When the wind is strong, fish fetch a premium — Dalton Venture plays a different game as the catcher.

"A market downturn is a good thing for investors who actually know what they're doing. Anyone can solve easy problems; it's the hard ones that separate the capable from the rest."

Source | ChinaVenture

This year has looked tough. Geopolitical turbulence in the foreground, wave after wave of industry crackdowns in the background — the chill has settled over the entire capital market, and VC/PE firms have found themselves forced to reckon with the "down cycle."

Layoffs, travel restrictions, tightened investment committees — these concrete descriptions of the industry's hard times have become a kind of unspoken shorthand in investors' small talk. Plenty of firms in the market simply couldn't endure it and chose to lie flat. Yet deep in the cold night, we've been pleasantly surprised to discover a group of pathfinders walking with conviction and steadiness. Going against the tide — this is their attitude and their practice. The industry is hard, but the answers they've turned in are pretty good.

What did these investors who refused to lie flat do in 2023? The following is drawn from Dalton Venture founding managing partner Sun Qi's remarks and reflections at the firm's 2023 partner meeting:

PART 1

What Has Changed?

01

Capital markets operating at mid-to-low levels

Capital markets will operate at mid-to-low levels for a considerable time to come. In the past, founding teams could usually raise money as long as they had technical strengths or other standout advantages. Now the environment has changed. Hard-tech projects need to co-develop and generate their own cash flow. Good founders increasingly need comprehensive capabilities — not just professional expertise as a foundation, but also the ability to connect and integrate government and other internal and external resources, commercialization skills, fundraising ability, resilience under pressure, and an unbreakable tenacity. Teams that know how to bend are better suited to the market and will go further.

02

Domestic environment accelerating toward internal circulation

This year there's been a phenomenon in investment circles: some funds that previously specialized in innovative drugs have started looking at healthcare services. This actually reflects the fact that there's less money in the market, and people are searching for safety floors, building defensive positions. Beyond capital, other resources have also tightened. Layer on top of that strengthened industry regulation — centralized procurement, anti-corruption campaigns, healthcare system reforms — and the domestic environment is accelerating into an internal circulation model.

Still, the market needn't be overly pessimistic. Under new rules, investor logic will adjust, and entrepreneurial paradigms will shift too. Looking back at history, many major reforms and breakthroughs were forced by predicaments. After spring snow, the thaw is bitter cold — but spring light isn't far.

03

2023: The first year of Chinese healthcare going global

This year marks the inaugural year of Chinese innovative drug companies licensing technology overseas. Overseas technology licensing fees have jumped from tens of millions of dollars to hundreds of millions. Take ADCs: according to incomplete industry statistics, from 2022 through the first half of 2023, among companies globally making ADC plays, Chinese firms accounted for 35 license-out projects, versus 25 from the United States during the same period. Judging purely by numbers, Chinese companies have already moved relatively fast in the global wave of "going global" and commercialization.

The globalization backdrop has opened vast overseas markets for Chinese pharma companies, while the capital winter has accelerated their overseas push. Going global has now become an inevitable choice for companies to diversify market risk and create multiple revenue streams.

04

Rebuilding confidence

Due to unstable factors like shifting geopolitical patterns and cyclical volatility, capital markets were depressed for much of this year — healthcare especially. Given recent warming signs in China-US relations and the basic winding-down of industry crackdowns, both the macroeconomic cycle and the healthcare industry micro-cycle will likely see a recovery next year. The broader environment ahead should improve compared to now.

PART 2

What Adjustments to Make in Response?

01

Closely align with the "technology + security" main thread

In the current environment, capital and resource allocation is constrained. We must proceed from reality and prioritize our limited funds and resources toward areas the country needs. Going forward, investment centered on "technology + security" will become the main theme. What does security mean? The Party's 20th National Congress report has a clear description of "security," which can be summarized as: food security, energy security, supply chain security. If we look further for life science analogues, it could be seed industry technology — because seeds are the chips of grain — or bottlenecked biomaterials and scientific instruments, which fall under supply chain security.

02

Post-investment "security"

At industry troughs, we must pay special attention to guarding against the various disputes and risks that become more prevalent during economic downturns. Here's an example from our circles: a law firm was complaining bitterly last year, with equity business dropping sharply and layoffs looming. This year the situation turned around — M&A restructuring work surged, and litigation business has them swamped. This indirectly reminds us about post-investment management: during economic downturns, focusing on post-investment security, building risk prevention awareness, and holding the "security bottom line" is extremely necessary.

03

Global capability as standard equipment

Beyond investing in projects close to money and commercialization, going global deserves focused attention going forward. For healthcare companies, they currently need new growth points to hedge domestic risk, and going global gives them more options — beyond cutting long-term pipelines to save costs, companies can also choose to increase their cash-generating ability through license-outs to weather the capital winter. On the other hand, as domestic healthcare technology has developed, companies have also reached the right timing for going global.

When investors evaluate innovative drug companies in the future, they should pay more attention to teams with commercial acumen, overseas BD capability, and international vision — global capability may need to become standard equipment.

PART 3

Where Are the New Opportunities?

Staying focused on devices as a priority, staying committed to investing in healthcare innovation technology — this is our unchanging strategy. At the same time, we've consistently followed the main thread of "what the country needs," exploring new investment opportunities along the industry chain. As the world economy, including China's, enters an era oriented by geopolitics, "technology + security" tracks that align with national needs will become the main theme of investment.

Take seed industry technology under "food security." Seeds are the chips of grain. This track's policy dividends are about to open up, industry valuations remain at low levels, and relevant innovative technologies can form dimensional reductions against incumbents in the seed industry — creating new investment opportunities. But as a healthcare investment institution, we must ensure we're investing in "life science," not "consumption upgrade." On this point we've already developed a set of experience and methodology.

The upstream pharmaceutical industry will also see cost-reduction and efficiency-gain opportunities in the stock era. The growth era has ended, but innovative drugs still have stock-era opportunities. Having bid farewell to the past few years of capital's carpet-bombing of the biopharma industry, under current market and capital constraints, we're seeing domestic substitution of upstream pharmaceutical equipment just getting started, while the government is beginning to lead domestic substitution industries in pharmaceuticals. Pharmaceutical consumables are simultaneously at a historic bottom opportunity.

Beyond this, scientific instruments represent a niche market with particularly pronounced bottlenecking. Because it touches on the "supply chain security" theme, capital can also watch for investment opportunities here. Currently import dependence for domestic medical devices remains high, with core components and raw materials still unresolved. Scientific instruments, as one niche market, shows especially acute bottlenecking. Walk into research institutes or healthcare technology companies' labs, and what you see are almost entirely imported brands — Danaher, Thermo Fisher, Zeiss. But because market scale is small, capital has always shown little interest. Objectively speaking, it will be hard for domestic scientific instruments to compete with global giants in the short term, and performance will be hard to match global leaders quickly. But we must have them — otherwise technology upgrades could be constrained by overseas players, just as with chips.

In sum: understand the trends, follow policy, and you can seize new opportunities.

PART 4

When Does the Market Bottom?

In recent years, pushed by capital, biotech companies invested heavily in building factories, pipelines saw repeated investment and excessive involution, and the pharma industry accumulated massive excess capacity that still needs time to digest. By now, the secondary market adjustment in healthcare has basically bottomed, while the primary market — due to economic resilience, prior fundraising reserves, local government subsidies, intervention, and other factors — has not fully adjusted but is already in a relatively safe zone below the waist.

The current market overall is like a compressed spring: apply some external force and it will bounce up. What's missing right now is precisely that external force. Markets actually have their own operating laws. Once the adjustment completes or newer technology emerges, incremental capital waiting on the sidelines will naturally enter. Look at Novo Nordisk — even against today's backdrop of tightening liquidity and tech stock declines, it keeps hitting new highs. This confirms that as long as the product is solid and fits clinical and market needs, capital will chase it in any environment.

PART 5

Understanding Policy, Understanding Trends, Getting the Timing Right Matters More Than Ever

In 2021, we predicted that the dollar would start raising rates and global liquidity would tighten. So that year we did accelerate exits and follow-on rounds — quite a few projects even raised two rounds, putting on thick winter coats before the cold arrived.

Even though biopharma industry sentiment has dropped to freezing this year, I still want to make a bold prediction: a cyclical recovery in healthcare. If we underestimated in 2021 how dollar rate hikes would squeeze tech stock bubbles, today we may be equally underestimating the valuation support that dollar rate cuts — likely beginning within the next year — will provide.

When markets fall, we tend to reach for geopolitical explanations. When they rise, we find other reasons to support that too. Undeniably, geopolitics and industry cycles are at play, but the most important factor remains capital itself. Return to fundamentals, then consider the answer — it may be simpler. Right now, being bearish carries no risk; being bullish carries pressure.

In China today, making contrarian choices, investing in non-consensus — how hard is that? But only non-consensus can generate excess returns.

PART 6

On Lying Flat

My feeling about the market this year is that most institutions haven't actually lain flat. Even if they've slowed in their core business, they've been refining their corporate culture and industry research — quietly cultivating during the hibernation, constantly sharpening their fundamentals. It's not in our nature to lie flat. If we really believe everyone around us has lain flat, we may well look back to find quite a few institutions have emerged from nowhere and made their peers sit up and take notice.

For the future, I want to say: let go of anxiety, maintain a sense of ease. The world is beautiful; striving is beautiful. Learning new knowledge and new things every day, witnessing all things grow, witnessing miracles happen — this is already a beautiful thing in itself.

Worry less about the future; enjoy the present more. Lying flat is one day; striving is one day. I, and Dalton, choose to strive alongside you!

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ID: daltonventure

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