Fund focus: Genesis targets China's tech inflection points

Genesis Capital's sweet spot is defined by timing, as well as by industry and size: the Chinese growth-stage investor wants to back technology-enabled companies after their products are proven but before they achieve critical mass. 

The starting point is simple enough, with records made of every company that raises a Series A round. Identifying the select few that possess clear business models, enjoy high barriers to entry, and have strong management – and then figure out when they are poised to reach an inflection point – is much harder, contends Richard Peng, who founded Genesis in 2015 after seven years leading the investment program for domestic technology giant Tencent Holdings.

"Many companies struggle after the A and B rounds as they figure out the right business model or product fit and they may have trouble raising money at the Series C stage. You need to spend a lot of time observing them," he says. "It requires tremendous experience and effort to identify companies that are about to take off. Most businesses are not that popular when we make our investment, but they go on to reach an inflection point."

Peng cites Miss Fresh as an example. Genesis backed the online grocer in 2017 following a two-year period during which the company had not prospered. The number of names on the investor register at the time – approximately 20 – was indicative of the challenges Miss Fresh faced in previous funding rounds, he claims. The company secured $450 million in funding last year, with Tencent Holdings, Goldman Sachs, Jeneration Capital, and Davis Selected Advisers taking the lead.

Thirteen companies are represented in the firm's debut US-dollar denominated fund. All of those that received financial backing from Genesis before 2018 have since raised a follow-on round, while the others don't yet need additional capital. The average mark-up in valuation between rounds is 2-3x, with "no single superstar, it's across the board," Peng attests. Seven of the 13 have achieved unicorn status.

Optimal size

As a growth rather than VC investor, Genesis likes relatively concentrated portfolios, with only 10-15 investments per fund. Its optimal bite size is $50-60 million. Fund I, however, was raised at a time when the firm had little to show for itself apart from the pedigree of its founders, Peng and Kurt Xu, who spent 13 years with Tencent, primarily in project management and strategy roles. They raised $450 million, which meant that checks for some deals were in the $10-15 million range. Two renminbi funds of undisclosed size followed.

Having recently closed a second US dollar vehicle at the hard cap of $850 million, Genesis has taken a step up in size, but into the space it was originally intended to occupy – and no higher. The $50-60 million might be spread across two rounds if allocations are small, but once the upper limit is reached, there's no re-up. Rather, LPs are invited to join subsequent rounds. This happened with logistics platform Full Truck Alliance Group and education provider Zhangmen, among others.

The sector remit is unchanged. Genesis focuses on consumer and enterprise services, looking for opportunities where information technology can reshape, upgrade or disrupt traditional industries. Tapping into a need among companies to improve operational efficiency in the face of rising labor costs and intensifying competition was a theme of Fund I, and Peng expects it to remain prevalent during the Fund II investment period. Another key trend is geographic expansion within China.

"IT is really expanding into lower-tier cities and changing people's lives," he adds. "We've seen it with e-commerce – most community-based e-commerce platforms, including Etao, one of our portfolio companies, are focused on tier-three and tier-four cities – and with distribution."

The firm is currently tracking around 10,000 companies. Of these, 800 met basic investment criteria and were marked for further inspection last year, due diligence was conducted on about 25, and four deals were completed. The 10 investment professionals are involved in every transaction and diligence always includes interviews with 30-50 employees of a target company.

The drop off in activity that came on the back of China's economic slowdown, ongoing trade tensions with the US, and the decline public markets in 2018 has not deterred Genesis. Indeed, the valuation inflation of recent years now appears to be correcting, with some once popular start-ups forced to modify their expectations or even consent to down rounds.

"We are seeing many companies not able to raise money or struggling to raise money. The fundraising cycle is lengthening, and valuations have certainly come down," says Peng. "A lot of the hot money has left, and this creates more opportunities for groups like us who know the industry and are committed to the market."

Engineering exits

Genesis sees exits within a five to seven-year timeframe as reasonable and realistic for growth-stage companies, whether through IPO or trade sale. There has been one realization so far from Fund I, following NASDAQ-listed dating app Momo's acquisition of industry peer Tantan last year. Investors in the latter, including Genesis, received $600 million in cash plus Momo stock.

Genesis claims to have played a key role in bringing about the trade sale, leveraging its founders' experience in M&A from their Tencent days. A few months earlier, the firm helped engineer a merger between Huochebang – one of its investees – and Yunmanman to form Full Truck Alliance. Last year, SoftBank's Vision Fund led a funding round for the company of $1.9 billion, more than the aggregate raised by Huochebang and Yunmanman as independent entities.

"If you end up with two or three dominant players doing similar things then mergers are always a possibility," Peng explains. "We haven't seen any further opportunities – most of our portfolio companies are the strongest player in their respective markets. But these companies could acquire smaller players in the same or in parallel segments. We are working with one group on that right now."   

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• Topics
• Greater China
• Fundraising
• Technology
• Growth
• GPs
• China
• Genesis Capital