Dialogue with Northern Light Venture Capital: 2023, the Beginning of a New Cycle

A set of slightly anxious figures was released at the recently concluded J.P. Morgan Conference: over the past year, the total number of IPOs in the U.S. market plummeted from 310 in the same period to just 20, including 11 in the healthcare sector, which raised $700 million, marking a steep decline of 94%.

The negative developments in the global economy have, to some extent, spilled over into China. Coupled with the ravages of the COVID-19 pandemic, nearly every citizen has felt the chill of this winter.

However, hitting rock bottom often signals the release of pent-up growth potential. As Europe’s energy crisis receded and China lifted its domestic pandemic control measures, public confidence was restored, leading many to view 2023 with high expectations as a year of hope.

At the crossroads of a changing era, how can we dissolve past sentiments? How should we navigate new beginnings? VCBeat held discussions with Aurora Venture Capital partners Yu Fang and Song Gaoguang to review 2022 and map out 2023.

Left: Yu Fang Right: Song Gaoguang

Q: How difficult was 2022 in the eyes of investors?

A: Over the past decade, China’s economy had been on a steady upward trajectory. However, in 2022, the confluence of macroeconomic and microeconomic factors caused the economy to plummet abruptly from a peak to a trough. Few investors and startups of our generation have ever encountered challenges of such magnitude.

Growth and recession are both inevitable phases of the economic cycle. 2023 marked the end of the old cycle and the beginning of a new one, with economic recovery gradually unfolding.

Q: Taking Aurora’s expertise in post-investment management as an example, how does investors’ guidance to portfolio companies differ during headwinds?

A: The challenges faced by enterprises are far greater than those faced by investors. After all, investors are the buy-side; they can choose to invest or hold cash and wait on the sidelines, adjusting their expenditure as needed, with the capital remaining securely in their pockets. In contrast, entrepreneurs must keep their companies operational, fulfilling their responsibilities to both employees and customers. Under these circumstances, many entrepreneurs lack the time to analyze, plan, or reposition their businesses; they must keep a firm grip on the steering wheel and continue driving forward. Our role is to sit in the passenger seat, filling in the gaps for enterprises and providing assistance within our capabilities. In short, our advice to enterprises is: secure funding, cut costs, and shed burdens.

Cash is often the best tool for navigating crises. Especially when facing downside risks, ample cash flow can help companies resolve many issues. Companies that secured financing by late 2021 or early 2022 had a relatively easier and less anxious year. Therefore, we guide entrepreneurs to recognize the importance of fundraising, encourage strategic financing, and assist them in securing capital.

“Open Source” is followed by “Cost Control.” In a down market, companies recognize the need to control costs and understand that appropriate layoffs are necessary. However, since employees are hired one by one and business units are built piece by piece, entrepreneurs often find it difficult to let go, leading to hesitation and internal conflict. As outside observers with clear perspective, we partner with companies to calculate costs, develop strategic plans, and even facilitate employee communications when founders struggle to broach the subject. Only by ensuring survival first can there be an opportunity to thrive later.

Finally, there is stress relief. During the industry’s rapid expansion in previous years, we collaborated with entrepreneurs on annual planning and strategic roadmaps. Last year was exceptional; many plans were formulated but could not be implemented. Consequently, we devoted more time to communicating with enterprises. Entrepreneurs shared their challenges, engaged in mutual commiseration to unburden themselves, and then moved forward with renewed lightness. At this juncture, it may be more important for investors to help companies manage psychological expectations and cope with sustained internal and external pressures over the medium to long term, rather than rigidly offering supportive advice or setting ambitious development goals.

Q: How did Aurora Venture Capital select projects in the healthcare sector throughout 2022?

A: In 2022, Aurora Healthcare Capital invested in a number of outstanding companies in the healthcare sector, including Manlang Medical, Xinrui Medical, Migesi, Chaoshiji, and KaiTuo Biology. When the storm hit, some chose to dock and wait it out, but we continued to seek opportunities according to our rigorous strategy—albeit at a slower pace, with longer evaluation periods and a corresponding reduction in the number of investments made.

Amid unknown risks, we are paying greater attention to companies’ future revenue and product scarcity than ever before. In the past, a “small but beautiful” niche was highly attractive when evaluating a sector; now, however, we assess whether companies within it can rapidly capture market share, quickly generate profits, and meet the regulatory requirements for future IPOs. If a company lacks these capabilities, it will struggle to secure additional financing during crises and is likely to fail before achieving self-sustaining cash flow.

Based on these considerations, we place greater emphasis on a company’s comprehensive capabilities and growth potential when screening projects. In the past, the top three players in any given sector had the potential to emerge as winners; nowadays, we typically select only the market leader.

Q: In the wake of the rigorous test posed by the pandemic, will Aurora Venture Capital’s investment strategy undergo any changes?

A: Polarlight Ventures has consistently focused on early-stage projects with strong technological content. While our overall investment strategy will remain unchanged, we will adjust certain areas of focus. For instance, whereas we previously invested heavily in medical device projects, we will now strategically position ourselves in consumer healthcare, innovative medical devices, and upstream raw materials for the device sector. We will also evaluate products that have not yet entered clinical trials but address future clinical needs.

Take the medical device sector as an example. Competition here has always been fierce, with traditional players leaving little room for newcomers. To survive in such an environment, startups must either achieve leadership in core technologies or develop distinctive advantages in materials. Moreover, their products must deliver substantial improvements over traditional ones across multiple dimensions. As investors, we also need to step out of our comfort zones, rapidly acquire new knowledge and insights into unfamiliar industries beyond our areas of expertise, and uncover greater opportunities.

Q: The rapid development over the past few years has accumulated significant risks, which are now being released all at once. Will this cause some high-quality projects to be undervalued due to the impact of the overall environment?

A: After three years of pandemic-induced trials, investors have become more rational and rarely compete for deals by offering high valuations. Meanwhile, with fewer transactions being made, investors have devoted greater effort to project screening, ensuring that valuable opportunities are seldom missed; thus, the notion of “bottom-fishing” is largely inapplicable.

Furthermore, entrepreneurs are always sensitive to valuations; they prefer high valuations and can easily drive them even higher when the market recovers. At such times, we, as existing shareholders, may need to exercise restraint, because from a long-term development perspective, excessively high valuations are detrimental to a company’s sustainable growth and hinder its ability to secure emergency funding during difficult periods.

Q: Will the industry recover in 2023?

A: Our team has also been discussing this issue recently, and everyone shares a similar sentiment that 2023 will undoubtedly be better. With restrictions lifted across various regions, there is a strong collective drive to work harder during this precious period of stability. This provides a sound foundation for development.

Despite challenges in the short to medium term—such as payment pressures on the healthcare side, the withdrawal of overseas capital, and the fading demographic dividend—investment enthusiasm will not rebound to its level from three years ago overnight, and investors will continue to exercise rationality. Nevertheless, we are observing that government-guided funds are becoming increasingly active, which can help mitigate the impact of overseas capital outflows to a certain extent. More importantly, Chinese entrepreneurs are diligent, intelligent, and highly resilient in the face of adversity. These factors give us cause for optimism about the future. The recovery and development of the industry will not happen overnight; it will take time to heal the rifts.

2023 is a transitional year; it is crucial to navigate this pivotal period effectively, as it lays the foundational confidence for the company’s development over the next five to ten years.