based portfolios?
There was “a closed-loop” for Chinese internet companies in which they raise money from U.S. dollar funds since Series A round on account of a listing in the US. Many valuable Chinese Internet firms used to target American boards. [After the series of accounting scandals,] the closed-loop did embrace some impacts, but I don’t think they’re fatal. Kingsoft Cloud, for example, had a great IPO performance lately.
(Note: Kingsoft Cloud raised $510 million in its U.S. IPO on May 8, 2020. The company had planned to sell 25 million shares but increased the size of the deal to 30 million shares because of better-than-expected demand from shareholders. The IPO valued the Xiaomi-backed firm at $3.7 billion.)
Of course, some Chinese companies have set sights on the Hong Kong Stock Exchange (HKEX), which has been a supplement to the closed-loop and offers an exit alternative for investors behind sizeable, high-potential Internet companies. Besides Hong Kong, China’s STAR Market and Shenzhen’s startup board ChiNext are also made available as additional avenues for technology companies, including players in Beijing’s much-highlighted semiconductor field, to raise money and finance their product upgrades.
Beijing’s proposed reform of the ChiNext market will build an even better exit location for the country’s early-stage technology startups and consumer companies. It will shorten the duration from investment to exit and further increase liquidity for issuers. Meanwhile, I think the market capitalization of [future] issuers on the ChiNext board will be widely divergent with their IPO sizes ranging between two to three billion yuan to 20 to 30 billion yuan.
The STAR Market as well, has made it substantially easier for investors to exit from their high-tech portfolios. In the past, Chinese technology companies used to take more than 10 years to grow mature before they can access the secondary market. The IPO systems and standards on mainland boards long favoured traditional industries and state-owned companies. There were only a few listed high-tech firms in the mainland, simply because they usually need a long R&D duration and massive capital to back them up, plus the difficulties to grow revenues. Not many investors were willing to back Chinese technology companies because they saw relatively fewer possibilities to exit from such investments.
As exits become easier, investors are more willing to pour money into Chinese early-stage technology companies. Investments into Series A round and after will also heighten, contributing to a less difficult development path for high-tech companies that rely heavily on massive capital and talent investment to grow in the early stage.
This is the overall market condition I’ve seen for investment exits. Early-stage investors like Unity Ventures would slightly adjust our investment decisions and evaluation for future exit possibilities in accordance with the market condition. However, we essentially make the decision based on companies’ value and their long-term development potential.
After Alibaba’s $11-billion Hong Kong secondary listing in November 2019, many US-listed Chinese internet companies followed a similar plan. What do you think is the underlying meaning of the trend?
From a business perspective, a simple logic behind the trend is that some Chinese issuers are underappreciated in the US, while they can earn a better listing price and a higher market capitalization in the home market. The key reason is that their company value is not fully recognized.
Additionally, Chinese brands listed on domestic boards will have a stronger resource allocation capability in the capital market. Their pursuit of a secondary listing is also “a safe move” that allows access to their shares by investors at home and abroad, instead of “putting all eggs in one basket.”
It is already an ongoing trend for US-listed Chinese firms to return back to the domestic capital market. Such a trend will certainly continue in the following one to two years, but we’re not sure yet of its longer-term development.
In the backdrop of China’s STAR Market and proposed ChiNext market reforms, what is your outlook for investment exits on mainland boards in the next three to five years?
I think the number of Chinese small and medium-sized technology companies, especially leading players in their respective areas, will increase following the reform of the ChiNext board. We will see companies of all development levels including both quality startups and their inferior peers. The market will then undergo a return of rationality to weed out smaller player and grow more mature.