Coronavirus & North Asia VC: Diverging fortunes

One of the most striking aspects of the way COVID-19 impacts smaller countries is how little market maturity and political stability appear to matter. North Asia offers the broader region’s best case in point, with two advanced economies that reflect many of the woes seen in less developed areas while demonstrating few distinct similarities to each other.

VC investment in Korean start-ups totaled $346.4 million across 73 deals in the first quarter of 2020. This compares to about $1.5 billion and 105 transactions in the prior three-month period, when four deals eclipsed the $150 million mark, including a $312 million round for e-commerce platform WeMakePrice in December. Only one investment – medical software provider Lunit – cracked $20 million in the first quarter of 2020.

The decline was less severe from a year-on-year perspective, however, with Korean start-ups pulling in only $477.8 million across 99 deals in the first quarter of 2019. Indeed, there is a sense that the Korean technology ecosystem may be set to emerge from COVID-19 considerably less worse for wear than most markets around Asia.

Much of that outlook is attributed to aggressive virus testing and control measures after Korea became the first country outside of China to record massive spikes in confirmed infections. In a departure from most comparable economies, daily life is already seen as inching closer to normal, with many restaurants and offices open for business. Importantly, this has created a relatively workable environment in terms of investment due diligence.

“My friends in Silicon Valley and other Asian countries are not meeting in person, so it’s impossible for them to invest, but in Korea, we are,” says Aaron Shin, a managing director at Seoul-based Ascendo Ventures. “Large conferences or meetings are still discouraged, but one-on-one meetings are happening. That’s a big difference between Korea and other countries. So, investment activity is slowing down but not as much as in other ecosystems.”

Shin, who was an Asia-focused partner at US-Asia investor Formation Group before helping set up Ascendo in 2018, notes that uncertainty around valuations – rather than practical deal execution challenges – remains the key hurdle locally. His firm, which is mulling the launch of a second fund this year, has begun to implement tougher diligence criteria, including a condition that potential investees must have a strong enough cash position to survive the current malaise for 1-2 years without additional funding.

Culture to enterprise

Runway is naturally a similar concern in Japan, but with added layers of sectoral pain. The drop-off in global tourism, travel, and leisure economy is hitting the start-up ecosystem particularly hard. According to AVCJ Research, PE and VC investment in Japanese travel sank to $7.7 million in the first quarter, down from $581.5 million a year earlier. The number of disclosed deals fell from 18 to three.

The development of cultural industries has been a massive agenda in recent years as the country prepares to host the 2020 Olympic Games, now delayed to next year at the earliest. In VC, the charm offensive is best exemplified by the government’s lifestyle-focused Cool Japan Fund, which has seen an already rickety reputation for financial acuity hit new lows.

“Companies focused on travel traffic from overseas into Japan, including all the Japanese equivalents of Airbnb, are going to be decimated. Travel is probably written off for the next two years,” says one industry professional. “Cool Japan is a government PR mouthpiece and doesn’t invest as a financial investor. I would probably never invest in what they invest.”

Overall, the impact of COVID-19 on Japan’s fledgling VC space has been less dramatic. Investment came to $460.6 million across 110 deals in the first quarter of 2020, compared to $502.5 million in 122 transactions during the preceding three months and $586.9 million across 112 during the first quarter of 2019. For internet start-ups, the relative stability has come with a sense that the crisis is finally delivering a more business-friendly environment. 

In addition to creating opportunities in areas such as streaming content and online gaming, Japan’s coronavirus lockdown is seen as pushing a stubbornly paper-based enterprise space online. The trend has included increased pressure on schools to develop virtual education tools and regulatory changes in healthcare. In recent weeks, the government has reversed rules blocking the establishment of telemedicine businesses after intense lobbying efforts by an overwhelmed hospital industry.

Myriad enterprise digitizations are expected to follow suit as COVID-19 exposes the weaknesses of companies that have not embraced change. This effect is expected to be particularly sharp in Japan. Corporate leaders in the country are said to be 10-20 years older than their counterparts in the US and China, and their younger subordinates appear freshly empowered to make a case for modernization.

“I know that in the middle management layers, there are a lot of people that want change, but they’ve never had the opportunity to force it on senior management. Now suddenly, that’s become acceptable because there is no choice. Do you want sales to be zero or do you want to start doing something online,” says Akio Tanaka, a co-founder at Infinity Ventures. “The culture places huge emphasis on face-to-face meetings to do business, but now, people are forced to do things online. That’s probably going to change the whole landscape.”

Tanaka uses Zoom every day to communicate with portfolio companies, about 25% of which he says are growing faster due to COVID-19. Some of these have received emergency funding, not to stay afloat but to meet rapidly increasing demand for virtual infrastructure. Standouts include streaming service 17 Media and accounting software provider Freee, which received $230 million across nine rounds before raising $320 million in a Tokyo IPO last December.

Like many similar businesses, Freee is a monthly subscription service but most of its clients pay annually to receive a cheaper rate. This is expected to effectively eliminate revenue impact in the short term, but it will not prevent long-term issues if many corporate clients are unable to renew next year due to virus-related economic pressures. The idea of targeting digital winners in a crumbling paper-based business sector will therefore require a more nuanced look at the underlying macro supports.

Macro prognosis

In both Korea and Japan, those supports are said to be in mostly adequate supply, especially in terms of institutional LP contributions. Banks and various government vehicles have kept capital availability high and VC fundraising on track so far this year. A smattering of recent closes appear to bear this out, with Korea’s Company K Partners confirming a raise of around $150 million for its latest vehicle in February and Japanese firms Jafco, Hiroshima Venture Capital, and I-nest Capital all closing funds in the past month.

Meanwhile, Coral Capital, formerly 500 Startups Japan, established a $25 million growth fund to augment its typically seed-stage agenda. The plan is based on the notion that growth-stage capital availability is set to fall away due to a retreat by corporate investors that need to divert resources from venture experimentation into their core businesses.

In Korea, this effect is not expected to be a problem, with Ascendo’s Shin noting that later-stage start-ups will be among the least vulnerable players due to their more established investor relationships and their improved ability to alleviate runway concerns by generating revenue. “Direct investments by large corporations like are not a huge part of later-stage investments in Korea,” he explains. “There might be some impact, but it won’t be very big.”

Japan’s less developed VC space is another story. Some 40% of the members of the Japan Venture Capital Association are the captive corporate managers, which continue to dominate the landmark deals. Japan’s marquee VC investment during the coronavirus outbreak so far was arguably a Series C last week for financial technology provider Paidy led by Itochu Corporation with support from Visa and PayPal. Paidy has now raised $281 million in total, $91 million of which came from Itochu alone.

“We’ve already seen situations where there was a lead investor that was a corporate and everything seemed to be fine, and then all of a sudden, they started renegotiating the terms and investing at a much lower valuation with much less money. We’ve witnessed many stories like that,” says James Riney, CEO of Coral. “It’s unfortunate, but these are, in a way, tourist investors. When times are good, they’re around, but it’s not their main business. So when times get tough, a lot of them are not going to stay.”

The damage of this theme will depend to some extent on the structure of the corporate VCs in question. In Japan, up to 70% of corporate venture funding is said to come from balance sheets, which are more easily collapsible than a formal fund. Notably, Japan Post Bank and Japan Post Insurance, whose VC programs have inspired much confidence in Japan’s growth-stage tech market in recent years, invest primarily with balance sheet capital.

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• Topics
• North Asia
• Venture
• Technology
• Early-stage
• Japan
• South Korea
• TMT
• Coral Capital
• Infinity Group
• covid-19
• coronavirus