AVCJ Awards 2021: Fundraising of the Year - Venture Capital: 5Y Capital

5Y Capital’s latest fundraise was not only significant in terms of size – USD 700m was collected for a venture fund and USD 1bn for an accompanying growth-stage vehicle – it also coincided with a rebranding. The name Morningside Venture Capital is no longer a feature of China’s technology, media, and telecom (TMT) space.

“Rebranding is a precious opportunity to stimulate curiosity about us in the market and to communicate with others; it’s also a precious opportunity for us to reflect internally on what 5Y Capital is, the value we provide, and our differentiated methodology,” explained Richard Liu, a founding partner of 5Y.

That said, most LPs in the new fund are existing investors that were present in the previous vintage – the firm raised USD 1bn for its previous set of venture and growth funds in 2018 – and in several preceding vintages. They were familiar with the team and with a strategy that has changed little in years.

The rebranding included a new slogan: You who are crazy in the eyes of others are beginning to be believed. This is essentially a message to entrepreneurs as 5Y looks to back visionary start-ups that bring paradigm change.

“Such change might be very unclear and non-consensus in the early stages. It may begin to make sense only several years later. But once embraced by the mass-market, it leads to huge innovation and makes a significant impact on society,” Liu added.

Pivotal transitions

The first paradigm change the 5Y team bet on was mobile internet. It was the first institutional investor in Xiaomi, a mobile phone manufacturer that built a smart devices ecosystem, and an early backer of short video platform Kuaishou. Both companies went on to list in Hong Kong, with 5Y said to have generated an 886x return on Xiaomi.

The focus then shifted to artificial intelligence (AI) and robotics – 5Y began tracking AI-enabled trends in 2014 – and from there to autonomous driving and smart cars.

"The most important conclusion we reached in 2014-2015 was that the next paradigm shift in AI would be robotics, with smart cars as the first killer application,” said Liu. “The biggest difference between robots and mobile phones or PCs is that robots have the ability to perceive and make intelligent decisions.”

5Y’s three key early investments were in electric vehicle (EV) manufacturer Xpeng, automotive AI computing platform Horizon Robotics, and autonomous driving technology player Pony.ai.

There were several reasons for the emphasis on smart cars. First, 5Y recognised that autonomous driving would require intense computing power because of the need to comply with passenger safety standards. Second, the relatively high unit price of cars would translate into demand for expensive microchips and a lot of sensors. Third, progress would stimulate automation in other industries.

“We expected large car delivery volumes to create a scale effect, bringing down the cost of relevant chips and devices. This would help build a comprehensive supply chain,” Liu said. “Consequently, a cleaning robot – for example – would enjoy the spill-over effect of the technology and supply chain that developed around smart cars.”

Meanwhile, AI is behind a similar paradigm change in biotech, facilitating the adoption of new drug discovery methods. Four years ago, 5Y incorporated ITBT – IT plus biotech – as a key strategy. It is underpinned by the integration of computer science and life science: the use of algorithms to predict the structures of proteins based on DNA or RNA sequencing and accelerate macromolecular drug development.

Nevertheless, 5Y continues to define itself as a generalist. The firm started out pursuing a single strategy – consumer internet or model innovation – and then moved into hard technology, such as cloud computing, AI, and semiconductors, and life sciences, but evolution has been natural and logical.

"We don’t easily or recklessly expand our investment field. For example, our entry into life sciences came from the accumulation of knowledge in AI and cloud computing over a long period. We are constantly expanding our cognition boundary and learning ability. We are, to some extent, a knowledge management institution,” Liu explained.

Later and larger

The firm also broke new ground with the latest fundraise by introducing a separate growth fund. Previously, sidecar vehicles were employed to re-up in later-stage rounds for portfolio companies and avoid excessive dilution. Now, 5Y can do this and explore new growth-stage opportunities. The LP bases for the venture and growth funds are identical.

The new investment strategy is run by a separate team that is expected to rely more heavily on quantitative analysis tools than in the early-stage space. Modelling is easier when target companies have greater balance sheet transparency and the future drivers of business growth and operating costs are better understood.

Growth-stage activity in China has surged in recent years, with USD 172bn deployed between 2018 and 2021, a 56% increase on the four years before that. However, momentum ground to halt midway through 2021 – investment fell from USD 15.1bn in the second quarter to USD 8.5bn in the third – as regulatory uncertainty descended on the technology sector, especially consumer-facing companies.

Valuations corrected across public markets, almost regardless of impact to specific business models, and this filtered through to private markets. But Liu is relaxed about immediate turbulence, regarding valuation cycles as a common and recurring phenomenon across early-stage and growth-stage investments, as well as in the secondary market.

“The value of a good portfolio may grow 5-10x over the course of five years, and we have found this long-term growth rides out most short-term volatility,” he said.

“When the market is high, the best way to manage valuation risk is to stick to or even raise your investment standard and select only the best companies. When the market drops substantially, don’t lose your nerve and cash out; there might be great opportunities to screen and observe which are the best quality companies and entrepreneurs.”

Mutual reinforcement

Moreover, 5Y claims a differentiated investment rhythm. For example, Liu disputes the notion that the potential of model innovation has expired and hard technology will deliver the best returns. Consumer internet remains central to 5Y’s strategy and the firm is tracking opportunities involving local brands, new consumer retail, and immersive interaction.

Model innovation and technological innovation are inseparable; indeed they are mutually complementary and mutually reinforcing, Liu stressed. “China has entered a new era where model innovation alone is not enough. Technology must be lockstep with model innovation – when the model moves forward, so does the technology.”

This is perhaps best characterised by the sheer scale of China’s internet industry. Many local companies have more than 500 million users, which means they must deploy cloud computing and cloud-native infrastructure on a level beyond the comprehension of most foreign competitors.

The theme resonates in the mission statement behind 5Y’s new slogan: to support ideas that are not yet widely understood. And in embracing the new, the firm benefits from the decisions of old – a network of portfolio companies and entrepreneurs that includes board representation at Xpeng and Xiaomi, now global leaders in mobile and automotive.

“A lot of intelligent products will emerge in these two industries, and they will integrate a lot of technology,” Liu added. “We have grown up with these industries, so we can bring resources to start-ups and be part of that development.”

Pictured: Richard Liu speaking by video at the AVCJ Awards

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Fundraising
• Venture
• Technology
• China
• 5Y capital
• AVCJ Awards