In this, part two of a four-part series, we’ll explore how SEA’s SME sector is primed for ETA to take place. Over US$1 trillion in family business assets will transfer in the coming years, yet the second generation increasingly chooses other careers over inheriting traditional enterprises.
These deals are also typically too small for private equity players and banks to support. Search funds uniquely solve both problems at once, providing transition capital to the region’s most vital yet overlooked economic engine, right as the first post-independence generation reaches retirement.
If you missed part 1, please find it here.
The SME powerhouse: The engine of ASEAN economies
The economic landscape of Southeast Asia is overwhelmingly defined by the scale and significance of its SMEs. SMEs are not merely a part of the region’s economy; they are its primary engine. There are 70 million SMEs across SEA, compared to approximately 14 thousand funded startups.
SMEs constitute over 97 per cent of all business establishments, hire 85 per cent of the workforce, and contribute to over 40 per cent of SEA’s GDP, highlighting their foundational role in the economic structure of every SEA state. In a mature hub like Singapore, SMEs employ over 70 per cent of the workforce, underscoring their critical importance even in the most developed economies.
This economic backbone is dynamic and evolving. Spurred by the COVID-19 pandemic, SMEs across the region have accelerated their adoption of digital technologies, embracing e-commerce, productivity and fintech solutions at an unprecedented rate. This digital transformation is supported by increasingly sophisticated government policies aimed at enhancing SME competitiveness through improved access to finance, technology, and entrepreneurial education.
This confluence of factors creates a fertile ground for the ETA model: a vast landscape of fundamentally important businesses that are simultaneously becoming more resilient, more digitally savvy, and more open to the strategic and operational improvements that a new generation of leadership can provide.
A looming crisis, a golden opportunity: The great generational handover
However, beneath the surface of SEA’s vibrant SME sector, a profound demographic and cultural shift is creating both a looming succession crisis and a golden opportunity for the ETA model. The region is on the cusp of one of the largest intergenerational wealth transfers in its history, with estimates suggesting that over US$1 trillion in family business assets will transition to the next generation in Asia in the coming years.
Also Read: The new succession: Charting the rise of Entrepreneurship Through Acquisition (ETA) in SEA – Part 1
However, this transition is far from guaranteed. Historically, the odds of a successful handover are long; studies show that only 30 per cent of family businesses survive to the second generation, with a mere 12 per cent making it to the third. In SEA, this statistical challenge is compounded by a widening cultural and aspirational gap between generations.
Many of the region’s SMEs were built by first-generation founders who are now nearing retirement age. These entrepreneurs often came from humble beginnings often lacking better alternatives and forged their businesses through immense hardship, instilling a set of values and expectations that may not resonate with their successors.
The next generation, often raised in relative affluence and educated at reputable universities at home or abroad, frequently want different career aspirations. They may be drawn to exciting careers in technology, finance, or consulting, or they may wish to start their own ventures rather than take over a traditional family business.
Some also wish to pursue alternative careers in music or academia. This generational disconnect creates a growing pool of “orphan businesses”: profitable, stable, and respected companies but no clear successor to carry them forward, following the path of other aging societies like Japan and Hong Kong.
Not just only a succession: Challenges faced by SMEs in SEA
The challenges facing SMEs in this region extend far beyond succession planning. Through extensive research with various stakeholders conducted by GenCap, we’ve identified several critical issues threatening the viability of these businesses.
- Lagging digitalisation: While COVID-19 accelerated technology adoption globally, SMEs in this region continue to lag significantly behind. Limited digital literacy, constrained financial resources, and inadequate infrastructure have left them at a considerable disadvantage, not only against larger, more technologically sophisticated corporations, but also compared to their Western counterparts.
- Rising operating costs: Unlike larger players who can leverage economies of scale or negotiate favorable supplier terms, SMEs face an impossible dilemma. They must either pass cost increases to customers and risk losing competitiveness, or absorb the losses and jeopardise their survival.
- Talent acquisition challenges: SMEs are fighting a losing battle for talent against multinational corporations and well-funded startups that offer superior compensation, comprehensive benefits, and clear career trajectories. This challenge is often compounded by the companies’ reluctance to invest adequately in employee development and competitive compensation packages.
- Limited international expansion: Complex export procedures, insufficient market knowledge, and difficulty meeting international standards restrict SMEs’ ability to compete globally. The absence of established networks and strategic partnerships further constrains their access to more lucrative international opportunities.
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The real challenge isn’t simply succession; it’s about transforming these businesses through renewed leadership, professionalised management teams, stronger governance frameworks, and strategic technology adoption that can help offset rising operational costs and unlock sustainable growth.
Taking on new challenges: How search funds fill the market gap
These challenges are made more acute by a persistent gap in the region’s capital markets. While private capital investment in SEA has seen a significant boom, with deal value reaching a high of US$34 billion in 2022, this flood of capital rarely reaches the SME sector.
Private equity with their larger overheads are typically structured to pursue larger transactions while venture capital invests in high-growth, often pre-profitability, technology startups, leaving the vast majority of established, profitable SMEs outside their investment mandate. In almost all the LOIs that GenCap has issued, we are practically the only party issuing these LOIs.
Simultaneously, traditional financing routes remain constrained as banks tend to lend to larger corporate clients which are more profitable. Bank lending growth has been insufficient to meet the needs of the SME sector, with a remarkable 70 per cent of SMEs in Southeast Asia reporting that they rely on personal savings or financial support from family and friends to fund their businesses.
As such, there are hundreds of thousands of healthy, cash-flow-positive businesses that are too small for institutional private equity but too large and complex for most individuals to acquire on their own. Search funds are uniquely and perfectly positioned to fill this capital chasm.
By targeting companies in this underserved segment, typically with enterprise values between US$5 million and US$30 million, search funds bring both professional management talent and structured, patient capital to a vital part of the economy that is critically overlooked by other investors. Most importantly, search funds come with a new CEO with a fresh vision that can unlock their next phase of growth.
The case for ETA in Southeast Asia is compelling in theory. But who’s actually doing it? And more importantly, what does success look like? In Part three, we’ll move from “why” to “how”, examining the early movers who are proving the model works in Southeast Asia, with the different search fund operators already on the ground, the investors backing them, and the specific types of deals they’re pursuing.
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