For the past couple of years, Southeast Asia has been a very attractive region for tech investors. The region’s capital investments have been driven by mega-deals, startups reaching mature funding stages, and a general increase in check sizes for smaller deals, according to Cento Ventures’ “Southeast Asia Tech Investment in 2019” report. In particular, the spike in deals below USD 50 million signals continued healthy investor interest.
One of the main drivers is a strong supply of capital. For instance, Vertex Ventures closed their fourth fund at USD 305 million, while Insignia Venture Partners sealed up their second fund with USD 200 million last year. All in all, it was expected that as long as general economic conditions remain favourable, the uptick in tech investments would persist in 2020. However, the onset of COVID-19 has turned that assumption on its head. Efforts to contain the pandemic have brought economic activity close to a standstill, with far-reaching implications on global financial markets and capital flow.
While public markets are reacting with extreme volatility amid uncertainty about how the crisis will shake out, private markets respond differently to the ongoing turbulence. For VCs, the propensity to look beyond short-term conditions is natural, given that venture capital investments are made with the long haul in mind.
Chua Joo Hock, managing partner of Vertex Ventures, believes that VCs who have maintained a prudent and disciplined investment strategy, as opposed to being “trigger-happy” to chase market hype, will be able to leverage current opportunities to set the foundations for long-term returns.
“From my experience, there is usually a three- to six-month lag effect in VCs and startups awakening to the reality of the general economic downturn. We are now seeing a significant increase in cold calls from startups and intermediaries. However, there will be a slowdown in investment pace,” shared Chua. He candidly added, “Many VCs whom I know are ‘hibernating’ because these once-prolific investors and darlings of the media have now run out of money. It is almost impossible to try to raise a new fund during this period.”
Chua likens the current situation to the dot-com bubble in Silicon Valley in the late 1990s and early 2000s, where the crisis will separate the wheat from the chaff. Unsustainable startups and opportunistic VCs will be wiped off the board, leaving robust companies and investors to remain in play. “I actually think that this is a healthy situation because of overfunding and unrealistic valuation in the last few years,” he said. This makes for a great situation for VC firms who still have plenty of dry powder to invest in companies that survive the Darwinian cull.
Vishal Harnal, partner at 500 Startups, believes that Southeast Asian VCs have approximately USD 3.9 billion (as of March 2020) that is ready to be deployed into the right opportunities. He counterpoints Chua with his observation that there has been an uptick in investment activity and attributes it to investors settling in with the “new normal of COVID-19.” He predicts this rise will continue for the rest of the year alongside an observed trend of smaller startups being consolidated in the market. “In the past few months, a number of our portfolio companies in our Southeast Asia-focused, 500 Durians family of funds have either acquired other companies or are in talks to be acquired themselves. To me, the consolidation was long overdue and the COVID-19 pandemic served as a forcing function,” adds Harnal.
The animal kingdom of startups
The pandemic has exposed systemic weaknesses in the global economy, even pushing a pin through frothy valuations. Could the speedbumps faced by high-profile startups like Oyo and Gojek serve as cautionary tales?
“Too much money, fear of missing out (FOMO), and investors chasing valuation bumps while hoping that they will not be the sucker who holds the ball when the music stops are symptomatic of the startup scene in the last few years,” said Chua. “We have now seen a number of these high-profile, ‘grow big at any cost’ startups in serious trouble. Such a business model is unsustainable and the only way for an investor to make money is to be the first investor and exit through secondary sales before it is too late.”
He provided an anecdote about one of Vertex Ventures’ portfolio companies, Spacemob, which was acquired by WeWork in late 2017. Back then, WeWork carried a much-hyped USD 20 billion valuation. Investors were offered either cash or WeWork shares for the deal. “Vertex was the only investor who took cash returns, while the others proceeded to stake it out as the market was frenzy hot, thinking that the valuation will continue to climb. Well, what happened is now history,” Chua said. He cautioned, “Investors should always heed the saying, ‘don’t be greedy.’ Unfortunately, this is not a discipline that most VCs have.”
COVID-19 has exposed the fault lines within some unicorn startups and offered this truism as a timely reminder: The valuation of a startup does not necessarily reflect its financial health. Instead of unicorns, a different beast has emerged as a favourable alternative: Camels—startups that not only capitalize on opportunities, but also focus on sustainability and are able to trek through a capital drought. But will camels replace unicorns as the new king of the startup jungle? Not necessarily.
“We’ve always invested in a diversified zoology of startups, whether unicorns, camels, or others. These terms are a convenient shorthand for different approaches towards building great companies,” Harnal said. “Unicorns may come under greater scrutiny from investors, and may have to be more prudent with spending during COVID-19, but their strategy towards growth will remain part of the playbook for some types of startups.” He clarified that approaches are often decided based on a number of factors such as the competitive dynamics of the market, experiments with customer acquisition and the philosophy of the founders and investors.
While startups may choose to follow a unicorn type of business model in a post-COVID era, investors will undoubtedly be more cautious. Yinglan Tan, CEO and founding managing partner of Insignia Ventures Partners, pointed out that investors have been signaling their preference for sustainable business models over growth at any cost even before the pandemic.
Tan added, “Before the crisis, the headline scrutiny was mostly on unicorns, given the false illusion of safety that massive war chests often cast. Now, in order to survive, every startup must think about ways not just to conserve cash but also rethink their business model for profitability, as the crisis is expected to draw out for the next two or three years. It is possible to achieve both fast growth and high valuations as well as strike a path to profitability. We saw this with the likes of Zoom, even before its adoption blew through the roof.”
Crisis and opportunity: Two sides of the same coin
Another driver of investment growth last year was the ongoing digitalization of businesses sweeping through sector after sector, multiplying opportunities for new and existing startups. With COVID-19 changing the game of venture capital and entrepreneurship, while winnowing the chaff from companies that are the real deal, what kind of startups are VCs paying attention to now?
Chua of Vertex Ventures stated that there has been no change to their investment strategies. “We choose startups that are solving big pain points with simple solutions, startups that have a path to achieve profitability in the medium term, and a team we believe can execute the plan,” said Chua.
Insignia Ventures are looking at how startups will cater to the evolving internet consumer experience in a pandemic-stricken world, and they expect these changes to run through the whole gamut of sectors. “The crisis can be a defining moment for a tech startup if it survives and thrives, in the same way that past crises made the Alibabas of this world,” Tan said.
Harnal, on the other hand, has been studying the immediate effects as well as the second- and third-order consequences of COVID-19 in the mid to long term. “Our investment strategy is not sector- or company-specific. Rather, we focus on broad themes we believe will shape the world to come, and then look for opportunities across multiple sectors in line with those themes,” he explained. Some of the themes they are exploring include contactless interactions and transactions, hygiene and trust, mental wellbeing and loneliness, the convenience economy, as well as employment and debt.
“Crisis and opportunity are two sides of the same coin—it’s a matter of perspective,” Harnal offered. “We see time as an opportunity and encourage our portfolio companies to see it the same way. There has never been a greater push for the adoption of technology and innovation, and startups are best poised to take advantage if they can be bold and decisive.”
Chua Joo Hock is managing partner of Vertex Ventures Southeast Asia & India. Throughout his career at Vertex, he has been involved in VC investments globally, particularly in the US, Singapore, Taiwan, India, China, and Israel. He spent several years in the US, where he was head of Vertex US investments and operations. His portfolio includes companies such as Grab, M17, and PatSnap. Vertex Ventures Southeast Asia & India has more than 40 investments across the region and focuses on early-stage Series A tech companies in the areas of consumer internet, fintech, and enterprise tech.
Vishal Harnal is general partner of 500 Startups and leads their investments across Southeast Asia through the 500 Durians funds. He has invested in over 100 companies in the region in multiple sectors and is always on the hunt for talented, passionate founders. Harnal is also a Kauffman Fellow and teaches programs on venture capital at leading global universities.
Yinglan Tan is the CEO and founding managing partner at Insignia Ventures Partners. Insignia Ventures Partners is an early-stage technology venture fund focusing on Southeast Asia started in 2017. Prior to this, Tan was a venture partner at Sequoia Capital, where he was the first hire in Southeast Asia. Insignia Ventures Partners is the recipient of two back-to-back “VC Deal of Year” awards for Payfazz (2019) and Carro (2018) from the Singapore Venture Capital and Private Equity Association.