Asia’s evolving venture capital market

Asian venture capital (VC) markets are undergoing a decade-plus expansion that has seen assets grow 21x from 2011 to 2022 (Figure 1). The surge in available capital has been a driving force for innovation and entrepreneurship across Asia, fuelling the growth of 594 unicorns by 2024 from just nine in 2014 (Figure 2).

But as with any growth story, peeling back a few layers reveals the opportunity set is just as complex as it is exciting. In our view, it is a mistake to assume that Asian VC markets operate in the same way as their Western counterparts, and investors should carefully navigate the key differences between them to translate this growth into strong performance. 

Figure 1

Figure 2

Performance disparities between Asian and Western funds

Despite Asia’s rapidly growing ecosystem, the performance of Asian venture capital and private equity funds has generally lagged their Western counterparts. Historically, Asian funds have returned 40% and 20% less than their peers in the US and Europe, respectively (Figure 3). This has ultimately manifested in less money distributed to LPs, seen in distributions to paid-in (DPI) ratios that are 15% – 25% lower than Western funds (Figure 4).

Figure 3

Figure 4

What is driving this relative underperformance? In our view, it is critical to dive deeper than surface-level metrics to identify the unique characteristics that differentiate the Asian VC opportunity set from its Western counterparts.

Is the power law a fallacy in Asia?

The power law of venture capital maintains that a small number of startups deliver the majority of returns for a fund. While this is generally accepted as fact in the US and Europe, we believe that investors may overstate the significance of the power law in Asia. Comparing the five largest venture-backed IPOs between the two regions helps demonstrate this point:

Figure 5

The difference in scale is likely due to the regional focus of many venture-backed startups in Asia, which are frequently localised versions of Western successes. These companies can be leaders in their respective regions but often struggle to expand outside of them, resulting in smaller total addressable markets (TAMs). Additionally, these startups frequently compete with global players in their local markets, which in many cases could limit or delay their market potential. For example, Coupang and Amazon competed in the South Korean e-commerce market. Though the former is now the leader in its region, the data above shows it is clearly not to the scale of the latter globally. 

In fact, scaling up in Asia generally takes longer, leading to extended times to liquidity events like an IPO. This delay is often due to the need for companies to build underlying infrastructure before achieving significant growth. A simple example would be that of an e-commerce business building out everything from logistics to payments instead of just adding a software layer on top of existing infrastructure available to many Western startups.

Are Asian VC markets overcapitalised?

With these unique factors in mind, we believe many Asian VC funds may overestimate potential investment outcomes, leading to overcapitalisation of startups. This, in turn, further pushes out the liquidity window for companies, potentially contributing to the lower DPI noted above. For instance, a startup valued at US$500 million after raising US$250 million would need to reach a valuation of US$1.5 billion to ensure a successful IPO with sufficient float for its shareholders whereas a company with a leaner capital table would have a much easier path to listing, even at the US$500 million valuation.

Take Southeast Asia (SEA) as an example. The five largest SEA-focused venture funds formed in 2021 – 2022 cumulatively raised ~US$2.5 billion. Figure 6 illustrates the dilemma this presents:

Figure 6

The value creation these assets require is a tall task, considering that the combined market value of all VC-backed IPOs in the region over the past five years amounted to US$9 billion.¹

Asian VC opportunities

While these dynamics may seem like significant challenges, we believe the outlook for Asian venture capital is far from bleak. In our view, numerous markets in Asia offer companies the potential for steady, long-term growth. While fewer companies may experience the extreme growth seen in some US and European startups, they do have the ability to compound steadily over a long period of time. 

Moreover, another bright spot appears in the form of regional stock markets like Japan, South Korea, and India, which are emerging as viable alternatives for local listings, and increasing demand for new-age companies. In fact, India has been one of the best-performing public markets over the last 20 years (Figure 7). Growth in these public markets has the potential to change the landscape for Asian venture capital, especially late-stage venture, in the form of improved exit opportunities.

Figure 7

In addition, Asia also appears to be witnessing a deeper pool of liquidity providers. Because it often takes companies in Asia longer to reach scale, the venture ecosystem has a greater need for liquidity providers. Traditionally, this role has been filled by private equity players. However, there seems to be an increasing number of secondary funds that are stepping in through both GP- and LP-led transactions.

Asian venture capital best practices

To capture Asia’s growing opportunity set and navigate its commensurate risks, we believe asset owners and investors need to better adapt to Asian venture capital’s regional nuances:

• Do more with less: While the easiest advice would be for VCs to be more selective in their investments, the nature of the venture industry necessitates making multiple bets due to the high mortality rates of startups. As discussed above, companies that pursue regional forms of a global product will likely have smaller TAMs with similar cost structures as the West, resulting in higher burn rates and the need to raise more capital. Each additional capital raise increases the bar to exit, resulting in deteriorating liquidity/DPI. In order to be successful, we believe these companies need to be more disciplined about how they spend the money they raise, thus limiting dilution and reducing the time and scale required for a liquidity event that offers compelling returns for investors.
  
  In short, we believe that capital efficiency is critical to success in these markets.
• Right-size funds: In a similar vein, we believe asset owners need to partner with VCs that realise there is a limit to the fund size that each region can support. In our view, venture funds should incorporate realistic growth estimates for companies in the region and focus on the capital optimisation outlined above. We believe this should allow for smaller fund sizes and improve their ability to deliver value for their limited partners. 
  
  Asset owners should ensure their VC partners have the local expertise to understand how to properly size their allocations to this region.
• Consider a global approach: We believe that one way to approach the Asian venture capital opportunity set while limiting the risk of overcapitalisation is to invest in global funds with reasonable allocations to Asia. The Asian VC opportunity set remains robust and offers significant geographic diversification potential, but we believe funds should aim for a limited number of deals each year in the context of a global approach. Importantly, in our view, dedicated resources with regional expertise and networks will be crucial for investors to navigate Asia’s evolving market.

Outlook for Asian venture capital

Asia’s venture ecosystem has powered wealth creation, employment, and quality-of-life gains, among many other benefits. Moreover, the region’s rapid growth and rate of innovation show no signs of stopping. Critically, as the industry has evolved, many have treated Asian venture capital as a mirror of its Western counterparts. In our view, understanding Asia’s unique performance drivers (and limitations), the need for capital efficiency, the importance of right-sizing allocations, and the role for a deeper liquidity pool will be critical to success in the region. After all, the region’s distinct characteristics are not just risks to be monitored but can also be seen as opportunities for generating value for investors who understand them.

¹Source: Pitchbook. Venture exit value from 2H19 to 1H24.