Thanks to advanced social media, today everyone has access to an enormous amount of information. In the age of COVID, while staying indoors, it seems people are reading more. When you combine more reading with enormous amount of published material, it results in folks having opinions pretty much about everything, some set in stone. Geopolitics falls right in the middle. The debate where the COVID virus originated and how, we will leave for smarter minds. We can also delve into conspiracy theories but are opting instead to figure out ways to make money. Let’s rather look at the geopolitics in terms of China and the venture capital landscape. In terms of China, I believe the situation is bad and getting worse, perhaps on the verge of a war, hopefully not WWIII. On the other hand, when it comes to venture capital investing, I believe things are not great in Q2 but over a full cycle, the space will probably fare very well.
Why is the situation with China so dire and possibly getting worse? We know the root cause of current global crisis, the COVID-19 virus originated in Wuhan. We do not know with certainty whether the virus is man-made but when it comes to making good investments, that does not change much. Global economies are at a standstill and enormous losses are being sustained. In today’s divided society, there is one thing most agree on. People on the left and on the right, democrats and republicans, folks in the US, Europe and Australia agree on the notion that, in some way, China is to blame for COVID-19. China is now viewed as the international pariah.
Before the current crisis, our relationship with China was not great and trade talks/tariff negotiations did not accomplish much. The Trump administration will continue to blame China and, to appease the base, will look at retribution (expect more sanctions). Democrats also, with Senators Elizabeth Warren and Chuck Schumer leading the charge, have been vocal critics of China. Europeans and Australians have also been vocal in criticizing China, distrusting the information from there and publishing reports about massive Chinese government orchestrated COVID-19 cover-up.
Chinese Communist Party’s (CCP) role with current crisis is not well covered by the media. Communism sucks. I know first-hand how ruthless communism and communist parties are. I grew up under one in Former Yugoslavia. China is not a democracy; there is no First Amendment and everything a person does, says or publishes is closely monitored. Consequences of challenging or disagreeing with the regime could be severe. Yes, consequences could be very severe and oftentimes deadly. It is worth noting that China’s communist party is guided by 3 principles:
- Peace and stability within China – ensures CCP and its members stay in power
- Capital gain or greed – it enables the CCP members to enrich themselves
- Control – domestic and global, as much as possible
Any retribution from the US and the rest of the world threatens one or all of the guiding principles above and expect the CCP to aggressively fight back. For now with COVID-19, the CCP dictatorship is stonewalling, spreading disinformation and intimidating global critics (remember US reporters were expelled from the country). They are also using other tactics to intimidate and silence the critics. Latest example took place in international waters in South China See where the military boats intimidated its neighbors. For more details, check the below link from the Dot Com News:
CCP actions are inviting some kind of retribution. One can only guess at this time, but we expect the Trump administration to impose additional tariffs. Expect CCP to retaliate. Expect this to inflict most damage to Chinese economy but also to negatively impact the US and global economy. Consequently, expect market volatility to spike. The US could consider confiscating or not paying interest on US Treasury bonds held by China. This would be terrible for the markets and is an unlikely scenario. What is more likely to happen? Major lesson of the current crisis is that the US and the west cannot rely on China for critical supplies. In the not so distant future, we expect agreement from both political parties on legislation that will either incentivize moving away from China supply lines or flat out ban US companies from manufacturing there. When western retribution hits the CCP pockets, expect them to fight back with force. We hope the back and forth will not escalate into WWIII. While war is not on the horizon currently, make no mistake we are in the midst of a cold war with CCP, not the Chinese people.
The anticipated legislation creates great opportunities for US startups and for the VC space. Going forward, expect a lot less reliance in China and other unfriendly markets. The lesson of chasing lowest manufacturing cost at any price while ignoring the geopolitical risks turned out to be very expensive. We are still in the midst of the current crisis and the price tag is still unknown. The price tag is going up daily, as most of the country is on lock down. As a result of China, tensions look for opportunities in:
- Supply chain management
- Manufacturing and automation
Post COVID-19 crisis, expect some critical manufacturing will return to the US, either via incentives or force. It is rational to expect supply management will be critical and startups that can reduce cost or increase efficiencies stand to benefit.
As more manufacturing leaves China and comes on-shore, cost reduction and increased productivity should ensure success. Innovation and automation in the space, in order to reduce cost, will be very important and expect startups that focus on innovation and automation to benefit.
In the healthcare category, as we expect the scars of COVID-19 to last for a foreseeable time, companies that come up with vaccines, efficient virus diagnosis, rapid testing, containment, mobilization, efficient prevention, and management, among other things, should perform well.
COVID-19 has impacted the Proptech space in the profound ways and those most flexible to adapt new approaches and technologies are expected tol fare the best. It is logical to expect significant disruption and innovation in the proptech space in the name of cost reduction.
Fintech looks like a very attractive category. The distrust of larger banks continues to grow, especially in light of the issues with the recent PPP disaster. Need for more virtual transaction, global payments, lower cost, enhanced middleware, increased security and more personalized experience provide just some areas of opportunity for fintech innovators/disruptors.
Productivity and enhancements around it to adjust to the new normal of remote work/operations should be critical. Current crisis changed forever how some of the business is being done. All should expect a lot more video conferences in the future and lot less in-person meetings. Other things to expect that probably most of us did not even dream about are virtual sales, virtual on-sites meetings and due diligence sessions and virtual closings. All this is expected to become the new normal and the best innovators stand to benefit handsomely.
When crisis hit, many are quick to conclude the startup space is dead. Past crisis show that is not the case. When compared to previous periods, VC activity and data for 2020q1 was down, but not disastrous by any measure. This is because 2020q1 VC transactions were worked on and negotiated before the COVID-19 state of emergency was announced mid March. 2020q2 activity is probably a totally different story. The rest of the year is anyone’s guess. However, it is important to remember a VC cycle is not a quarter or two but rather around 10 years. Current crisis, just like the Great Recession, it has negatively impacted millions of people. However, it has not stopped innovation and creativity and it has not caused a run on the bank for VC firms. It has forced the discussion around what percentage of the capital to set aside for current portfolio companies (to ensure they weather the COVID storm) and what percentage of the capital to use to pursue new opportunities.
We looked at past crisis periods of the Great Recession of 2008/2009 and the dot.com burst in 2000 to help us analyze the current COVID crisis. It appears the current crisis is more in-line with the 2008/09 Great Recession and totally different from the 2000 dot.com burst. After the 2000 tech bubble crash, many VC funds and investors were decimated and, for years to come, there was no startups coming to the market. On the other hand, the Great Recession of 2008/09 was of much larger economic magnitude than the previous crisis but not that devastating to the VC space. In fact, some great unicorns were started during the 2000/09 crisis period (Uber, Airbnb, Slack etc.). Given large amounts of capital currently in the sidelines coupled with need for innovation/disruption, expect the VC space to do well over the next full cycle, with those closely following the geopolitics and innovations in categories referenced above reaping significant rewards.
Nick Markola CIMA® is an experienced investment professional and venture capital investor. His experiences span some of the largest global banks, startups and family offices. He started and successfully ran investment and financial businesses. Currently he serves as Chief Investment Officer for a family office. Views and opinions expressed are his own.