Until two-three years ago, venture capital investors invested in tech startups almost extravagantly and mindlessly, and many without proper due diligence. They kept on pouring capital even into startups with no good product-market fit, no clear path to profitability, no scalable product, or no differentiation — probably for fear of missing out (FOMO).
But that era of cheap money is over, at least for now. Consequently, fundraising has become challenging, with VCs becoming more cautious and LPs more vigilant. A funding winter, as it is called, has set in, adversely affecting startups, mainly the consumer-oriented ones (which burn more money than their B2B counterparts).
Funding Winter refers to a period of market correction in capital inflow which lowers the probability of startups getting higher valuations in short to mid-term. The winter is due to an accumulation of many negative forces — macro (years of quantitative easing, investment speculation, etc., despite substantial fundamental challenges) and micro (weakness and implosions of various companies across the tech industry worldwide).
The winter has hit developed markets in the West the most, with late-stage companies and unsustainable startups the hardest. This has forced young companies to be prudent, cut costs, slash jobs, and lower their valuations, and many are staring at a bleak future. In Southeast Asia, many renowned unicorns, including GoTo Group, Sea Group, and Carousell, cut their workforce to save cash and survive.
Undoubtedly, the road ahead looks rocky as a prolonged winter spell is anticipated.
The moot question is:
How long will the winter last?
“Current macro parameters point to a sluggish economy in 2023, which will likely continue into the first half of 2024,” says Dave Ng, General Partner, Altara Ventures.
Tin Men Capital Founder Murli Ravi concurs. He believes there remains a lot of uncertainty in the macro-economy, resulting in increased capital cost and volatility in public equities, bonds and almost every other asset class. “I don’t expect the uncertainty to go away in the short term. Even today, VC is a small fraction of the asset universe and is subject to the same overall trends.”
While the world faced many global recessions and macroeconomic headwinds in the past, high inflation sets the current slowdown apart from them. And if inflation remains high, interest rates will also remain high; hence the era of cheap money is over.
“It might be difficult to predict when ‘funding winter’ will end, and we foresee it to continue through the year,” predicts Jefrey Joe, Co-Founder and Partner at Alpha JWC Ventures. “Market growth has slowed globally and is likely to remain so in 2023 due to factors such as inflation, rising interest rates, and geopolitical uncertainties.”
Unlike during the global financial crisis of 2008 or the COVID-19 pandemic, governments worldwide are not expected to act as a saviour this time. “Hence, the downturn may last longer, especially in terms of risk appetite for business models with no clear path to profitability,” says Helen Wong, Managing Partner of AC Ventures.
Dusan Stojanovic, Founder of True Global Ventures (TGV) and Ascend Vietnam Ventures (AVV) General Partner Eddie Thai also anticipate the winter will last long.
However, not everyone agrees. 1982 Ventures Managing Partner Herston Elton Powers believes global VC funding will rebound sharply over the next few months with increased competition to back the best founders and deals. He, however, admits that the “era of easy money” is over.
What is a way out?
According to AVV’s Thai, emerging from winter requires the accumulation of negative forces to be flushed out. Unfortunately, that usually takes more than just a few months.
“I guess that there are still some dominos to fall. In any case, the recession in Europe, possible recession in the US (Wall Street consensus forecast: 65% likelihood), and slow China recovery mean 2023 will be a tough year for the global economy. Beyond that, it will take several months of recovery in the public markets plus several specific big positive news — successful tech IPOs, big acquisitions or late-stage fundings, etc. — for winter to thaw into spring.”
Studies show that the Western markets are being hit the hardest across global tech ecosystems, which is starting to spill over to other regions, including Southeast Asia. While the overall global recovery may take longer, recovery in Southeast Asia (Singapore) and the Middle East (Dubai) will occur earlier, experts feel.
Of these, Southeast Asia remains a bright spot due to its favourable demographics, supply chains shifting to the region, and continued digitalisation. “Hence, SEA could get a larger slice of a shrinking pie of funds allocated to venture capital,” AC Ventures’s Wong observes.
According to Alpha JWC’s Joe, emerging technologies and developing innovative business models can help jumpstart investment activity in the region. With all relevant parties and stakeholders taking proactive steps to stimulate economies, it could positively impact and increase investor confidence.
In addition, SEA — particularly Indonesia — still has a lot of growth potential in digital penetration, making this region very attractive, Joe adds.
Also Read: Of COVID-19 and funding winter: Why these 2 VC firms are bullish about SEA amid back-to-back crises
“While our primary market Southeast Asia is one with a highly competitive startup ecosystem, we are confident that there are still plenty of opportunities to invest. For example, with its enormous digital economy potential, Indonesia has kept increasing for the past years, encouraging our VCs to make more intended deals with potential founders and sectors. We also see Indonesia at a value creation discovery stage for the year, where VCs will carefully observe the economic conditions from the valuation, liquidity market, and cost of capital from their last evaluation cycle before deciding anything,” Joe elaborates.
Elton Powers bets big on strong early-stage companies in SEA, which are still in high demand. For example, 1982 Ventures’s portfolio companies, such as Fundiin and PasarMikro, managed to close oversubscribed rounds at higher valuations over the past six months. “While 2021 was a bit of an anomaly in terms of total global VC funding, SEA’s fintech funding in 2022 continued to outperform and was on track to match or beat the record inflows of 2021. There is still a lot of capital sitting on the sidelines. We expect investors to be pickier and focus on sustainable companies while avoiding unproven and buzzy trends.”
What does the winter mean for VCs?
According to Pitchbook, VCs hold nearly US$600 billion in meaningful dry powder globally. But with the uncertainty in the market, VCs should deploy with caution and look for business models with strong unit economics. It is also time for VCs to focus on managing their portfolio companies to ensure they are resilient and can emerge stronger after the downturn.
“We see globally a flight to quality where institutional investors are back to making rational decisions and valuing businesses on real profits rather than GMV or revenues,” says Andy Hwang, General Partner at Wavemaker Partners. “In SEA, valuations in overhyped sectors and geographies come back to more reasonable levels.”
Corporate governance and strong financial oversight should be top of mind for VCs. A founder-centric environment characterised the past cycle as money was chasing founders. “Hopefully, we will transition to one that encompasses the interests of all stakeholders,” says AC Ventures’s Wong.
Some VCs commonly look for the following aspects as forms of validation before investing in a company: vision, market, product, and the ‘X-factor’, which are significant advantages the team have. This is not limited to having a strategic backer but also includes other factors, such as the founder’s unique expertise to the team’s industry experience, solid historical traction to various monetisation channels and proprietary networks to innovative business approaches. “So, while 2023 may seem tougher compared to previous years, this doesn’t mean there is zero opportunity for both VCs and startups to collaborate and grow,” comments Joe.
VCs should go back to basics, says Peng T. Ong, Co-Founder and Managing Partner of Monk’s Hill Ventures. This includes following the First Principles, i.e., if the valuation is reasonable, if real opportunities exist to build a big business, and if the entrepreneurs are strong.
Ong, however, says the downturn is, in a way, good for the tech ecosystem. “Historically, if you look at VC investments in the last 20-30 years, you see some of the best times to invest as a VC is during the recession because everything is cheaper. It’s cheaper to build products, and it is cheaper to go to market. If you build a more efficient product and attack the market better, the market will be more likely to choose you because you are cheaper. After all, people are cost-sensitive. As we all know, Google came up in the middle of the dotcom bubble, and Facebook came up in the middle of the Great Financial Crisis because they were much more efficient ways to do.”
How does the winter affect the launch of new funds?
The fundraising environment is more challenging than in 2021 or H1 2022. Limited Partners (LPs) are more hesitant, given the recent market selloff.
However, as work travel is back and LPs seek to diversify outside of China and look at new fast-growing regions such as SEA, new funds with solid and unique value propositions will still be able to raise, according to pundits.
“Despite the slowdown, we still see new funds being successfully launched, particularly those with robust performance with previous funds and started by seasoned startup operators or investors,” says Wavemaker’s Hwang.
Also Read: Funding winter: VCs ask startups to focus on corporate funds from developed countries
While LPs from the West are more affected by the slowdown, their counterparts in the Middle East are not negatively affected by the downturn, which also bodes well for Southeast Asian VCs.
Stojanovic opines that VCs can get LPs if they prove they can invest in cash-flow-positive companies. Many high-growth tech companies can turn around to be cash flow positive with slightly lower growth in 12 months if they keep the same staffing/halt recruiting. “Once that happens, LPs will see that there are companies that are cash flow positive and that they can get funding in around 12 months.”
For instance, Indonesia-based AC Ventures completed the first close of its US$250-million fund in August 2022 in the middle of the winter and claimed it continues to see strong interest from LPs. Ascend Vietnam also hopes to close two 7-figure investments this month.
However, Dave Ng of Altara looks at things from a different angle: “Different LPs would have different mandates and, therefore, different preferences. For instance, institutional LPs tend to be less cyclical as they deploy across a very long horizon. They look for track record and performance and would continue to invest in funds that have established partnerships with them. While for family offices and high net-worth individuals, the variation could be more diverse due to different risk appetites and allocation strategies. Some may slow down because of the ongoing headwinds, while some may double down instead! (because prices of assets are coming down in a downturn.”
The exit landscape during the winter
According to industry watchers, exits at the very large end of the spectrum (for example, IPO) are expected to be slower than in the past two years. Some expect M&As, especially at the small and mid-cap, to pick up due to opportunities now to consolidate and expand inorganically for those acquirers with strong balance sheets to do so.
“There are also selective opportunities for the merger of peers to gain a greater footprint and critical mass. However, this usually depends on the post-merger teams successfully executing such merger strategy and working together after that. Statistically, not many mergers are successful,” says Altara’s Ng.
Stojanovic agrees, saying most exit opportunities would be linked to consolidation, especially in tech, as opposed to IPOs for the first six months. Many companies may delay IPO to focus on value creation while awaiting more favourable valuations.
Meanwhile, M&As will probably be the major form of exit for smaller companies as larger companies with strong balance sheets will continue to acquire for growth at decent valuations. However, as the economic conditions improve in H2 2023, companies may take advantage of the positive market conditions and strong investor interest in new offerings to go public.
“The number of IPOs in Singapore and globally will decrease significantly compared to 2022. However, Singapore’s economy has been recovering relatively well, and the market is not in free fall anymore. It’s possible that the memories of past crashes during market uncertainty will continue to make companies and investors cautious in the short term. This may lead to a decrease in IPO numbers or the overall performance of IPOs in Singapore in 2023. ,” Stojanovic observes.
He also feels that a robust tech stock exchange ecosystem is missing in the region and, surprisingly, in Singapore. With the influx of capital coming in from Hong Kong and mainland China, it could be an opportunity for the regional stock exchanges (particularly the Singapore Stock Exchange) to create a strong ecosystem for tech IPO.
“We still think that the largest tech companies will still choose to IPO on Nasdaq in the US, especially those who have Indonesia as a market, which still has the potential to create new unicorns in SEA,” adds Stojanovic.
Helen Wong of AC Ventures says as tech IPOs have generally underperformed recently, it will be more challenging for startups to attempt an exit through a public listing. Hence, the M&A market will likely become more viable for exits.
“Some of our portfolio companies have been acquired by corporates in the traditional sector/tech companies looking to expand their topline. It is a good time for those companies with deep pockets to acquire companies at more reasonable valuations and get ready for growth when the economic upswing comes,” remarks Wong.
The years 2021 to 2022 have been landmark years for the Indonesia tech scene with the IPOs of Bukalapak, Gojek, and Blibli. The market also saw the successful de-SPACs of Grab and PropertyGuru in the greater Southeast Asia market.
Also Read: Funding winter? Indonesia marches on … and why it will survive the gloom
“While these stocks have generally performed poorly post-lockup — similar to other tech stocks worldwide, we should acknowledge that there are no impediments now to tech listings for yet-to-be profitable tech companies. Looking forward, the H2 2023 should look better, as there are about 1,000 unicorns globally, and the best ones are likely to test the IPO waters then. Also, some of these unicorns have gone through down rounds,” says Wong
“Hence, their IPO valuation should be closer to their public comparables now. Public market investors would find it easier to digest such IPOs, especially if such companies demonstrate both profitability and growth potential,” Wong maintains.
Conclusion
While no one is sure about how long the recession and funding winter will last, it is almost certain the era of easy and cheap money is behind us. Startups with no clear path to profitability will find it increasingly hard to survive. Unicorns will be forced to raise venture capital at a lower valuation. And until this crisis is over, many more startups, and even big tech companies, will continue to shed people.
The immediate future is bleak for the global startup ecosystem.
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