Southeast Asia has made good progress in venture capital and private equity funding, as the ecosystem has built itself quite nicely. While the region is still behind mature markets like the US and Europe, the momentum is growing, which is a positive sign. However, the slowdown Southeast Asian economies are experiencing affects the relationship between investors and start-ups.
Jeremy Tan, the co-founder of Singapore-based venture capital fund management company Tin Men Capital, says the abundance of capital that went into investing in start-ups until recent months has dried up.
He adds that a few things are happening in the market simultaneously, explaining that when the tide recedes, it will be evident that companies have relied solely on cheap capital to grow and are now suffering as there is no clear path to profitability.
“Once the funding stops, the lucky ones still get to raise money but at a reduced valuation. Unfortunately, those that eventually run out of cash will come to pass. A lot of VCs (venture capitalists) are asking their portfolio companies to prepare for a long winter,” says Tan.
To circumvent the challenge, Tin Men Capital’s portfolio companies have been encouraged to shift towards profitability because funding will still occur as a fair bit of committed capital sits on the sidelines.
“Research suggests that anything be- tween US$350 billion ($471 billion) and US$500 billion of dry powder needs to be deployed because these funds have a fixed time frame to be deployed. These funds need a home,” says Tan.
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“I think what’s happening now is that companies that demonstrate good growth and positive gross margins are getting funded, and there is a renewed focus on capital efficiency and good business models to be profitable.”
Meeting customer needs
Tin Men Capital invests in companies raising Series A funding, specifically companies with products that have achieved product-market fit. In other words, the product has to meet customers’ needs.
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The firm focuses on investing in enterprise tech companies in the business-to-business (B2B) space as the gross margins are positive — a segment many investors are looking into because of its profitability, especially since capital is scarce.
Tan stresses that fundraising is not — and should not be — the end game for companies, and a start-up’s success should not be tied to whether it achieves unicorn status.
He puts forward this analogy: If Company A is sold or takes the initial public offering (IPO) route for US$500 million and has raised US$50 million through its lifetime, on a blended basis, it is providing 10 times the return. Meanwhile, Company B, which achieved unicorn status, may have raised US$200 million through its lifetime, which means that the blended returns are five times. From a shareholder standpoint, Company A has done better through the lens of returns, even though it is not a unicorn.
“But then again, if we take a step back, this example is still quite flawed because there are many facets to a good company, such as its culture and impact. Even from this narrow example, you can see that being a unicorn is not the be-all and end-all,” says Tan.
“Unicorns are quite rare and hard to find. That’s why we veer away from depending on building a unicorn. Many good companies out there that never achieve unicorn status are efficient with their capital, provide good service, and deserve the same attention.”
Capital is there but standards are high
The demand for returns is greater today because of higher interest rates and a turbulent economic landscape. And because of that, the pace of deployment has come down. Tan says this domino effect will impact everyone in the ecosystem, whether it is a deep tech company with a long gestation period or a software-as-a-service company already in the market.
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The impact varies depending on the stage a company is in. Growth-stage companies are the most impacted as they would have seen a lot of capital inflow and, thus, ramped up valuations. The correction that is happening now is much more pronounced, says Tan.
“Investors are waiting for the dust to settle before doing deals because they don’t know how to price them. If you’re a late-stage investor, you’re also considering whether you can exit the public markets for what you’ve priced to sell.
“For companies with a longer gestation period, like tech companies that carry out a lot of R&D and have less visibility to profitability, they will be impacted too because of the focus on profitability. But different funds might focus exclusively on this type of start-up.”
Tan advises companies to have a sense of mission and to ensure that their product meets customers’ needs before trying to achieve product-market fit. This is to avoid investing too much in the scaling and selling of the product if it is something that people do not want.
“If you sell something people may not want, you’ll burn cash. And usually, if you’re burning cash in the early stage, it indicates that you’re not efficient financially,” he says. “A sense of mission is also important. And from a fundraising standpoint, raise whatever you need and don’t chase valuation. Because if you do that, you will set the bar much higher.”
This article first appeared in The Edge Malaysia
