"Winter" in US & Valley Need Not Mean Shakedown in Emerging Markets

By: Ganesh Rengaswamy

Start-ups in India and parts of Asia catch cold when US unicorns sneeze. They don't have to but even century old habits well past their expiry dates die hard . Enough has been said about the downturn that has descended on start-ups in 2016, primarily led by melting of unicorns (about time!). In this regard, I came across two thoughtful articles in last couple of months - One is a rather long and thoughtful LP letter from First Round Capital highlighting the reasons for end of honeymoon of irrationality. The other, On the Road to Recap by Bill Gurley of Benchmark (the word, unicorn, appears 44 times in the article!), is focused on the collapse of unicorns due to death by excesses (primarily capital). In run up to all these, I have been repeatedly asked about the impact of it on our portfolio, which is a pretty healthy representation of emerging markets (India, Africa, LatAm, SE Asia). Here are my summarised thoughts -

  • Single biggest problem in USV (US + Valley) was excess and unbridled capital which unicorns got used to but emerging market companies have rarely experienced that luxury (except for maybe handful of poster child companies in India etc but rarely the case for 99.5% of start-ups in emerging markets)
  • Unlike Unicorns, most of our portfolio companies are Series A, B or C, much younger with much lesser capital deployed at rational terms. For e.g. Even a company that grew 6x last year and has a differentiated product (with a revenue of ~$10mn and profitability expected in Q1) saw its valuation go up less than 2x (steep but not really irrational).
  • We look for founders who have been scrappy and seen companies through lean times. Most of our entrepreneurs have experienced downturns directly or indirectly; companies are frugal and can hunker down to survive longer in our markets.  
  • It is appreciated that appropriate protection in follow-ons and new investments, especially in these times of uncertainty, is important. Unlike USV, modest structured terms are not uncommon in emerging markets even in normal times; it helps provide a protective cover and is not taken out of the sheath only in difficult times (of course, the key principle here is to be fair).
  • After years of disparity, private and public markets are adjusting back to parity in the US. This is leading to significant downward shift in private market valuations. But, in USV the course correction is hitting all companies. In emerging markets, high quality companies are always at a premium despite softening macro scenarios (except if the bottom falls off like in 2001 and 2008).
  • Having said that, drying up of capital irrationally in a downturn is probably the single largest concern in emerging markets. This is one phenomenon hard to predict and has the "falling off a cliff" impact.
  • Finally, summing it all up - we are very excited that all our portfolio companies are raising (or have raised) follow-ons this year. and we are working hard to close open rounds soon. The idea is to be well stocked for dry spell ahead......