ZWC Partners, a dual-currency venture capital (VC) firm that invests in both China and Southeast Asia, has held thefirst close of a new RMB-denominated fund at 1 billion yuan (about $150 million).
ZWC Partners has drawn capital commitments from China’s state-backed funds of funds (FOFs), global institutional investors, and regional family offices for the RMB vehicle. The fund counts Chinese out-of-home advertising company Focus Media and publicly listed supplement provider Xiamen Kingdomway Group as strategic limited partners (LPs), according to a statement.
With this, the firm joins a slew of investment companies raising dry powder in local currency at a time when startups in Greater China are more prone to a public listing closer to home. Startups, which are re-routing to an initial public offering (IPO) in mainland China, prefer venture money in local currency for the convenience of building a business structure ready to go public on a domestic stock exchange.
According to data cited by Chinese media outlet TMTPost, the first quarter of 2022 saw the setting up of 1,354 RMB funds in China, which is about 67.7 times the number of newly launched USD funds. These RMB funds raised about 377.8 billion yuan ($56.4 billion), up 11.6% from the same period in 2021; while the combined fundraising size of the new USD funds dived by 62.6% from Q1 last year.
Other Greater China-focused players who have launched or raised RMB vehicles recently include GF Xinde Investment, Cathay Capital, Vivo Capital, Yingke PE, Huaxing Growth Capital, Cedarlake Capital, and BlueRun Ventures China.
Having raised 1 billion yuan for its new fund, ZWC Partners targets 1.5 billion yuan ($223.3 million) for the final closing in the second or third quarter of this year.
Founded in 2015, ZWC Partners manages both RMB- and USD-denominated funds with a team of professionals operating across Beijing, Shanghai, Shenzhen, Hong Kong, and Singapore. In its latest fundraising success, the firm secured an equivalent of over 5 billion yuan ($785.3 million) in capital commitments in June 2021.
As an investor of Indonesian tech giant GoTo, ZWC Partners aims to invest most of its capital raised in the Greater China market. Its China portfolio includes AI technology startup 4Paradigm, dating app Tantan, medical test services platform Yunhu Technology, and job recruitment website Boss Zhipin, just to name a few.
Edited excerpts from an interview with Michael Yao:
What is the LP composition of the new RMB fund?
Most LPs in our RMB fund are from mainland China. We intentionally selected LPs with deep industry backgroundas our key LP component, because we consider LPs as sort of a resource that can help us create good investments and tap into our investment thesis of “technology plus industry”. We look into technologies like advanced manufacturing, AI, and robotics that can be adopted for industrial applications across construction, manufacturing, and pharmaceuticals.
In addition to that, we also secured commitments from funds of funds (FOFs) and China’s local government-backed funds to diversify our LP base.
When do you expect to hold the final closing of the RMB fund? How many deals are you planning to do, and what is the average transaction size?
As we have already raised two-thirds of the fund, we plan to reach the final closing by the second or third quarter of this year.
We have prepared a whole pipeline of deals that we intend to invest in through the new fund, including four deals already secured in the consumer, semiconductor, and autonomous driving industries. We target about 15-20 deals with the cheque size ranging from 15 million yuan ($2.4 million) to 100 million yuan ($15.7 million). We will focus on growth-stage companies from Series B to Series C, with potentially a small portion for early-stage deals. For 2022, we have a goal to deploy about a quarter to one-third of the RMB fund in five to six deals.
We will focus heavily on DPI (distribution to paid-in) for the RMB fund, so we think that the fund will probably have an investment period of three years, followed by another 2-3 years for exits.
Are there any updates on the USD fundraising side?
We closed our latest US dollar fund at about $500 million last year. It focuses on the similar funding stages of Series B and Series C. But we may deploy a little bit more portion from the USD fund to venture deals because the fund size is bigger, and the investment duration is longer.
Has the team encountered any challenges in raising US dollars from overseas LPs amid the trade tensions and regulatory scrutiny in China and the US and the Russia-Ukraine war?
We work with long-term investors who are unfazed by market slowdowns and geopolitical turbulence. China is an important country for long-term investors. That’s why our long-term LPs are not affected. They probably think it is the best time to pull the trigger because valuations are cheaper, and [it is the time when] the strongest players can survive and consolidate the market.
But we may see some pullbacks by short-term investors like family offices and [individual] investors.
In 2022, which industries will be more popular in the IPO market in Greater China? Do you see any downside risks that could influence the after-market performance?
I think the industry performance in the Hong Kong and A-share markets in the past few years could be a good indicator of future trends. A few sectors have clear, long-term growth prospects. The first is the energy sector, especially technology-enabled new energy like EVs (electric vehicles) and solar energy. Market adjustments happen, but the sector’s fundamental growth trajectory is undeniable. A lot of value has been created in this area over the past two years.
Another industry is automation. There are not many listed automation companies in Hong Kong, but there are quite a few in the A-share market including some venture-backed robotics companies. It is an undebatable trend that machines will become smarter and replace more labour-intensive work.
The third is the consumer space where selected brands with differentiated products, strong brand image, and wide customer recognition will present great growth trajectories.
Is there a rough number of potential exits in your pipeline?
We have a strong pipeline of about five to eight exits in the next 12-18 months, either through IPOs in the Hong Kong and mainland markets or through M&As.
As an investor who focuses heavily on the Chinese market, how do you mitigate regulatory risks, given the upheavals across industries from online education to gaming?
GPs are different from LPs in their understanding of the local market. At ZWC, we will first identify if the sector is on the tailwind of government policies, and then pick just one or two very promising companies in that sector rather than betting on 10 companies at one time.
I think the Chinese government is correct in its crackdown on sectors, such as school curriculum-based education, that do not necessarily have the technology component but focuses more on marketing. That’s why we stay away from these so-called “neijuan” [Note: “Neijuan,” a popular Chinese term that literally means “involution,” is used to refer to the fierce competition across certain industries and the hyper-competitive culture in China’s labour market] sectors, where players were burning money to snatch a leading market share and become a monopoly. Once they dominate the market, they would raise the price, and everybody would suffer. But you cannot neijuan and simply pile up money to develop new technology.
I think the government is encouraging companies to develop technologies and offer differentiated products. This will also encourage healthy businesses for us to deploy capital and help develop the economy. In the education space, for example, companies that provide all-around education like sports, drawing, and music training still exist.
How much are regulatory risks influencing PE-VC investors’ decision-making these days?
I think big-sized funds, which used to like the cash-burning sectors, will become very cautious of the so-called platform economy, and shift focus to those that really have technology components and those that can help promote people’s wellbeing and the efficiency of the economy. I think the government is sending a message that there should be a balance between undertaking social responsibility and earning money.
What do you think is the most “neijuan” sector in China these days?
Semiconductor. Many outliers are investing tons of money in the industry just because the government is supporting it and Shanghai’s Nasdaq-style STAR Market enables exits from such investments – even though they don’t understand chips. These GPs may be under some sort of transformation to find new profit generators. In some cases, although the products and talent are not ready yet, investors still give a multiplied increase in valuation,splashing money to chase opportunities in a sector that they think they understand.
It is, in fact, an R&D-heavy industry that requires many years of cumulation of industry know-how. We can’t be like a hot head and follow startups touted as the “Nvidia or Intel of China” when their BPs (business proposals) are exactly the same. Venture investments are not storytelling.
That’s why I said that GPs need to really understand China in order to make sound investments. Instead of blindly following regulatory directions, investors need to evaluate factors like the entry barrier, valuation level, and time for exits to identify a sound investment.
Are you staying away from semiconductor investments? ZWC last year invested in Beijing ESWIN Technology Group, which provides artificial intelligence of things (AIoT) chips and services. What did you see in this company?
It is not to say that we cannot invest in the whole sector, but we need to be very selective. For ESWIN, the first thing about this company is that it is a manufacturing company that produces 12-inch wafers, not like a fancy chip firm [that develops everything from the ground up]. China has a manufacturing edge. Secondly, the development of mega chips is the trend, in which we have seen existing players with market caps of about 50-60 billion yuan ($7.9 billion-$9.4 billion). There is a proven business model. Thirdly, they have talents who previously worked with companies including Samsung Electronics and the founder of ESWIN [Wang Dongsheng] previously served as the chairman of BOE Technology Group, a Chinese display panel supplier that has a market cap of about 200 billion yuan ($31.4 billion). And their first funding round was already completed. We think the hit rate is much higher compared to investing in other semiconductor startups.
Let’s zoom out a bit. What is your investment strategy for the overall hard tech sector? Which hard tech segments do you see more upside potential these days?
There are a few sectors with strong momentum. The first is the EV value chain, where a lot of features need to be added to EVs to differentiate them from traditional cars. These features include EV control systems, new materials, suspension systems, and EV batteries, which are yet to become lighter and more enduring. Many solutions and products in the EV value chain are still in the phase of early adoption. With China’s talent, battery technologies, and supply chain, this sector will be very promising in the long run, and I firmly believe that China will be the centre of EV manufacturing, exporting EVs to the US and Europe.
The development of new-generation batteries, which are not only for applications in EVs but also for their usage across other areas, combines China’s core competencies of technology and manufacturing. These companies will be very welcomed in the A-share and Hong Kong markets, and there is no need for them to go public in the US.
Another sector is carbon neutrality. A lot of industries, such as steel and cement, need to consider it as a critical lifeline. It is increasingly important for them to find solutions to make their manufacturing process de-carbonised or carbon-zero. The sector will see more domestic solutions for domestic companies because the way that China approaches carbon neutrality could be different from that of other countries.
These sectors are in line with our investment thesis of “technology plus industry.” They are the key components of our RMB investments.
In the hard tech space, we focus on companies with differentiated products and relatively good margins, and those that can complete an IPO in around three to five years. Our evaluation criteria include an edge in TMT technologies, a strong distribution line, and a well-functioning supply chain. For example, our investee companies Narwal and Ecovacs Robotics are both providers of consumer-facing smart home appliances with strong supply chain capabilities and self-developed technologies.
This trend will also happen to corporate-facing companies on the industrial and manufacturing side, where ZWC has an edge because of our industry expertise and LPs’ industry resources. We’re able to tap into this trend a little bit earlier than anybody else and make it a focus of our RMB fund
How is your RMB investment strategy different from the US dollar strategy? Given the rising uncertainties of Chinese IPOs in the US, are you adjusting your exit strategies? How do you strike a balance between RMB and USD deployment this year?
Whether we invest with an RMB fund or a USD fund depends on the exit plan, the management team’s preference, the duration before exits, and the investment size. We mainly use our USD funds to invest in the “industry plus software/Software as a Service (SaaS)” space, such as our investment in social CRM startup Weshine, because these companies typically look for an overseas listing. Our RMB funds mostly invest in the “industry plus hardware/manufacturing” space, including manufacturing automation, robotics, and OEMs.
Our USD funds are larger than RMB funds, so we will invest with US dollars if it is a big-ticket deal. The cheque size of our USD funds is $15-25 million.
Does ZWC have any plans of investing in Web 3.0 and metaverse startups?
I think for most domestic GPs, Web 3.0 is still a western concept better accepted in the US. China’s and many Asian countries’ social mentalities are not there yet. Our Singapore team is learning, but we will take a wait-and-see approach for the right time to come.
How is ZWC positioned for SE Asian investments? Do you see more competitive valuations in SE Asian startups than their Chinese counterparts?
SE Asia is still in the early adoption of mobile Internet. It is a rising industry supported by the young generations in the market. We will leverage our industry know-how and China expertise to handpick companies that could grow bigger. Not many companies can grow as big as Sea Ltd and Tokopedia. Luckily, we have invested in Tokopedia at its very early stage.
Our fund mandate is to invest the majority of the capital raised in China. For SE Asia, we will probably complete one or two deals this year with a total investment size of $10-15 million. Mobile Internet is still one of the key sectors that we’re looking at. Another trend is that we’re seeing a lot of Chinese talents moving to SE Asia to found startups across the fields of Web 3.0, mobile Internet, and SaaS. We’re also searching for companies with a business model similar to Shein, which leverages China’s supply chain to export products globally.