Southeast Asia has never been a more exciting place to do a tech startup. Years ago many tech entrepreneurs fretted about the lack of funding, low valuations and lack of VCs.
Today we have more VCs than ever before, more money being raised and bigger valuations than we’ve ever seen in this region. We hear about investment bankers, lawyers or consultants leaving their jobs in Singapore and joining startups in hope that they’ll become millionaires from the stock options. I’m happy that tech is getting the recognition it very much deserves and how we’re beginning to feel like we’re in a mini Silicon Valley but it’s worrying when you realize what’s missing:
1) The number of exits
In order for a sustainable tech ecosystem, our VCs need to make money for their investors. And the only way they can do that is if they have exits. Not just small exits too. It’s not good enough if a VC exits at 2X their investment when the quantum is small because that probably won’t be enough to make up for the other 8 or 9 failed investments. They need BIG exits (and companies like Viki don’t count because they’re not companies that were born out of the ecosystem here. Their investors are mostly from the US. Has anyone heard of Reid Hoffman investing in any other Singapore startups after Viki)?
Tech In Asia compiled a good list of exits SEA has had since 2008. You can count the number of sizeable exits there. We don’t have many and when you take into account the meaningful exits that’s even less. Which brings me to my next point. What is a meaningful exit?
2) VCs need REAL exits. Not paper exits.
A real exit is when an acquirer buys and pays the price in CASH or Listed company stock. The kind of exits we often get are like this:
You sell your company for a small amount of cash and the rest paid in stock from the acquirer’s private company.
We see this all the time. They normally look good in the news too. You see headlines like “Startup A gets acquired by Startup B for $20 million in cash and stock”. The local tech community celebrates that we have yet another successful company out of the ecosystem and we have new tech millionaires but the insiders know better.
The insiders know that $2 million was paid in cash. The rest of it was paid in stock in the acquirer’s private company. The stock in the acquirer’s private company is useless to a VC until they can EXIT in the form of an IPO or a trade sale. It is illiquid. None of that $18 million can be cashed out and put into another promising startup in the ecosystem.
What makes matters worse is that share swaps like that tend to happen on a very inflated valuation because it’s just an agreement between two parties on what both their companies are worth collectively. So now the other players in the industry are going to their VCs and saying “Hey… this competitor of ours got acquired at this valuation that would make it 10X revenue. So that’s my valuation now.”
3) The rise of zombie companies.
I first heard about the term “zombie companies” from this Techcrunch article. It’s a very interesting read.
What the article basically says is (and I quote)
VCs typically raise new funds every 2-4 years. However, it historically takes 5-12 years to exit (liquidate) an investment. To communicate the success of the fund to potential investors when raising money, VCs show that their portfolio companies’ valuations have continued to rise, which is great — if the numbers aren’t artificially inflated.
If a business is doing poorly, the logical move is to stop throwing money at it and shut it down. If a VC firm does this, it’s legally obligated to report it as a loss to limited partners when raising the next round of funds.
But if the VC chooses to keep the company going, the zombie rises.
By keeping the company artificially alive, the VC can tell limited partners that the valuation of the business has stayed constant or is even going up. It certainly doesn’t want to show that the company is doing worse than when the investment was made. Therefore, VCs sometimes go to great lengths to keep valuations artificially high.
This results in zombie companies on VC life support. The company receives injection after injection of capital, even though it’s not hitting its numbers, all because the VC is unwilling to write off the investment.
I’ve seen this happen a lot even in SEA. I know of a startup that raised a round at say a $5 mil valuation. One year later the startup fell apart. Some of its initial founders had given up and left, the startup had cashflow issues and their revenues had dropped from the year before.
One thing they did have though was an acquisition offer. The acquirer wanted to buy them but after their own due diligence was only willing to pay $3 million. Makes sense because the company now was worth less than a year before. It had less money, less revenue and burning even more money.
The VC who invested in them though didn’t want to take the deal because then they would have to report a loss in their portfolio. So what did the VC do? They ploughed in more money into the company at an even higher valuation.
They used good money to chase bad money. It’s a company that should be shut down but VCs incentive schemes like in the Techcrunch article was to keep the startup alive because as long as it was alive, it would still hold that paper value on its portfolio. At the very minimum it would retain its value instead of showing a negative value. In fact in this case because they put in more money at a higher valuation their portfolio value went up. One day I’m sure they’ll report to their investors that their investments have been very successful and their portfolio value is now 6-8 times their initial capital. They feel good and the investors feel good.
When does the party stop?
Eventually VCs will have the close their funds. Whether it’s 5 years, 8 years or more it comes a time when they have to liquidate their investments and return cash to their investors. When that happens they’re going to realize that a number of their portfolio companies can’t be sold at the price they valued it at. Worse… they can’t be sold at all.
When that happens at the end of the fund we’ll see huge write-offs. Investors get burnt and not only is there no profits to put back into other promising startups in the ecosystem but investors just walk away from tech entirely.
So we’re in a bubble? When is it going to burst?
Yes I think we are in a bubble but when it’ll burst is a question I can’t answer. In Silicon Valley, billionaires like Mark Cuban and Chris Sacca have been predicting a tech bubble crash since the beginning of this year.
I think the exact timing is really hard to predict because there are too many variables in place. It depends on when a significant number of VCs have to close their funds (which I understand is still quite a way to go). Many things could happen in between that would prolong the bubble though. The Singapore government could put in more money to fund startups. There could be more investors from overseas chasing the SEA dream putting more money in.
Or who knows… with some luck.. maybe we’ll start seeing some huge exits and some VCs in SEA making BIG money and putting it back into the ecosystem.
Our ecosystem’s cycle for now is not complete. Who knows what the future has in store for us?
Timothy Tiah – Co-Founder of Colony, Kuala Lumpur Co-Working Space