Fresh, higher-quality deal opportunities sprout during funding drought

FUNDING in South-east Asia declined sharply in the second half of 2022 from the first half, dropping 48 per cent from US$6.8 billion to US$3.6 billion, Cento Ventures has reported.

This funding winter has only continued into the first half of this year.

Neo Wei Sheng, partner at venture capital (VC) firm Qualgro, said: “This same sentiment is going to be around for at least a year, and comes from the main sources of capital – the US, Europe and Japan, where the tap has been tightened.”

As a result, companies have dropped their valuations in order to attract more investors, which is a trend that Cento Ventures has seized on, said Dmitry Levit, partner at the VC firm.

“We are leading two rounds with companies that are about three to four times the size of our usual investment target in terms of revenue,” he said.

Other investors are also finding deal opportunities in markets they would have previously overlooked; markets like Vietnam and the Philippines, for example, are getting a closer look, said Neo.

“I’m having my team spend more time in Vietnam, because I see that the quality of founders and business models are what I would back,” he said.

In South-east Asia’s biggest market, Indonesia, tales of layoffs and closures have hit the headlines as funding has dried up. Adrian Li, partner at VC firm AC Ventures, said this reality is not necessarily a bad thing, because the exuberant 2021-to-mid-2022 period had pushed survival rates among companies in the ecosystem to a higher-than-historical norm.

Neo agreed, and described the current situation as a positive one, and a reset to normalcy. Back when capital was chasing startups, founders were able to keep the lights on – even if their business model was questionable.

But a tough funding environment sifts out founders who might not be fully committed to their venture. It also weeds out VCs that may not have been that serious about the region, but were handing out funding at almost every opportunity they had.

The current funding winter has thrown up better-quality startups and founders in the region.

“In this fundraising environment, if you are a founder looking to raise, you are by design committed, because how crazy are you if you still want to raise in this environment?” said Qualgro’s Neo.

Early-stage startups are still fanning deal activity; recent reports point to investors’ interest in this segment rather than growth- or late-stage startups. AC Ventures’ Li said the company is seeing quality deal flow in these tough times, with startups set up in 2021.

For Indonesia-focused AC Ventures, such startups are either Indonesian or have gained traction in the country. Li noted that these businesses, which set up in 2021, have founders with a different set of expectations; they aim to build in a lean, capital-efficient way.

He said: “Oftentimes, (these founders) didn’t even fund-raise for these companies. They bootstrapped or took some angel or friends-and-family money, and worked hard on product market fit and the unit economics of their business to prove there was a sustainable business.”

The tales of funding rounds closing at lightning speed are over. Cento’s Levit said those anecdotes were a bad signal of how funding was being approached in the past.

Now, more information is being made available than used to be the case, and founders are now better prepared for funding rounds. Anecdotally, deals are moving faster because of the amount of information provided, said Levit. People are no longer satisfied with very little information, and are asking for the kind of metrics any investor would want.

Questions are being asked now, ranging from revenue to costs, from cash flow to unit economics and supplier concentration – questions that used to raise eyebrows or cause consternation.

Just because “somebody made exceptions in the last three years” doesn’t mean VCs are now sitting up and paying attention. Levit quipped: “Does it mean that suddenly, VCs have started scrutinising more? They’ve just stopped scrutinising less.”

In the tougher environment that is likely to continue over the next six months, the market will shake out and test both founders and business models. Later-stage startups will likely be separated into two distinct camps: those that can change their current course by cutting cash burn, and those that cannot.

Li said: “There are probably some companies in the market that have received a bridge round, but if they are unable to properly course-correct by one bridge round, they will probably have to shut down or seek a strategic sale by next year.”