Looming startup failures are giving VCs a reality check

FOR years, venture capitalists could sleep easy, knowing that an influx of easy money was helping to prop up startup valuations. Now, some portfolio companies are unravelling because that money has dried up, and venture capital (VC) firms have to brace themselves for a wave of startup failures.

The industry has begun to see instances of down rounds and startup struggles. The valuation of Thailand’s largest crypto exchange, Bitkub, fell to around US$184 million following an investment from gaming firm Asphere, announced last week. It was a significant haircut from the more than US$1 billion valuation it was assigned in a deal with Siam Commercial Bank, which fell through last year.

Singapore-headquartered Circles.Life, backed by Warburg Pincus, has reportedly been given 180 days to turn the company around, prompting cuts across departments and a management reshuffle.

In an ideal world, businesses with solid fundamentals are backed with valuations that make sense. The reality is not so simple, and in some ways similar to a game of hot potato.

The idea is that you always need someone to pass the potato to. In venture capital terms, that means you’re more likely to invest in a company that you know other bigger investors will eventually fund, especially if it’s at a handsome price.

You’re willing to back the company, even if it means being extra forgiving of the weaknesses in the business – as long as you’re not the last one holding the potato when the music stops, as were the investors who had to write off their investments in bankrupt crypto giant FTX.

And while VCs claim that they avoid business models driven by hype, many are actually drawn to the hype because that’s where exponential growth in valuations happen the most.

All this means that valuations are pushed into ranges that, in an increasingly sour economy, make it challenging to reap acceptable returns for an illiquid investment.

VCs are beginning to feel the effects of the slowdown. South-east Asia headquartered firms raised US$3.72 billion in the first half of this year, less than half the amount raised over the same period in 2022, a DealStreetAsia report showed.

It marked the second consecutive six-month period in which regional VC fundraising fell below pre-pandemic levels, the report said.

It’s prompting a rethink about how VCs back businesses. Cash has become so precious that one startup founder – recounting to The Business Times a recent chat with other founders – said some investors have asked for the return of money that had been raised right before the downturn.

The investors’ reasoning was that since conditions no longer favoured certain business models, the company could be better off abandoning growth instead of going down an uncertain path, the founder said.

Due-diligence processes are taking much longer now than when term sheets were offered within a day during the height of the boom.

The unravelling of Indian company Byju’s, once among the world’s most highly valued edtech startups, is a stark reminder that nothing beats business fundamentals.

After being hit with financial and operational issues, the company’s valuation plunged from US$22 billion last year to US$5.1 billion this year.

Its auditor, Deloitte, recently resigned over the company’s long-delayed financial statements; three board members reportedly severed ties with the company. Byju’s is also laden with debt, and locked in a dispute with its lenders.

As startup cycles go, more businesses in South-east Asia’s ecosystem are likely to collapse in the coming months. Amid worsening economic conditions, investors and founders should know when it is time to call it quits.

When this happens, we are bound to hear the common refrain that 90 per cent of all startups fail. But not every startup failure rests fully on the shoulders of its founders. In many cases, ill-disciplined VCs must share the blame.