“Emerging” Emerging Markets Venture Capital
Timeless Principles
In my last blog post, we built the case for why LPs should seek exposure to nascent digital ecosystems to drive outsized returns within their VC portfolios. One stand-out statistic was that most of the top-quartile performers in the Cambridge Associate VC data set were GPs raising one of their first few funds (otherwise termed "emerging managers").
As opposed to developed markets where investing in emerging managers is an option, in almost all cases, LPs wishing to gain pure exposure to nascent digital ecosystems need to go through emerging VCs. VCs established at the earliest stages of digitalisation tend to be run by groups of diverse individuals with "non-traditional" CVs. This can often make it hard for more institutional LPs to gain comfort investing when the return potential in these markets is highest. Like successful investors before us, Sturgeon is also capturing substantial market share in geographies that have recently developed a minimum viable digital infrastructure. For this article, I researched the journeys of several pioneering emerging markets VCs. These VCs were once considered "emerging" and "deeply contrarian" yet have generated some of the best-returning funds in VC history. Thanks again to Nico Berman (Kaszek - LATAM), Paul Santos (Wavemaker Partners - SEA), Pranav Pai (3one4 Capital - India) and Alex Lazarow (Fluent Ventures - Global) for their input.
In a view to helping LPs understand the market evolution and evaluate the next generation of "emerging" emerging markets VCs, we have identified five general themes that arose from the conversations/research:
Even the most high-profile EM VCs today were initially considered deeply contrarian by institutional LPs
Some of the most enduring VC firms were built when digital ecosystems were in their nascency
The best investors defined opportunity as "actual value less perceived value"
The Partners got their hands dirty to add real strategic value
Resilience and responsiveness to feedback loops were greater success determiners than traditional VC experience
1. Even the most high-profile EM VCs today were initially considered deeply contrarian by institutional LPs.
With the benefit of hindsight, early-stage technology investing in SEA, LATAM, China and India at the nascent stages of their "technology supercycle" seems like a no-brainer. However, at the inception of once-emerging EM VCs, traditional sources of institutional LP capital were largely absent. The earliest LPs went against the prevailing conventional wisdom (a view that can be crudely characterised as "emerging markets are too risky") to generate outsized returns.
In almost all cases, the earliest VC fund LPs were wealthy individuals and industry contacts that deeply believed in the Founding Partners' ability to execute on the opportunity set without reference to traditional VC DD prerequisites such as prior fund performance, big brand exposure or even traditional VC experience.
Despite often being overlooked by larger institutional investors, managers such as SEA-focused Wavemaker (whom Sturgeon has co-invested alongside in Bangladeshi EdTech Shikho and OTA GoZayaan) gained sizeable early fund checks from the likes of David Su (Matrix Partners), who had himself generated significant wealth investing at the earliest stages of China's digitalisation - investing in the likes of Baidu. Wavemaker now has a roster of globally leading LPs such as Pavilion Capital, Temasek Holdings, IFC and Cercano Management (formerly Vulcan Capital).
Nico Berman was a member of the initial Kaszek team that had just spent 13 years building MercadoLibre (ML) - starting in 1999 when internet penetration was less than 3%. ML was a business built during a "nuclear winter of funding", which saw over 130 competitors fail. By 2011 internet penetration in LATAM had reached approximately 40% (roughly in-line with Sturgeon's target markets), and three founding members of ML saw the enormous potential digitalisation offered to build iconic companies and so founded Kaszek - a combination of the last names of the two ML founders Nicolas Szekasy and Hernán Kazah. Kaszek's first fund was raised from industry friends and individuals at large global VCs and corporates. Their funds today are oversubscribed and contain a who's who of international LPs.
All the VCs interviewed did not compromise their strategy or team to gather LP assets. For example, they resisted the temptation to bring in Partners with more institutionally LP-friendly CVs or focus early investments in consensus sectors. Eventually, their track records spoke for themselves, and there were enough early adopter LPs to make their funds successful. Institutional investors tended to join in larger quantities from the third fund onwards.
2. Some of the most enduring VC firms were built when digital ecosystems were in their nascency.
Being present at the nascent stages of a digital ecosystem provides an opportunity to develop a deep moat in securing the best deal flow as the market evolves. As a digital ecosystem develops, second-time founders emerge who will choose to work with those loyal to the market and present from an ecosystem's beginning.
3one4 was founded when the Indian market was characterised by a small group of lower-quality, locally focused VCs. Pranav (Founding Partner) had recently exited a SaaS business in the US called EdCast and saw the enormous emerging digital opportunity set in India. For context, despite being initially perceived as a risky frontier market, India now exports $194bn of IT services a year (higher than Saudi oil exports in 2021). The team deeply understood the local ecosystem (being born and raised in Bangalore) and the experience of building and exiting companies in more developed markets. The Indian VC landscape is now crowded with names such as Sequoia having a major local presence. Despite this, 3one4 has secured access to the best deal flow by embedding itself early into the local ecosystem. This has allowed them to identify and invest in companies such as India's first D2C unicorn Licious and leading HRM platform Darwinbox.
When Kaszek started, most investments were in first-time founders. Now approximately 95% of their investments are in second-time founders. Kaszek's long track record of operating and adding value in LATAM has made them the first-choice ticket for any founder.
VCs with a global focus can certainly earn their place on a cap table, but having a strong local (or local-global) approach represents an edge. Global VCs tend to invest after the first wave of successes, and their exposure to nascent digital ecosystems represents a relatively small portion of the overall fund.
As nascent markets begin to see more technology success stories and the scale of the digital opportunity becomes normalised, individuals that may have stayed for jobs in banks and consultancies in developed markets (where they often attend university) return home and look for backing from experienced, locally entrenched VCs.
3. The best investors defined opportunity as "actual value less perceived value" (Paul, Wavemaker).
The best returns were seen when VCs minimised the latter portion of this equation – i.e., they focused on the details and did not fall prey to unsubstantiated biases. For example, Wavemaker saw value in B2B opportunities such as TradeGecko (inventory management / SaaS) when VCs were only looking for high-profile consumer opportunities.
Like developed markets, emerging markets VC can also become consensus-driven. When this happens, the most successful VCs stick to their principles despite the short-to-medium-term pain and ridicule of shunning momentum sectors which enjoy rapid rises in paper values.
One of Wavemaker's earliest successes was Luxola, an online B2C store for skincare and cosmetics. Many other VCs said no before Wavemaker said yes, largely due to the investor communities' lack of focus on unit economics and operational insights. Further complicating the competitive landscape, a Rocket Internet-backed competitor competed aggressively through discounting. In the face of those focused on growth at all costs, Luxola's founder, Alexis Horowitz-Burdick, focused on the customer experience and profitability. The business was ultimately sold to LVMH. Paul points out that despite the high perceived value, businesses that require huge amounts of funding to succeed are frequently too much of a risk in nascent markets where sources of funding are so uncertain.
The recent downturn has highlighted that in nascent digital ecosystems, high-bravado, momentum-driven businesses tend to struggle. Our markets value a patient approach. Companies building a solid foundation and pursuing sustainable growth are more likely to succeed. Essentially, the Tortoise beats the Hare.
4. The Partners got their hands dirty to add real strategic value.
Mark Twain once said that "history never repeats itself, but it does often rhyme". Across all the markets studied investors went from being perceived by founders as faceless providers of capital to being perceived as invaluable arbiters of knowledge and strategic support. Investor willingness to get their hands dirty and add real value was common among those with the best long-term returns and access to deal flow - in increasingly crowded/competitive markets.
Nico and the founding team at Kaszek had spent over a decade learning through trial and error to build ML, ensure its profitability, and drive the organisation to IPO. The knowledge and resilience gained from this process have defined Kaszek as an organisation and how they select and support their portfolio companies. Kaszek was one of the earliest investors in Brazilian neobank - the largest neobank in the world - Nubank (together with Sequoia). Other unicorns they have backed include MadeiraMadeira, QuintoAndar, Gympass, Loggi, Creditas, and Kavak.
When Paul started Wavemaker SEA in 2012, generally speaking, all investors needed to do was write a check (investor capital was seen as a rare commodity). Today the best "hands-on" early VCs are winning the most competitive deals as founders have become much pickier and more experienced – and capital is available in greater abundance. A similar transition has taken place across every “more developed” emerging markets.
Once all is said and done, VCs must always add significant value. Paraphrasing Nico: "make sure to add value because, in the end, this is all that matters".
5. Resilience and responsiveness to feedback loops were greater success determiners than traditional VC experience.
Early-stage investing in nascent digital ecosystems requires investor resilience. These ecosystems are characterised by a rapidly evolving environment, shallow capital markets and few second-time founders. These are not markets for "hobbyists" or investors partially focused on the opportunity. The best investors saw the enormity of the long-term digital secular trend and remained calm in the face of adversity – they also learned quickly from any mistakes.
Pranav Pai was in his 20s when he was part of the founding team at 3one4 and instantly saw himself competing for limited LP capital with well-known local industry figures in their late-50s reinventing themselves as VCs. Despite these competitors' brand-name credibility, they ultimately could not write code and were unwilling to get their hands dirty to support companies. The team stuck to their core principles and maintained a collaborative culture. They spend as much time on the ground (and in the same room) as possible, working with founders through the ups and downs and iterating to develop a winning investment process (both pre-and post-investment).
Paul Santos was previously an entrepreneur in the Philippines. Despite having built and sold several traditional businesses, he was not from a typical tech background and had no preconceived ideas of "how things should be" – he was also an outsider in Singapore. Eric Manlunas (Founder of Interfoods and SiteStar) saw Paul's potential and was his earliest backer. The rest is history.
The Kaszek leadership team had built ML in some of the most hostile economic conditions possible. Their resilience allowed them to continue believing in companies such as Nubank, which was built while Brazil suffered through the recession, hostility from incumbent banks, and Covid-19.
Conclusions
While researching this blog, it was striking how many similarities could be found in the experiences of VCs targeting geographies on different sides of the world. Ultimately, all these VCs were tapping into the same secular trend of early digitalisation, which, whilst heavily localised, has the same significant return potential across geographies. This has played out time and time again, and we are now seeing this play out in our markets.
As Alex Lazarow writes in his latest blog, “non-consensus alpha” comes from spotting opportunities that are overlooked — often in underserved geographies and populations. In the least developed digital ecosystems, time and time again, it is emerging managers who capture the lion’s share of the upside because even if established funds see the opportunity, they might not be comfortable taking the perceived risk or be confident in their ability to add value. Our job is to ensure Sturgeon is overwhelmingly the best “vehicle” for LPs to capture the opportunity in our markets.
We will be following up with several blog posts unpacking the digital transition playbook and all its participants, but in the meantime, if anyone would like to discuss any of the items discussed in this post, please reach out to the team or me!