Tips for a Successful Cross-border VC Model
Venture capital has traditionally been a local industry. Investors historically avoided foreign markets due to geopolitical risk, legal or administrative red tape, and general lack of knowledge about other economies. However, as VCs from Silicon Valley to São Paulo become savvier and more numerous, there is pressure for investors to differentiate themselves by looking abroad.
What is Driving Cross-border VC Activity
Now more than ever, innovation is happening on a global scale. The world’s largest companies are blossoming out of India, France, Brazil, Colombia, China, and Nigeria, almost at the rate of startup growth in the US. In 2018, 48 per cent of the world’s $245 billion venture capital dollars were invested outside of US borders. According to a survey by Silicon Valley Bank (SVB), a majority of micro VC limited partners and general partners seeking new deals said they expected to make an international investment in 2019. When asked which new regions they are considering investing in that they haven’t yet explored, 23 per cent cited Asia, 18 per cent said Canada and 13 per cent chose Europe.
And while the unprecedented amount of investment is expected to have decreased slightly in 2019, rounds in companies outside of Silicon Valley are getting bigger. For instance, Latin America’s five biggest rounds in 2018 – all topping $100 million – totaled $1.2 billion, more than the entire VC investment in the region for 2017. These ‘supergiant’ rounds, popularized by Japanese investor Softbank, have doubled in number worldwide from 20 per year to over 50.
One of the factors driving this international investment is the opportunity for geographic arbitrage, where companies in foreign markets might be undervalued compared to a similar startup back home. A VC might be able to invest a small ticket in a company abroad for a relatively low valuation, then help that business reach the US or European market and sell at 2-5X the local price. As liquidity is often significantly more available in the US market than in Latin America, Asia, or Africa, VCs can use this opportunity to help a company grow and find a valuable exit in their home market.
Furthermore, geographical arbitrage helps startups and investors access and retain talent at a lower cost than in large hubs like New York, London, or San Francisco. This advantage allows foreign companies to scale faster than local alternatives, as well. “Many tell us they are exploring regions in which they have never invested previously. They are in search of new talent and lower startup operational costs, notably in Asia and Canada,” stated Jim Marshall, Head of SVB’s Emerging Manager Practice.
Additionally, cross-border investments can help VCs distinguish themselves in the market and become specialists in an industry across various markets. For example, a London-based VC might invest exclusively in blockchain startups but have a hand in companies in Brazil, Mexico, Canada, and Japan to stay on top of new innovations across several markets.
Foreign VC investment continues to grow as startup hubs pop up in emerging markets worldwide. Cross-border investment could bring advantages to startups and venture capitalists by growing their international networks and diversifying investment portfolios, respectively. Nonetheless, investing abroad is still far from simple, especially for those who are doing so for the first time.
Challenges of Cross-border Venture Capital Investing
Doing business abroad, whether in venture capital or any other industry, presents unique cultural and legal difficulties. However, as cross-border VC investments are becoming the norm worldwide, international administrative structures have become more streamlined and widely-accepted in the industry. Cultural barriers remain more challenging to overcome.
Even a few years ago, many Silicon Valley VCs would shy away from any company not registered in Delaware; today, a Cayman Islands incorporation has become one of the industry standards that is bringing US venture capitalists out of their home market. Furthermore, VCs based in Asia and Latin America have paved the way for investing across borders by managing investments throughout their geographic regions for the past 5-10 years. The legal structures and investment vehicles needed to conduct these deals are now enshrined as best practices, so VCs looking to start investing abroad need not reinvent the wheel.
Still, regulatory practices in new countries might slow investment. For example, Europe has at least 27 different regulatory areas, so small VCs might struggle to learn how to manage these different regimes if they are investing in multiple countries. Doing taxes in Brazil looks very different from in Chile, or in China or Singapore. It takes a particularly sophisticated and experienced investor - with a good lawyer - to manage these regulations across numerous countries. Given the current geopolitical climate, these regulations may also change suddenly, cutting off the ability to send funds to startups or even killing companies. Governments can be unpredictable, and this unknowable factor creates excess risk in international investments, which can also scare away many venture capitalists.
Another issue that some smaller cross-border VCs might face if they operate under a single global fund is a fight for resources among distributed teams, leading to low collaboration. If one of the markets outperforms the rest, then the teams in smaller markets will have to push hard to get funding for their companies. Often the best way around this issue is to work to connect startups and investors in the fund through partnerships to align incentives, or even pursue greater integration through M&A.
Finally, cultural and language barriers are one of the most intangible challenges for VCs looking to invest abroad. Many cultures are much more averse to risk than the US and have negative relationships with failure, which can be counterproductive for startup development. Negotiation strategy, networking, and even attitudes toward working hours might vary across countries and can cause friction for international investors who are not accustomed to these differences.
Looking Internationally for New Opportunities
Traditionally insular venture capital firms now need to start looking abroad to stand out, diversify their portfolios, and ensure they are receiving the best deal flow. To focus on a single country or market in today’s industry might be seen as myopic to a top startup that will rely on a global strategy to scale. While investing internationally might pose additional risks and challenges, it can also be rewarding both economically and educationally, for VCs in any market.