The Business Times' Column | Due Diligence: Why South-east Asia still holds much promise for startups and venture capital

Gary KHOENG | 21 Aug 2023

This column was first published on The Business Times

By Gary Khoeng

IS SOUTH-EAST Asia biting the dust in the global startup race? South-east Asia’s startup scene, still very nascent, only began to bloom in the last decade. But are we lagging behind, struggling to keep pace with other global tech powerhouses? Now is the moment to critically examine our trajectory and determine if the South-east Asian startup scene needs a stern reality check.

The region’s growth potential is staggering. Forbes predicts that by 2025, South-east Asia’s technology startups could reach an astounding valuation of US$1 trillion by 2025, trebling from US$340 billion in 2020.

Indonesia, the largest e-commerce market in the region, commands nearly half the entire market share. Moreover, Indonesia’s economy is expected to grow by 4.8 per cent in 2023 and trend higher at 5 per cent in 2024, as the commodity boom wanes and domestic demand normalises, the Asian Development Bank forecasts.

However, investment in South-east Asia is experiencing a slowdown, with venture capital (VC) funding plunging by 58.6 per cent in the second quarter of 2023, according to DealStreetAsia. Startups raised only US$2.13 billion, compared to US$5.13 billion in the same quarter of 2022.

Other headwinds include higher interest rates triggered by escalating inflation. Economists have also expressed concerns regarding lower-than-expected growth in South-east Asian economies, signalling a need for careful observation and strategic planning.

Against this backdrop, the presence of VC dry powder, combined with demographic factors favouring South-east Asia, provides a ray of optimism.

What are some of South-east Asia’s unique attributes?

South-east Asia’s relatively young and large population represent a unique advantage. Youth in countries such as Indonesia and the Philippines are adept at embracing and adopting new technologies, creating burgeoning markets for innovative services and products. This trend is exemplified by the rise of social e-commerce apps, in parallel with the exponential growth of virtual content creators.

In Indonesia, the largest country in South-east Asia, the number of Gen Z and millennial individuals is about 145 million, or about 53.8 per cent of the total population. In the next decade, this demographic will enter their prime earning years, making them a crucial driver of global spending. Content creation and “wealth creation” has been on the rise.

Across South-east Asia, more than 325 million people and 15 million businesses use the popular TikTok platform alone.

Which markets or verticals will be especially exciting in the next 5 years?

As the region’s middle class expands as a segment and disposable income rises, demand for consumer tech products will naturally rise in tandem, mirroring patterns already observed in other developed markets. The Gen Z cohort of “digital natives” will play a significant role in driving this demand.

Digital natives aged 18 to 29 in urban areas spend 75 per cent more than the median population and boast one of the highest adoption rates of consumer tech, second only to the “affluent consumers” cohort in South-east Asia, according to Google, Temasek and Bain & Co’s e-Conomy SEA 2022 report.

Moreover, consumption patterns are expected to shift towards online platforms, providing convenient access to consumer tech products for people living in suburban areas, or those living outside of Tier 1 and Tier 2 cities, where currently 41 per cent of the digital population resides.

Interestingly, despite significant online presence, there remains a notable disparity in the penetration rate of consumer tech, such as in e-commerce and travel, in suburban areas compared to urban locations. This indicates a vast untapped market potential and opportunities for growth and expansion.

One area with immense potential is financial inclusion, as nearly 70 per cent of the population is unbanked or underbanked in the region, according to the e-Conomy SEA 2022 report. While attention has focused on retail digital banking services for South-east Asian consumers, there still exists a gap in the infrastructure supporting small to medium-sized enterprises (SMEs). This situation creates fertile ground for innovative solutions.

What are the bright spots in South-east Asia’s tech ecosystem?

Startup ecosystems across markets such as Singapore, Indonesia and Vietnam are fast maturing, and a second wave of startup companies is being built by early employees of unicorns such as Agoda, Grab, Goto and Traveloka.

Total VC investments in the Asean region grew by a factor of 2.6 between 2015 and 2020, outpacing both China and India, according to a Straits Times report. We can expect to see sustained growth of startups across different parts of the region in coming years, even with the respite in VC funding this year.

Climate tech will be an area that many investors will be watching closely. South-east Asia, with strong commitment from nine out of 10 Asean members to achieve net-zero emissions by 2050, holds significant potential for the sector.

Globally, natural climate solutions such as agriculture, forestry, and other land use have the potential to abate seven gigatonnes of CO2 emissions per year. South-east Asian countries, including Indonesia, can play a vital role in achieving these ambitious targets. Indonesia alone is said to be able to abate up to a significant 20 per cent.

What are some challenges and roadblocks ahead?

While capital is still flowing into South-east Asia, the recent massive market correction puts a damper on the region’s venture prospects. The exuberant funding environment we saw in 2021 has led to a mismatch in startups’ valuation and their business fundamentals, leading to rounds of startup valuations “right-sizing” we see today.

Global startups have seen valuations cut by between 50 per cent and 90 per cent in 2022, according to DealStreetAsia, and this is playing out in a similar way in the region. Even when the economic conditions improve, average valuations will not recover to what they were in 2021.

Regional startups still face a talent crunch despite tech layoffs in larger companies releasing talent into the market. Skilled employees are often recruited by traditional companies that can afford to provide more attractive salaries and benefits than startups.

Another key challenge is that the full realisation of potential growth in sectors such as logistics and e-commerce depends on the development of key infrastructure. While governments in the region are actively taking steps to address this challenge, with projects such as the Trans Java and Trans Sumatra Toll Roads in Indonesia, infrastructure takes time.

Angel investing, family offices and venture capital (VC) funds are growing in South-east Asia, but the startup ecosystem in South-east Asia is still relatively nascent. In Indonesia alone, since 2022, more than 70 per cent of the number of deals funded that were reported publicly were at seed to Series A level fundraising, according to Crunchbase.

This is also reflected by the fact that most of the local and regional funds also primarily invest in earlier-stage companies. At the moment, there is somewhat of a gap in growth-stage funding, and startups may encounter difficulties in securing later-stage funding to support their growth plans.

Still, despite the many hurdles, the potential of South-east Asia is significant. With the right mix of innovation, strategic foresight, resilience and dedication, the region can develop into a robust startup economy.

Gary Khoeng is a Partner at Vertex Ventures Southeast Asia & India

We publish monthly on The Business Times Due Diligence column and we invite you to read our previous articles here.

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