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Make room, China: VCs look to India for fintech startups

Who is winning capital, and what’s the exit picture like for Asia’s fintech companies?

Narendra Modi

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Last year was a tough year for Asian fintech startups to raise funds from venture capital. That trend is likely to endure, with Indian companies an exception.

The headline numbers suggest otherwise: in 2018, the venture capital industry in Asia raised a blockbuster $34 billion, more than double the previous year, says Sherry Lin, head of global venture capital in San Francisco at Willett Advisors, which manages the philanthropic assets of the Michael Bloomberg family.

Moreover, five of the six largest global VC investments last year were to Chinese companies, such as Ant Financial, while four of the top five exits were also Chinese, such as Xiaomi’s IPO in Hong Kong.

But those figures disguise the reality that capital has gone to bigger funds and bigger companies, and less to startups, she says, speaking at an investment conference in Hong Kong. (Unless specified, the comments in this article were sourced from a stage.)

Tough times for startups

In fact, the environment for startups has gotten tough since mid 2018, as U.S. Federal Reserve interest-rate hikes began to bite, and equity markets began to slide.

Some of this is a natural cycle: rising interest rates make risk assets less attractive, so startup valuations fall. This creates more attractive buying opportunities for VCs, but startups struggle to raise affordable capital.

In Asian fintech, moreover, another cycle is working against startups. Investors feel that the innovation that has driven money to fintech in the past several years, particularly in China, has played out (disastrously, in the case of P2P lending) – and the next trend has yet to materialize.

“The first wave of mobile internet companies is fading,” said Cheng Yu, partner at Morningside Venture Capital. “Artificial intelligence is the biggest investment thesis for the next five to 10 years,” especially as the Internet of Things creates vast amounts of new data. But VCs aren’t finding enough commercial opportunities.

“I want to see more,” Mounir Guen, CEO at MVision Private Equitiy Advisors, told DigFin. “More people, more talent, more ideas. Who’s got that X-factor in digital technology?”

Headwinds for A.I. entrepreneurs

One possible reason for the perceived lack of startups is that geopolitics is getting in the way.

“The [U.S.-China] trade war means a decoupling within venture capital,” said Melissa Guzy, managing partner at Arbor Ventures. It’s harder for American money to invest in Asian – especially Chinese – companies, and vice versa. The U.S., in particular, is also levying new regulation and taxes that make investing into Chinese companies harder. (Arbor relocated last year from Hong Kong to Singapore.) “We all live in a new world,” she said.

Another reason in China is the dominance of domestic internet companies such as Alibaba, Tencent and Baidu – the BATs. Cheng said, “Ten years ago, startups could compete against them. But A.I. has made the BATs stronger. They have all the data, all the talent, all the capital.”

He’s looking for startups whose own A.I. meets a specific consumer need and can scale fast enough to survive the BATs. Such stories are thin on the ground.

“There’s no more froth,” Guzy said. “Only the top companies get all the money, and seed investing is down.”

Investors wary

Investment bankers are also more wary of A.I. and other early-stage fintech, says Jeremy Choi, managing partner at China Renaissance, especially companies that are pre-revenues. They are not looking to package fintechs up for strategic buyer unless the story is very compelling.

“Fintech requires technical expertise,” he said, “and A.I. needs a big story about explosive growth in order to raise funds. The main buyers for these companies are the BATs.”

Bigger investors from the private-equity world still find fintech, and tech generally, hard to make sense of. The industry moves too fast for a long-term private investor to know what the company and its landscape will look like; it’s not always obvious which companies are on the sharp end of disruption. 

This is why even at the VC level, investors either place lots of bets – “spray and pray” – or they avoid fintech.

Last year they mostly avoided new investments. For bigger investors, exits for fintech have also become harder.

Difficult exits

The headline numbers for IPO proceeds in 2018 were actually very good, especially for Asia. Hong Kong was the world’s number-one destination; its recent rule changes allowing dual-share class listings helped attract the likes of Xiaomi ($4.7 billion) and Meituan Dianping ($4.2 billion), while Softbank raised $23 billion in December in the largest-ever IPO on the Tokyo Stock Exchange.

But these large deals obscure two things, says Clement Ma, managing director at S&P Global Market Intelligence. First, their success obscured the paucity of smaller-company IPOs, especially in Shanghai and Shenzhen, which saw a 75% drop in the number of IPOs from 2017.

Second, these deals all fared poorly in secondary markets: investors would have been better off buying the S&P 500 index, Ma says: “So in 2019 investor appetite has slowed, especially when it comes to China tech.”

So VCs face plenty of headwinds in capital markets and fintech trends, especially in China. And the silver lining of lousy equity markets (that is, cheaper valuations for new investments) may not even last, given January’s roaring market performance has already made up for last year’s losses.

Bright spots

The exceptions for VCs: data storage, data security, and countercyclical plays such as P2P debt collection are now in vogue in Asia; globally, it seems VCs can’t get enough of Israeli cyber-security firms, particularly those addressing virtual payments.

The biggest exception of all – perhaps heralding a tectonic shift – is Indian fintechs (and India tech generally).

Jessica Wong, founder and managing partner of Ganesh Ventures, says she set up the Beijing-based firm (with backing from Alibaba) to invest in India after Narendra Modi was elected prime minister, which she viewed as sign of a new business climate. “If you want to own the next unicorns, the opportunity is in India,” she said.

China’s tech giants now recognize this, with the likes of Alibaba, Tencent, Meituan and Bytedance scouring the country for strategic partners, she says. In particular, there is confidence that India will be the place to be now for the kind of consumer-loan and other fintech plays that have transformed China in the past six or seven years.

Why India

V.T. Bharadwaj, co-founder of Bangalore-based A91 Partners (and formerly head of Sequoia’s India business), says there are several reasons why fintech and other startups in India are now the darlings of investors.

First, GDP per capita is rising, so startups can scale more quickly.

Second, there is a new breed of entrepreneur. Gone are dabblers backed by wealthy families; now the scene is dominated by tech and finance professionals in their 30s and 40s, usually with experience abroad or working at multinationals. “They understand the importance of capital and how to make a return,” Bharadwaj said.

Third, there is more capital available in India. While foreign money such as U.S. endowments remain the dominant source, there is now China funds such as Ganesh, plus local family offices. Strategic investors such as Alibaba, Tencent, Huawei and Xiaomi are providing not just money but engineering and software too.

Fourth, India’s digital infrastrcture is maturing, with now 500 million people using broadband. “Entrepreneurs haven’t worked out how to monetize,” Bharadwaj said, “but they’re riding the tech wave. It’s like China six or seven years ago, when broadband took off.”

Finally, there remains plenty of juicy targets: “There are plenty of old, lazy banks and other incumbents for fintechs to attack,” he said.

Or as Guzy put it, more generally: “Financial service innovation will continue because no one loves their bank.”

Copyright © 2017 Digital Finance Media Limited. All rights reserved.

Make room, China: VCs look to India for fintech startups