Editorial: Risks of bringing a knife to the fundraising gun fight

There are a couple of interesting reactions to Japan-based internet conglomerate Softbank raising nearly $100bn for its Vision Fund, or the billions put out by Tencent or Naspers and others.

Some look at the peers trying to raise larger war chests based on the competition posed by the Vision Fund and call it an “inane idea that raising more money increases your chance of success,” as described by data provider CB Insights.

While Softbank’s vision in trying to take potentially longer-term bets on the impact of disruptive technology is ambitious it is influential.

As Recode noted in a hetorical question: ‘what happens if I decline and SoftBank funds my rival instead?’

Recode quoted Dara Khosrowshahi, CEO of ride hailing platform Uber, who said at Goldman Sachs’s tech conference last month: “Rather than having their capital cannon facing me, I’d rather have their capital cannon behind me, all right?”

The quote came weeks after Softbank chose to invest more than $7bn in Uber rather than its chief rival in the US, Lyft.

Naspers has just recycled close to $10bn by selling a small fraction of its shares in China-based internet group Tencent after a near 20-year hold and plans to use the money to fund other deals.

Fortune’s Term Sheet reported Sequoia Capital is raising as much as $12bn between its global growth fund and other VC and growth funds in the US and China. It added: “In today’s world, even a really well-funded startup company will have trouble competing when it is up against a “super-have” company backed by a mega fund.”

So what impact does a wall of funding have on Uber, Lyft, WeWork or the host of others raising not just hundreds of millions of dollars but billions in venture funding?

Traditionally, equity, whether public or private, has been used to fund a company’s growth before it reaches profitability, with investors being repaid through dividends or stock buybacks.

US-listed Tesla Motor’s net loss has widened from nearly $83m in the 2008 fiscal year to almost $2bn in the fiscal year of 2017, according to Statista, while Uber narrowed its Q4 2017 loss to $1.1bn, down from $1.46bn in the previous quarter, according to Reuters.

Alternatively, look at Meituan-Dianping, a China-based local services platform backed by corporates such as Xiaomi, Fosun and Tencent, which has entered discussions about an initial public offering in Hong Kong as soon as this year.

The company is exploring a valuation of at least $60bn, twice that at which it last raised equity funding, in a $4bn round led by Tencent in October 2017. Meituan-Dianping processed $57bn in transactions in 2017 between some 320 million consumers and four million merchants, and has received about $9.9bn in funding to date.

All those companies are valued at more than $50bn, so the heavy funding has paid off in terms of impacting consumers and investors, at least for now, which is hardly “inane”.  

The second group deny it has any impact on the innovation capital ecosystem and would prefer these investments to be viewed in a different category to everyone else. This is understandable but potentially short-sighted.

Ahead of our #GCVSymposium in May, I had a request from a keynote for audience thoughts on Softbank and Tencent: Firstly, does the peer group consider them to be CVCs that they aspire to emulate and could it ever be practical in their respective organisations? Secondly, do investments from the two have any reflection on core parent company strategy? Thirdly, does the peer group value news about these two in the same digest as other CVC news?

This reflects the challenge of both aspiring to Softbank or Tencent’s undoubted successes in backing entrepreneurs and their use of proceeds to reinvest in the next set of winners with even more money, and how to emulate them if they do want to.

Most listed companies have however preferred paying out to shareholders through dividends and share buybacks. For the 12-month period ending in March 2017, shareholder return totalled $909.6bn in the Standard & Poor’s 500 index, down 6.7% from the record $975bn for the 12-month period ending in March 2016.

Amazon, whose market capitalisation is about double that of Walmart’s, has been a poster child for a strategy of long-term reinvestment that keeps net profits low but net operating cashflow high to reinvest in development.

Similarly, Tencent said at the GCV Asia Congress in September its net income was primarily being used for investments.

It is clear that large investments can drive market development and value creation, and the groups committing most fully to future innovation sources rather than paying back existing shareholders are among those whose market caps have improved most in the current economic cycle as customer growth continues to rise.

SoftBank’s willingness to deploy its capital across different sectors and geographies may well see it creating a number of global market-leading businesses, as data provider Pitchbook noted about its investment in secondhand car market operator Auto1 in January this year.

It is a pitch that chimes with the times. Erik Vermeulen, professor of law at Tilburg University, spoke at the 12th Annual Development Finance Institution Corporate Governance Conference, hosted by the EBRD in London this week, saying: “We had a lively and very interesting discussion on ‘corporate governance in a digital age’.

“During the presentation and discussion, three corporate governance principles were identified, namely flat hierarchy (the trend towards more decentralised organisations), the inclusion of a variety of stakeholders, and storytelling (or open communication)…. Capital efficiency and financial metrics are, of course, still important indicators, but they need to be supported by a narrative that focuses on sustainability and innovation.”

Siemens talks about the 400-fold decline in costs of 3D printing in recent years, while the importance of intangibles is reshaping the economy. Tangible investment has declined from roughly 14% of private-sector gross value added (GVA) to less than 10%, while intangible investment has done almost exactly the reverse, rising from 10% to 14%, according to professors Stephen Cecchetti and Kim Schoenholtz last month.

Ultimately, those unwilling or unable to compete at the top end of creating market-leading companies risking effectively bringing a knife to a gun fight. They can win sometimes, in some areas, but the chances might be against them.