Dalton Venture's Sun Qi: Seven Questions We're Pondering "In the Springtime" | Dalton Insights

Background

On May 9, 2024, Dalton Venture founding managing partner Sun Qi was invited to speak at the "18th ChinaVenture Annual Investment Summit," co-hosted by ChinaVenture and ChinaVenture.com. At the summit, Sun delivered a keynote speech titled "Seven Questions We're Pondering in 'Springtime'", offering a micro-level perspective on Dalton Venture's deep reflections and strategies for adapting to the new landscape facing the venture capital industry.

What Should We Do to Keep Pace with This Era of Change?

Source: ChinaVenture

In today's relatively challenging environment, as financial professionals and as venture capital institutions weathering a winter, what should investors do to keep pace with this era of change? This is a question many investors are paying attention to and urgently seeking answers for.

At the "18th ChinaVenture Annual Investment Summit" co-hosted by ChinaVenture and ChinaVenture.com, Dalton Venture — one of the most active investment institutions in the market — managing partner Sun Qi used the healthcare track as his baseline, sharing his thinking on the above questions through seven questions and seven answers.

Sun stated, "Recently some people have been saying that minority equity investments are ultimately headed for sunset, gradually declining, and that only incubation or control investments will have a place in the future, will be the way out. I don't entirely agree with this view. Putting different types of LPs into a single product is becoming increasingly difficult. Rather than making a large fund that makes them harder and harder to reconcile, it may be better to disperse LPs with different demands into different products. This might solve the problem, but it tests the GP's art of balance and integration."

The following is the full text of Sun Qi's speech, edited and compiled by ChinaVenture:

Dalton was a relatively active investment institution in the market last year, investing in more than 10 new projects, and we're basically maintaining that pace this year. Looking back now, the results are decent.

Today's theme is "Silent but Unceasing" — unceasing is right, but "silent" — nowadays people aren't too willing to talk much. Today I want to share some of my personal thinking on micro-level issues in the current macro environment where everyone is somewhat anxious. I'll try to share substantive points, not empty words.

The international political environment has changed in recent years, and correspondingly all rules and all logic are undergoing profound changes. Over the past two years, the financial industry as a whole has been yielding profits to the real economy, driven by both objective and subjective factors. What people have talked about more in the past two years is financial institutions' staff reductions, salary cuts, and IPO tightening. What we've paid more attention to is that as the main cornerstone of the financial system, banks' net interest margins have been declining year by year, falling below 1.7% in Q4 last year (to 1.69%). The global banking industry recognizes that below 1.7% enters the risk zone, and this is also reflected in domestic banking self-regulatory rules with the "1.8% warning line."

The reasons include insufficient corporate loan demand itself — banks struggle to lend, so they can only lower interest rates to lend to central SOEs and local SOEs — and partly government push for finance and banking to reduce relatively high profit margins, offering preferential rates to sci-tech enterprises and real-economy companies in new quality productive forces. Both factors are at play. What problems does such low net interest margin bring? Possibly below 1.7%, it can't fully cover banks' operating expenses and risk provisions, so banks will have to tighten their belts in the future. If banks, which account for over 90% of financial assets, have to tighten their belts, one can imagine that others in the financial system — insurance, securities, and those doing equity investment in primary markets — probably won't have it too easy either.

Now on one hand, the state is encouraging finance to yield profits to the real economy; on the other hand, it's further forcefully rectifying financial order and standardizing financial industry rules. So since last year, some friends have begun leaving the financial industry, equity investment institutions, and securities firms to go to new quality productive forces fields, even starting their own businesses. Among them are quite some people with considerable resources and capabilities. Precious capital resources and talent are leaving financial institutions and flowing to areas the country needs more.

There is rationality behind this phenomenon — I won't expand on that discussion. What I want to say today is: against this backdrop, as financial professionals and as venture capital institutions in winter, what should we do to keep pace with this era of change.

Given time constraints, I'll share seven questions with everyone here today. Each question, if expanded, would be a major article in itself. For each question I'll probably just share one or two personal views, hoping they may be enlightening.

Q1: Should we expand into new sectors?

In the past two years, peers have been expanding into new sectors to varying degrees, into some hot tracks. Some have even paused biopharma investment. We've considered this question too. Dalton's choice is not to expand sectors — we remain focused on devices, pharmaceuticals, and life sciences.

Three reasons:

1. Cognition, resources, and capabilities all have boundaries. We only do what we understand. We believe the hardest road is the true shortcut.

2. Industries all have their cycles. Even the hottest market will have a cyclical downturn one day — perhaps it's already starting to decline. Rather than chasing fields we're not good at, better to hold fast to the life sciences track.

3. After this Spring Festival, the whole Party and people across the nation began studying new quality productive forces. Fund peers also need to familiarize themselves with this term. Among its three core sectors are semiconductors, life sciences, and AI. Shanghai even specifically launched a "pilot industry fund" for this.

Very fortunately, the biopharma that everyone pays attention to is among the most important core sectors. We see that after this Spring Festival in March, Beijing had its 20 billion RMB medical and health industry investment fund; early last month Shanghai announced its 100 billion RMB pilot industry fund (with 25 billion going to biopharma); and Zhuhai, Guangzhou, Beijing, and Shanghai have successively introduced policies and measures to promote biopharma industry development, and so on. I believe beyond this, more "reinforcements" are on the way. Compared to other industries under the capital winter, biopharma can gain some spillover benefits from industrial policies, making it worth focusing on.

Q2: What uncharted territories in life sciences deserve attention?

After the capital bombardment of the last cycle, after tracks have been repeatedly mined and cultivated — beyond devices and pharmaceuticals, are there other uncharted territories in life sciences worth attention? Actually I've heard quite a few peers discussing this privately, with some even saying they feel there's nothing good to invest in. This is also what Dalton has been thinking about. In recent years we've been talking about focusing on technology + security, investing in what the country needs. So with biotechnology as the underlying logic, does this biotechnology have other application scenarios in different fields, in different industries? Including in the devices field, are there still corners we've overlooked or forgotten?

I'll share three directions we've thought about and positioned in:

1) Seed industry

The 20th Party Congress report has a dedicated section on security, mainly discussing three issues: food security, energy security, and supply chain security. Security is emphasized precisely because it's not secure enough. Beyond supply chain security and the devices field, what's related to life sciences is food security.

Why is food not secure? In recent years, a term people have heard more in news media is "returning forest to farmland." In the past people talked about "returning farmland to forest," but in recent years it's been "returning forest to farmland." This is possibly one of the important tasks that village chiefs and party secretaries at the grassroots rural level are busy with — ensuring farmland isn't used for other purposes, ensuring basic farmland grows staple grains rather than cash crops. As everyone understands, staple grains are often not the most profitable. This work indeed requires grassroots government promotion and implementation.

Why is food insecure? Because available arable land per capita is very limited. With the 180 million mu arable land red line, we can only seek productivity from technology. But precisely our breeding technology is not leading. Take soybeans as an example: our soybean oil yield is 40% lower than the United States and Brazil. Speaking of breeding technology — is this life sciences? People may have questions.

Today's breeding is no longer the "natural selection in the fields" of yesteryear — randomly discovering special traits in nature, like the high yield or saline-alkali resistance we prefer. Today's situation is that we're actually doing molecular breeding in laboratories. Beyond doing whole-genome testing on humans, we've now done whole-genome testing on rice and barley. Humans are diploid; wheat is tetraploid, with four chromosomes. We clearly know what trait each chromosome segment represents. In the laboratory, we combine the traits we need into a new variety for field testing — somewhat like discovering new molecules, new targets, and taking drugs to clinical trials. The final approval and regulatory process is also very similar. Not only are the scientific theories and experimental tools very consistent, but even the final approval and regulation are similar — that one is the agriculture department approving seeds, this one is the CDE approving drugs.

You can understand this as a market one size smaller than biopharma today, but it's highly politically correct, with huge future space.

Under this logic, last year we invested in Biorichland, China's largest CRO company in the seed industry, in both crops and animals. This month there will be quite good financing news to disclose. We invested in瀚辰光翼 (Hanchen Guangyi), Biorichland's largest supplier, based in Chengdu. In January this year, Premier Li Qiang also met with Hanchen Guangyi's founder in Chengdu. It's an equipment and service supplier for seed industry automated testing equipment.

2) Health supplement raw materials, cosmetic raw materials, food raw materials

From drugs to upstream health supplements, upstream cosmetics — from a technical perspective, from a regulatory perspective, it's all dimensionality reduction. The benefit is relatively certain monetization, and R&D certainty is also much greater than drugs. Last year Dalton invested in Ningbo Taiyi, one of China's largest health supplement raw material suppliers, with major customers including Amway and By-Health, with considerable revenue and profit scale already.

3) Critical care devices

Devices are also Dalton's main arena. Going forward, everyone can pay attention to devices treating critical and emergency conditions. Imagine a scene: this place is full of doctors in white coats rushing in and out, few family members coming and going, patients lying quietly in hospital beds with ventilators, covered with various polymer biomaterial catheters and high-precision sensors, connected to extracorporeal cardiopulmonary and other precision devices. This is the ICU — the main battlefield of critical and emergency medicine. If we compare life and death to a door, then ICU doctors, critical care doctors are the "goalkeepers" guarding this door.

From 2019 to January 15, 2023, over the three pandemic years, bed numbers increased from 57,200 to 216,000 — a more than 3-fold increase. According to the National Health Commission's planning, this number will increase substantially further, because we still have a large gap with global averages. Per 100,000 people, China has 15 beds, Germany has 28, and the United States has 22. Whether in per capita bed numbers or in critical care technology and management levels, there are considerable gaps, meaning this track has large room for growth.

Under this logic we're also looking at related projects. Very few investment institutions in the market have separately positioned critical care as a track. Dalton has successively positioned in Shenzhen Hanuo over the past few years — China's first approved ECMO (January last year), and currently the only commercialized, monetized ECMO. We were the first and also the largest institutional investor.

Q3: Should we position in consumer healthcare?

Sometimes our LPs ask me, quite a few healthcare GPs are investing in or say they want to invest in consumer healthcare — why doesn't Dalton? I can only say each has their own choices; we don't follow trends. Because consumer healthcare has its benefits — seemingly close to money, quite popular, especially in the current capital winter. We did a systematic assessment at the end of 2021, and the conclusion was roughly this:

First, we believe product and technology are not the core of consumer healthcare, accounting for 20-30% of weight at most. The determining factors for consumer healthcare project success are brand, channels, and marketing — what our consumer-investing peers are better at, not what a healthcare fund like us is better at.

Second, as a healthcare fund, I slightly understand physical properties (the nature of things) rather than human nature, so we're more suited to invest in B2B rather than B2C. Because B2B talks about physical properties; B2C talks about human nature. We do what we're good at.

But we also indeed see that in today's capital winter, consumer healthcare still has quite some dividends, with relatively certain growth. If we want to share in these dividends, how to invest? We believe going upstream to health supplement raw materials, cosmetic raw materials — judging products from composition to purity to cost-performance ratio, it's basically serious healthcare stuff. Using synthetic biology, molecular breeding, gene editing technology to improve and reduce costs and increase efficiency is still reliable; there's opportunity here.

Q4: Where is the future of VC?

Recently some people have been saying that minority equity investments are ultimately headed for sunset, gradually declining, and that only incubation or control investments will have a place in the future, will be the way out. I don't entirely agree with this view. Of course, embracing industry and serving industry may become increasingly important, especially as resource allocation becomes increasingly administrative today. Simply earning financial returns — this space is getting smaller and smaller. Making more friends with industrial investors, embracing industry in all aspects of fundraising, investing, managing, and exiting — this may make things easier.

Why serve industry? Even if regulatory policies undergo major adjustments in the future, or funding sources change significantly — hard to say, I don't know — but if such changes occur, for industry funds, for investors who deeply serve industry, it may be more favorable.

If doing industry cooperation, one inevitably faces these core issues: how to choose a good partner, because cooperation isn't determined by one person's strategy; how to handle both parties' different demands; building mutual trust through cooperation; reducing divergence through mechanism safeguards; and striving for win-win through interest integration. These are major topics before all institutions wanting to do industry, and unavoidable questions.

Q5: Should we proactively embrace government and serve government as this super-LP?

Recently, especially since this Spring Festival, we've gradually seen some phenomena and realized that government is gradually no longer fully satisfied with deploying guidance funds to invest in GPs, having GPs do minority equity to complete investment attraction and landing, to complete reinvestment requirements. Why? Because reinvestment is difficult, reinvestment is slow — there's always that layer in between, always something slightly off. We've also seen some places where state capital directly forms teams to do direct investment, with considerable force, but in the long term faces market risk and post-hoc accountability issues. And not every place has the capability to build its own efficient, professional investment team independently — except some major cities like Guangzhou and Shanghai.

Thus we see that after this Spring Festival, Beijing first appeared with a 20 billion RMB biopharma government investment fund, co-managed by market-oriented institutions. Such phenomena can be summarized with two characteristics:

First, the vast majority or all of the funds come from a single government LP, or the government has raised most of the money and given it to managers to manage, because the managers basically don't fundraise themselves — they have no fundraising task.

Second, the choices managers face are not purely pursuing financial returns; they must consider government investment attraction and landing, consider industrial guidance and industrial clustering effects. In a market environment where state capital's proportion is increasingly large, government as the super-LP's thinking is still constantly evolving, and the forms and situations of government investment funds will also constantly change.

Whether to proactively embrace it? My answer is certainly simple: Why not? As long as you have this capability, why not? At the end of April, at Dalton CEO Summit's dinner, I told our portfolio companies and entrepreneurs: in the future era, just burying your head in hard work definitely won't work. Everyone needs to learn to integrate resources, dance with the system, and coexist with leadership.

Q6: Fundraising will be harder — what to do?

Given the increasingly severe absence of social capital, despite state capital's enthusiastic participation, I believe everyone here is above-mid-tier GPs, because below-mid-tier has already laid flat with no chance. The real bottleneck in fundraising is how much social capital participation you can obtain. Multiply that number by roughly 2 and that's basically the total fundraising scale of the fund. And different types of LPs' demands are increasingly differentiated. Putting different types of LPs in one product is becoming increasingly difficult. Rather than making a large fund that makes them harder and harder to reconcile, better to disperse LPs with different demands into different products — this may solve the problem, but it tests the GP's art of balance and integration. For the vast majority of market-oriented RMB funds without a "big tree" to rely on, except for a very few super-head institutions with extremely strong fundraising capabilities, if you want to grow your AUM, this is an unavoidable problem.

From a long-term perspective, the LPs that can truly provide long-term capital for venture capital are mainly industry-leading listed companies, industrial capital, and market-oriented insurance companies. This is also where fund leaders need to spend their main time and energy in the future.

Q7: Portfolio companies' subsequent financing is difficult — how to respond?

On this I believe everyone has many answers. I'll just share something slightly different: cross-boundary.

When investing, try to invest in cross-boundary projects. The benefit is that subsequent investors may not be limited to the healthcare circle — the financing opening angle will be relatively large. For example, a few years ago we invested in Zhiting, which has a Class II medical device certificate for hearing aids and can be positioned as a healthcare project. But its investors include industrial capital like Xiaomi from advanced manufacturing, healthcare funds like Dalton, and consumer funds. Recently it also took money from a top internet industrial capital. Because it's relatively cross-boundary, its financing in today's market can still go smoothly in all directions, and it can still raise quite a bit of money.

This is the case when investing; what about after investing? From a post-investment perspective, also need to find ways to push it toward cross-boundary, push application scenarios to diversify, from single healthcare scenarios to expand to health supplements, pets, cosmetics, etc. This is a relatively common approach in recent years. Because biopharma and innovative drug tracks have increasingly precious capital, people often freeze, cut, or pause pipelines that are relatively far from commercialization. But pipelines can be cut — how do you cut R&D teams? R&D teams are a company's core value, its lifeline. If R&D teams aren't cut, then R&D capacity forms redundancy. This redundant R&D capacity needs to find new scenarios close to money. On one hand, it can bring precious cash flow through the main business; on the other hand, it forms new topics, new sexy themes, which also helps with financing.

Final summary of three points:

First, respect common sense.

Sell when high, don't be greedy; buy when low, don't worry too much either.

Second, we need to be grounded investors. Understanding policy, understanding trends, and getting the timing right are more important than ever.

Third, in an era of great change, we need to maintain our ability to iterate and strengthen execution.

That's my sharing. I hope it's enlightening and helpful to everyone.

END

ID: daltonventure

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