Fund focus: China's Xiang He hits $425m hard cap on Fund II

Three out of the approximately 20 companies backed by Xiang He Capital were established by former employees of Baidu. Two are among the most valuable: online education platforms VIPKid and Zuoyebang have already achieved unicorn status. More deals are expected to follow as teams spin-out from the Chinese technology giant and reform as independent start-ups.

"It's a big part of our deal-sourcing, we work closely with Baidu alumni on opportunities," says Hesong Tang, founding partner of Xiang He, who served as head of strategic investment and M&A at Baidu for five years until 2014. He established Xiang He in 2016 with Maggie Yang, a former corporate development executive with the company. "The Tsinghua University alumni network is another big sourcing asset. I'm a Tsinghua graduate and so are a lot of my team; I also teach there."

Tang's networks and experience are the foundations of an investment business that now has $1 billion under management, following a final close on its second US dollar-denominated fund at the hard cap of $425 million. The target was $350 million. LP support came from existing and new investors from the US, Europe, the Middle East and Asia-Pacific, including global consultants, endowments and foundations, family offices, pension plans, and fund-of-funds.

Xiang He raised around $270 million for its debut fund in 2017 and closed a renminbi-denominated fund of approximately RMB1 billion ($140 million) earlier this year. The firm's investment remit is unchanged: it focuses on internet and technology-enabled companies that are on the cusp of exponential growth. There is evidence of operational traction, but they have yet to reach meaningful scale.

"We really need to understand the value proposition, that is the first consideration," Tang explains. "The business needs to be proven, based on conceptual analysis and operational data like user acquisition costs and retention ratios. Second, we need to be convinced it's a big market, that the ceiling is high. And third, we must be confident that the team can be a winning team."

Post-angel, pre-PE

The thesis is not unlike that of Genesis Capital – founded by Richard Peng, formerly head of investment at Tencent Holdings – which closed its second US dollar fund earlier this year. But they differ in terms of stage of entry. While Genesis targets Series C and D rounds, Xiang He goes earlier, typically participating in the Series B stage; after angel investors have got involved but before private equity money shows up. Extended Series A rounds and Series C rounds are also part of the strategy.

The firm tends to write checks of $15-20 million, with its overall commitment per company rising to $30-40 million once the follow-on rounds are completed. Target returns are set for each investment internally and these dictate the number of follow-on rounds in which Xiang He participates. For example, the firm led delivery start-up Lalamove's $30 million Series B in 2016 and re-upped for the Series C and D rounds. It did not contribute capital to the extended Series D, which closed in February.

Once Xiang He identifies a start-up it wants to back, it seeks to win over founders by telling a different story to other investors. "Our strength is our corporate strategic background – we have a proven track record of driving acquisitions for one of China's largest internet companies," Tang says. "We are able to sit down with our CEOs, conduct business reviews and give them some advice."

Investments fall within three areas: internet and internet-enabled upgrades of traditional businesses; artificial intelligence (AI) and big data; and enterprise services, chiefly software and cloud computing. Fund I was internet-heavy, with only two enterprise investments, big data analytics business Sensors Data and human resources-focused software-as-a-service (SaaS) provider Moka.

Enterprise on the rise

Tang expects the balance to shift somewhat in the new fund, citing a need for companies to find a competitive edge in a more challenging economic environment and the emergence of tech-savvy entrepreneurs. "Enterprises are also more willing to pay for software and cloud computing services. A lot of enterprise services companies now generate over RMB100 million in annual revenue, which is a significant milestone," he adds.

Four investments have been made from Fund II so far – there are likely to be about 15 in total – across e-commerce, online education, and enterprise services and AI. The latter company is Guandata, an intelligent data analysis platform that helps retail customers such as Unilever and AB-InBev predict sales patterns. It was founded by a team that used to work for US business intelligence player MicroStrategy.

Tang observes that China's technology sector has fallen back from the overheated highs of 2017. There is less competition for deals, which means investors are no longer being rushed into decisions and have more time for due diligence. Valuations have also flattened out, although relatively mature market leaders remain the exception to the rule. Tang plays down concerns that some unicorns will struggle to raise capital at their current marks, arguing that the long-term prospects for these businesses are good.

Xiang He has achieved one partial exit from Fund I, following the US IPO of iQiyi last year. Baidu took ownership of the online video platform under Tang's tenure and he continued to back the company on forming Xiang He. However, late-stage funding rounds are likely to be just as significant as the public markets in providing exit opportunities for earlier investors. "Ideally, we would do a partial exit at a late stage for a good valuation to manage the downside risk, but leave more for the IPO," Tang says.

Lazard served financial advisor and placement agent for Xiang He's second fund.

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• Topics
• Greater China
• Technology
• Fundraising
• Venture
• GPs
• China
• Xiang He Capital
• TMT