Battening down the hatches and finding alpha - VC due diligence in an Asian Century
The rise of Asia as an economic powerhouse has been one of the most powerful stories of the past few decades. And as Asian economies have continued to grow, so has the region's venture capital (VC) scene. Today, VC firms in Asia are playing an increasingly important role in the global startup ecosystem. But with this comes greater responsibility - and a need for situational risk intelligence and due diligence.
This post explores the VC due diligence process in Asia and how it differs from other regions in the search for situational risk intelligence and finding alpha. We also look at some of the challenges and opportunities VCs face in Asia and how they can overcome them.
We refer to the 21st century as the "Asian Century," with good reason. Asia is home to some of the world's fastest-growing economies, and its businesses are becoming increasingly competitive on the global stage.
The demands on due diligence have changed considerably over the last decade. We must address the financial, legal, and operational DD, and now we have ESG DD, compliance DD, and background checks. Today, the DD timeframes have never been shorter. The raft of service providers has never been more complex, and a strong IC with intellectual honesty is critical to operating effectively.
The current state of VC due diligence in the Asia Pacific
The current state of VC due diligence is quite strong in the region. Many firms are now allocating significant resources to the area and are focused on finding the most promising startups. In addition, foreign regulation is playing its part in encouraging due diligence, particularly on the challenge of GDPR, freedoms from foreign influence, and compliance to export controls. In addition, the rising ESG and impact investment scene has a pipeline of regulatory enforcement and fines for greenwashing, naming conflicts, and non-transparency of contracts - all regulations currently in the SEC pipeline, and finally with real muscle.
However, there are still some challenges that need to be addressed. For example, the cultural differences between Asian countries can make it challenging to identify and assess potential investments. In addition, the fast-paced nature of the startup ecosystem in Asia means that things can change quickly, making it challenging to keep up with the latest trends.
Overall, though, the current state of VC due diligence in Asia is quite positive. With more and more firms turning their attention to the region, despite the downturn in global venture capital investing, it is poised for continued growth in the years ahead.
But the due diligence landscape is a rapidly moving target, both macroeconomically, technologically, and geopolitically.
At AVCJ's annual conference, GPs were asked to question their firms:
The challenges of VC due diligence in Asia
One of the critical challenges for venture capitalists (VCs) when conducting due diligence in Asia is the lack of a developed ecosystem compared to that in Silicon Valley. This means fewer resources are often available to assess a company's potential, and VCs must rely more on their judgment and instincts.
Another challenge is the language barrier. Many startups in Asia are not yet proficient in English, so VCs need to be able to communicate with them in their native language. Be it Thai, Vietnamese, Bahasa or Tagalog, a necessity to play regionally / globally, but think local is essential. This can make understanding a company's business model and operations complex.
Finally, cultural differences can also be a challenge. Asian cultures tend to be more relationship-driven than transaction-driven, making it difficult to get straight answers from founders and employees during due diligence. As a result, VCs must be incredibly diligent in their research and analysis when considering investing in an Asian startup.
Data drives the machinery of capital.
Making sense of information is no longer manual due to compressed deal timelines - you need a robust data science strategy.?
The timeframes for due diligence on data have shortened significantly in recent years. Any VC needs a robust data science strategy to make sense of the vast amount of information available. Data science, in this context, is the process of extracting knowledge from data. It involves applying mathematical and statistical techniques to derive insights from data. A good data science strategy can help you make sense of large and complex datasets, identify trends and patterns, and make better decisions.
Due diligence on data has become increasingly crucial for venture capitalists in Asia. With the rise of big data, there is a growing need to understand how to use data to make investment decisions effectively. Data-driven due diligence can help you assess a company's business model, value proposition, and competitive landscape.
There are several things to keep in mind when developing a data science strategy for due diligence:
1) Understand the business: To develop an effective data science strategy, you must first understand the business you're looking at. What are the key drivers of success? What are the risks and uncertainties? What are the most important metrics?
2) Identify the relevant data: Once you understand the business, you can identify which data will be most appropriate for your analysis. This may include financial, customer, operational, supply chain, GHG emissions or water utilisation, or other datasets.
3) Clean and prepare the data: Once you have identified the relevant datasets, you need to clean and prepare the data and feed it into an appropriate dashboard that aligns with your due diligence lens.
Macroeconomics Matters
Understand the Macro risks on financial, shipping, and manufacturing supply chain
In this brave new world, VCs must be vigilant of the macro risks that could upend their portfolios. One such risk is the health of the global financial system, rising interest rates, and a looming recession. Data intelligence is the key to uncovering and navigating these risks.
With China now shouldering a more significant share of the world's economic growth, a sudden slowdown in the Chinese economy could have far-reaching consequences for the global financial system. Another risk is the potential disruptions to the shipping and manufacturing supply chains that crisscross Asia. A natural disaster or political upheaval in any of the countries along these supply chains could throw the entire system into disarray.
Of course, these are just two macro risks that VCs must now consider when assessing Asia's opportunities. But by being aware of these risks and factoring them into their investment decisions, VCs can position themselves to weather whatever storms come our way in this exciting new era.
The opportunities for VC due diligence in Asia
As the economies of China and India continue to grow, the number of opportunities for venture capitalists to do due diligence in Asia is increasing. There are several reasons for this:
1) The number of companies doing business in Asia is growing.
2) The amount of money being invested in Asian companies is increasing.
3) The number of people with disposable income is growing.
4) The standard of living is improving in many parts of Asia.
5) The regulatory environment in many countries is becoming more conducive to business growth.
Due diligence is essential for any investor and becomes even more important when investing in foreign companies. By doing due diligence, VCs can ensure that they are investing in well-run companies with sound business models and good growth prospects.
The future of VC due diligence in Asia
The future of VC due diligence in Asia will be defined by the speed and depth of market reforms, the availability of accurate and timely data, and the willingness of investors to embrace new opportunities.
In many respects, the future of VC due diligence in Asia looks bright. The region is home to some of the fastest-growing economies in the world, and its companies are increasingly global in their reach. However, several challenges must be addressed for VC firms to continue to thrive in this region.
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Data Accessibility and Reforms
One of the biggest challenges is the lack of reliable and up-to-date data on Asian companies. This makes it difficult for VC firms to assess opportunities properly and make informed investment decisions. Another challenge is the often complex ownership structures of Asian businesses, making it difficult to identify the ultimate decision-makers. And finally, there needs to be more understanding among international VC firms about how companies operate in Asia and what kind of returns they can expect from investments in this region.
Despite these challenges, there are several reasons to be optimistic about the future of VC due diligence in Asia:
It's always about the people.
"The Key is the people test. If the integrity of the people is not right, the deal is not right"
It is often said that the people involved are critical to any successful venture. This is especially true when it comes to venture capital due diligence. If the people behind a potential investment are not of good character and lack integrity, the deal is likely not worth pursuing.
Venture capitalists must be extra careful when conducting due diligence in Asia, as many cultural differences can make it difficult to assess someone's character. For example, in some Asian countries, it is considered rude to say no or disagree openly with someone in authority. This can make it difficult to assess a potential investee's business plans and intentions honestly.
At R3i Capital, we are data-driven and like to move beyond unconscious biases, so we deploy Fingerprint for Success to uncover whether the founding team have the natural motivations and cohesion to exit a company valued between 6m-1.2bn, based on 20 years of historical research. F4S is the secret sauce behind Canva's Bn dollar valuation; it can reduce the seed failure rate from 90%+ to as low as 12%.
However, despite these challenges, it is still possible to get a good sense of whether or not a person or team is worth investing in by paying close attention to their actions and words. Are they straightforward and honest in their communications? Do they seem like they have a clear vision for their business? Do they have a solid plan for using the funding if they successfully secure it? These are all essential factors to consider when deciding whether or not to invest.
Any VC will always tell you that the best way to ensure you make a wise investment decision is to trust your gut instinct. If something feels off about a potential target, it probably is. Following your intuition and paying close attention to the people involved can help ensure that you make wise investment choices in an Asian century.
Uninsurable and untransferable risks in venture capital
In venture capital, certain risks are considered uninsurable and untransferable. These risks can often be found in early-stage companies or companies with new and native technologies. They can also be found in companies operating in industries with high regulatory barriers to entry.
Some examples of uninsurable and untransferable risks include:
1) The risk of a company failing to meet its milestones and timelines due to unforeseen circumstances. This type of risk is often associated with early-stage companies that may not have the management team or resources to navigate difficult times.
2) The regulatory risk associated with new and native technologies. This type of risk can often be found in companies operating in industries with high regulatory barriers to entry. These companies may face delays or complete shutdowns if they cannot comply with regulations.
3) The political risk is associated with operating in countries with unstable governments or business environments. This type of risk can often be found in companies doing business in emerging or frontier markets. These companies may face delays or complete shutdowns if the political environment changes unexpectedly.
4) The reputational risk of a company's product or service being perceived negatively by the public. This risk can often be found in companies whose products or services are controversial or potentially cause harm. These companies may face negative publicity and lost sales if their products or services are perceived as "risky to human or animal health" or in "contravention of international standards".
Every company has a legal and regulatory license to operate for any company and a social license to grow and innovate. The key to value creation is protecting both.
Cyber Risk Governance matters.
Cybersecurity and data protection are now a massive focus.
In the age of big data and sophisticated cyber-attacks, industrial espionage, and foreign influence, protecting your company’s data and intellectual property has never been more important or critical to our national security. That’s why cybersecurity, data sovereignty, and data protection are now a massive focus for venture capitalists when doing due diligence on potential investments.
With the rise of Asia as a global economic power, VCs are increasingly looking to the region for high-growth startups to invest in. But with Asia also being home to some of the world’s most active cyber criminals and an average time to detection of more than 300 days, companies consider a target's cybersecurity and data protection measures before investing.
Here are some key questions VCs should consider when assessing a startup’s cybersecurity and data protection:
Answering these questions will give VCs a good idea of how well-prepared a startup is to protect its data from cyber threats. And with data breaches becoming so costly, it’s an increasingly important factor to consider when making an investment decision.
We love the service provider Detexian for its cyber risk governance solutions for SMEs and regulated industry players and its silver bullet reporting for cyber risk due diligence and situational risk intelligence.
Conclusion
Staying ahead of the curve on due diligence in Asia is a rapidly moving target.
Due diligence is no longer about only uncovering risks but rather about how we can deliver value once that investment has been made.
VC due diligence in the Asian century requires a different approach than in the past. With the rise of Asia as a global economic power, VC firms must be aware of the opportunities and challenges that come with investing in Asian companies. By understanding the unique business environment of Asia, VC firms can better assess the risks and potential rewards of investing in this region.
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Leesa Soulodre is the General Partner of R3i Capital LP and its Group of companies, which have a mission to mobilise one billion dollars into gender-smart climate impact and value-based healthcare over the next decade.
To learn more about the R3i Group's vision, visit us at?www.r3icapital.com?or follow Leesa on LinkedIn?here.
If you would like to learn more about Reputation Risks in an Asian Century, sign up for the Asia edition of the book series here.
If you too are passionate about climate-resilient societies, discover the latest publication edited by?Robert Brears?here:?The Palgrave Handbook of Climate Resilient Societies.?The Handbook provides a comprehensive overview of global attempts to create climate-resilient societies; it presents an invaluable survey of key themes and challenges and reports on best practices and lessons learned. Each chapter addresses one specific sub-theme out of the population of themes covered in the Major Reference Work: Water, Energy, Agriculture and Food, Built environment and Infrastructure, Transport, Human health, Society, Disaster, Business and Economy, and Financing Climate Resilience. It's worth a read. Be sure to dive into Leesa Soulodre's chapter Climate and Reputation Risks in an Asian Century.?