Since the pandemic, venture capital has witnessed a notable pullback from investors across various stages of investment. In fact, the global venture dollar volume has experienced a year-on-year change of -53%. In particular, late stage investments dropped from around $94.1Bn in Q4 of 2021 to only $39.2Bn in Q1 of 2023. This is posing challenges for both investors and founders alike. We propose that this drastic drop is largely due to a confluence of economic uncertainties and market adjustments. In this article, we will break down the reasons behind the drop into two sections: why VC investors are pulling back in general, and what specifically is happening in the late-stage investments amid this trend.
Written by: Jonathan Ouyang
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Outlook of Emerging Markets
In the post-pandemic world, emerging markets are on an upswing. Economic growth is expected to accelerate as interest rates and inflation rates both fall. Since the pandemic hit, many central banks in these regions have chosen more aggressive monetary policies to tame inflation and stabilise their currencies relative to the dollar.
As a result, most emerging markets, with the exceptions of those with specific issues, have seen inflation returned to normal, and economic growth rising faster relative to developed markets as emerging market central banks have begun to ease monetary policies in 2024. Economic stability at this stage is crucial in the consideration for the region’s future investment landscape.
We also see several additional factors that might make emerging markets an attractive destination to direct investments. Firstly, earnings growth expectations in emerging markets have now exceeded developed markets, projected to be 19% compared to 11% for the US. Secondly, investors are seeking to diversify away from US equities, as well as China and guard against a risk of valuation. This is good news for emerging markets. Given that they’ve performed better than developed markets in annual returns for the past 20 years, it’s not a stretch to think that investors might be attracted to these markets first once the global economic conditions stabilises.
With that being said, let us consider two notable emerging markets, LATAM and Africa, and consider whether their late-stage investments could experience a quick comeback.
LATAM: Even with a harsh funding drop (down 60% in 2023), LATAM has a strong foundation. The region boasts nearly 50 unicorns, with established fintech firms leading the pack. These firms with a proven track record of success are well-positioned to scale and capture larger market shares with the funding environment on the rise. In this sense, local investors, as well as experienced returnees from successful start-ups are the most likely going to be the backbone pushing the region’s venture ecosystem growth.
Africa: While Africa has fewer unicorns, it does pose the potential for a vibrant late-stage scene. Africa has a young and tech-savvy population, which would be the fuel of the region’s emerging sectors such as mobile money and enterprise solutions.
Indeed, the outlook is bright! Many late-stage companies in both LATAM and Africa aim to address fundamental needs (most notably financial inclusion) in their localities. These solutions, in turn, cater to a substantial and growing domestic market, which no doubt offers a predictable and optimistic growth trajectory. Combined with the fact that these VCs are often supported by government initiatives, and that the global funding slowdown might have led to more attractive valuations, especially for late-stage companies, it is very reasonable to suggest that emerging markets such as LATAM and Africa are a strategic move for investors that are seeking a faster comeback.
Is That True With All Emerging Markets?
However, it is important to note two issues regarding investments into emerging markets. The first is that ‘emerging markets’ encompasses a wide variety of economies, and it is difficult to say that each and every one of these would see rapid growth or rapid return on investment. The prime example of this is China.
In particular, China’s current rocky economic recovery, increased regulatory oversight, and strained international relations resulted in an outflow of capital from the world’s second largest economy. As such, we are witnessing a weakening in investor confidence in the prospects of the Chinese economy, especially after the recent Alibaba troubles and the fall of the property market. Although there was a slight increase in confidence after manufacturing improved the economy, it remains uncertain if confidence will reach pre-Covid levels. Subsequently, China’s equity market has halved since 2021, valuations for Chinese equities are nearing record lows, and overall returns have turned negative.
As such, while it is likely true that opportunities in emerging markets are abundant, it is important to consider each market individually before asserting that all emerging markets will experience quicker investment comebacks.
Can Investors Redirect to Emerging Markets?
The second issue is regarding the direction of investments. In this regard, General Partners (GPs) are primarily responsible for deciding where to direct funds on a deal-by-deal basis. When allocating investments, GPs face several constraints, including regulatory requirements, fund-specific mandates, as well as internal policies aimed at diversification and risk management. Therefore, whether emerging markets will experience a faster comeback also depends on how quickly or aggressively investors can shift their allocations towards certain markets or asset classes given their investment constraints.
In conclusion, the attractiveness of late-stage investments in emerging markets such as LATAM and Africa is becoming undeniable. With dynamic growth and resilience, these regions, with late-stage companies that sit on a fertile ground for scaling, are positioned well to experience a quicker comeback compared to developed markets, especially if investors would like to leverage the stabilisation of emerging markets in the post-pandemic environment.
However, even though the position is optimistic, investors should still take care to navigate the landscape characterised by diverse economic conditions. The case study with China is a good lesson of why a nuanced approach must be taken when approaching emerging markets. And lastly, the agility of investments in emerging markets will also depend on the GPs in their ability to adapt investment strategies within their respective investment regulations.
Finally, please do note that much of this article is only speculation by LVCN. Only time will tell whether these markets can indeed capitalise on their promising outlook and deliver the potential they currently hold!
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