posted on 20 Mar 2020
IN THE early 1980s, Chua Joo Hock, an engineer by training, cut his teeth in venture capital - the business of investing private capital in emergent companies, or more romantically, the art of betting on diamonds in the rough. As part of a secondment to venture firm Seavi (South-east Asia Venture Investment), Mr Chua helped with the founding of Venture Manufacturing Services (VMS), an electronics manufacturer, which was then just a "greenfield startup", as he put it. Fast forward over three decades, VMS has flourished into one of Singapore's most successful venture-backed companies. It is now Venture Corp, a S$4 billion behemoth listed on the Singapore Exchange.
Mr Chua himself is still a venture capitalist, but nearly everything else about his job has changed. Industrials are out. The 64-year-old is now immersed in the brave new world of ride-hailing, fintech and Saas (software as a service) - that carry even grander valuations than before.
As a managing partner at Vertex Ventures South-east Asia and India, his investments include US$14 billion super-app Grab, patents database PatSnap and remittance startup Nium.
Venture capitalism in Singapore has evolved dramatically since veterans like Mr Chua first kicked off their careers. For one, the very definition of a "startup" has changed with the advent of the smartphone in the late noughties.
And then, there has been so much more capital flowing in. After the Global Financial Crisis of 2008, low interest rates drove yield-hungry investors to the private markets, and South-east Asia's venture capitalists benefited handsomely.
According to private market intelligence firm Preqin, the region's venture capital market grew from US$200 million in 2010 to a whopping US$10.5 billion in 2018 (thanks to Grab's blockbuster funding round), which has since slightly cooled to US$7 billion last year (see chart below). In line with this, venture capital firms here began to scale up, raising ever-larger funds (see chart on facing page).
"The venture industry in the region has only reached its inflection point, with early funds starting to scale operations and more funds being set up," says Tan Yinglan, managing partner of Insignia Ventures Partners.
More ex-entrepreneurs have also entered the venture capital fray, notes Goh Yiping, a partner at Quest Ventures who was previously co-founder of an e-commerce startup.
But now here comes the Black Swan. After a decade-long bull market, the Covid-19 outbreak has accelerated a macro-economic slowdown in the region. Venture capital firms, which generally invest on a 10-year horizon, are still holding onto record levels of "dry powder" - industry-speak for undeployed capital.
"Venture capital firms in South-east Asia have been built in a low interest rate environment, and venture money has been commoditised. We have yet to see one full cycle. The tone is changing slowly and that's when the whole industry will be tested," says Raditya Pramana, a partner at Indonesian venture firm Venturra Discovery.
"This is really crunch time for many venture capitalists here because they have never experienced a sharp slowdown and possibly recession. Deals, if they happen, will take much longer to close," agrees Mr Chua.
How do South-east Asia's venture capitalists of this era plan to survive and thrive? Only those that focus on building sustainable startups will succeed, says Damian Tan, managing director of Vickers Venture Partners.
"The top companies of today like Apple, Google and Microsoft were venture-backed… This will be the case 10 years into the future. It's better to focus on the tech that has the potential to impact humanity, solving real-world problems, rather than unsustainable models," he says.
Too much dry powder, too little liquidity
The negative sentiment is not unprecedented. In 1990, when Singapore's young venture capital industry hit its first S$1 billion in funds raised, cautious optimism was the mood of the day. Tan Keng Boon, the managing director of venture firm Seavi, lauded the industry's growth, but also "warned that the problem of too much money chasing too few suitable opportunities might arise", The Straits Times reported in May that year.
Seavi was the first independent venture fund set up in Singapore in 1984. Even though the venture capital industry is vastly different from what it used to be, Mr Tan's concern is still being echoed by industry players in today's climate.
It has become more challenging to succeed as a venture capitalist in South-east Asia, "as competition ramps up for deals, particularly at the early stages", says Dennis Wong, an associate at investment firm Koru Partners, which is also active in venture capital. This is particularly because the region has yet to see a wave of "exits" - in the form of an Initial Public Offering (IPO) or trade sale - that will help venture capitalists realise returns.
"Exits are essential as limited partners (the investors of venture funds) will need to see good distributed returns before re-committing to new funds. The main challenge will be for venture capital firms that have recently raised large funds as they will be under pressure to deploy capital." Most venture capital firms in South-east Asia are still sitting on paper returns.
"Many VCs here are waiting for a major listing of a South-east Asian startup to signal that the public market is ready to accept our tech unicorns. We think this will happen in the next couple of years, although it may be slightly delayed given the weak macro-economic conditions," he says.
And with the ecosystem flush with capital, more venture capitalists may in fact find themselves being turned away by good founders, notes Jianggan Li, chief executive of venture builder Momentum Works.
"With more dry powder at hand, the pressure is higher as well… Because of the maturity of the ecosystem, good founders have become pickier. If I can get funding from Sequoia Capital, why would I go to a small, regional venture firm? New funds now need to be much more aggressive in getting good deals, and helping investees grow," he says.
For some players like Jungle Ventures, the trick is to focus on doing less deals, and to offer startups operational support beyond a heap of cash. "We make fewer investments than our peers and only target entrepreneurs with ambitions to build regional or global category-leading businesses. This helps us focus and provide our portfolio companies with hands-on support," says Amit Anand, managing partner of Jungle Ventures.
Mr Chua of Vertex adds that with tougher macro-economic conditions, venture capitalists have to be prepared to endure the pain with their portfolio companies. "If I were to characterise the efforts - 20 per cent is in investing, 80 per cent is in working and building companies after investing... A good venture capitalist is a partner or co-founder to the founders. He talks to and interacts with the company very frequently, helps them with strategic and operational matters, sharing the founder's pain... You must be there to support them, including their families," he says.
Hype or here to stay?
Beyond the accumulation of dry powder in South-east Asia's venture ecosystem, another pertinent challenge for venture capitalists is in being able to analyse new-fangled business models - and to sort the wheat from the chaff.
Since the release of the iPhone in 2007, mobile penetration has exploded in South-east Asia, creating a whole new digital economy worth about US$100 billion, according to a report by Google, Temasek and Bain and Co last year. And this could triple in size by 2025. But the tech revolution has also given rise to a whole new crop of "asset-light" companies that are difficult to value accurately. Venture capitalists can also be negatively incentivised to play up the valuations of their investments, just to flip them for a profit to the public markets. Naturally, venture capitalism has in part come to be associated with over-hyped business models that are unsustainable.
The botched listing of WeWork and heavy cash burn of Uber have added to the scepticism over the industry. As such, South-east Asian valuations are also coming under scrutiny. Mr Chua attributes the lofty valuations to the entry of other private equity giants into the venture space.
"Part of the problem is with the large hedge and buyout funds who were lured to the startup world because of the circular valuation bumps and hype in the last few years, and who try to behave like venture capital firms. This is not in their DNA," he says.
Terence Sim, an investment director at Smile Group, which invests in, builds and partners Internet businesses, concurs. "This is a case of oversupply of capital chasing too few good deals and also the FOMO (fear of missing out) effect," he says.
Hian Goh, founding partner of Gojek backer Openspace Ventures, is more direct. "I would say that there is really just one culprit: SoftBank," he says, when asked about the negative sentiment towards venture capital.
Other venture capitalists BT spoke to said that they are wary of not falling into the trap of weaponising capital. Mr Anand of Jungle Ventures says that his firm looks at fundamentals over hype. "A 'build to last' ethos has been essential to our success... We aim to help build profitable and capital-efficient companies from day one while supporting them with patient long-term capital," he says.
Vinnie Lauria, managing partner of Golden Gate Ventures, also advises his portfolio companies to stay clear of "vanity metrics" like gross merchandise value, and to instead focus on actual net profits.
"I've been in board meetings where startups say that their competitor is spending a certain amount of money to get less than that back, but their topline is growing and other investors like that. They ask if we want them to do that. But for me, I say no. We look at the unit economics," he says. In other words, a "spray-and-pray" approach to venture capitalism will not work.
On a more existential level, venture capitalists have also had to reckon with their sense of purpose - how much social utility does their aggressive strategy produce.
In an essay for the New Yorker, journalist Nathan Heller acknowledges the economic function of venture capitalists. "A thriving society needs moon shots, and, in the absence of a literal space race, only venture capitalists have the mandate to throw cash at an improbable success," he notes.
In South-east Asia, venture capital was crucial to disrupting long-entrenched norms, such as the dominance of the taxi industry and brick-and-mortar F&B players.
But have venture capitalists here been daring enough to bet on true moon shots, beyond the flavour of the month?
Mr Chua of Vertex acknowledges the presence of a "herd mentality", where capital pours into already-hot ventures rather than potential game-changers. But as the coming downturn leads to a "reset in valuations", he believes that the industry will produce stronger businesses.
There is room for more moon-shot bets to be made, agrees Mr Lauria of Golden Gate Ventures. But venture capitalists will also have to be wary of unsustainable businesses disguised as moon shots, such as WeWork, which was dressed up with the promise of revolutionising the workforce.
"For the money that you put in, real innovation has to come out. If you're just subsidising people buying your service, that's not a moon shot. If it's just financial magic, that's not good," he says. At the same time, venture capitalists can also re-examine their role in creating socially responsible companies, by exercising their influence as board members of startups, he adds.
Mr Tan of Insignia concurs that social good has to be front and centre of venture investing. "Venture capitalists certainly win with grand exits, but true success is being able to support enduring companies that are valuable, not just to their investors, but also to their customers and the larger community," he says.
If the venture capital industry tides through the impending downturn, perhaps the next wave of tech giants, in the vein of Venture Corp, could emerge from the ashes.
Source: The Business Times
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