Funding Archives

The equity winter is well underway and has impacted tech ecosystems globally. The catalysts behind this funding drought – rising interest rates, economic uncertainty, and a recalibration of valuations – are well-documented. While hopes for an imminent thaw remain, investors and start-ups have adapted to the new reality of longer and more difficult fundraising rounds with many companies choosing instead to cut costs, preserve cash, and raise bridge rounds from insiders until the equity market returns.

How has venture debt fared during this time? Have lenders been able to plug the gap or have they experienced similar trends? How did the collapse of venture lender behemoth Silicon Valley Bank (SVB) in March 2023 impact the lending ecosystem? Will venture lending developments in the United States (the undisputed market leader for venture lenders and borrowers) signal what’s round the corner for the Southeast Asia ecosystem?

We consider these questions and in parallel highlight key observations from Dr Jeremy Loh’s attendance at the second annual Venture Debt Conference held in March 2024 in New York (where Genesis participated in discussions and networking opportunities with the likes of prominent banks with venture lending businesses such as Silicon Valley Bank, a division of First Citizens Bank, HSBC, Deutsche Bank, Comerica and a spectrum of private debt funds ranging from dedicated venture debt funds like Runway Growth, Vistara Growth, Bootstrap Europe to private credit players such as Horizon Tech Finance.

Surprising Early Resilience Despite Headwinds

Figure 1: Data aggregated from PitchBook and Deloitte Tech and Media Predictions

Market predictions following the SVB saga anticipated a significant decline in US venture debt financing for 2023. Forecasts suggested a potential drop exceeding 50%, ending a four-year streak of annual activity above $30 billion.

However, conference participants were bullish about venture debt pipeline opportunities. In fact, PitchBook data revealed a surprising resilience, with 2023 marking the fifth consecutive year surpassing the $30 billion threshold (Figure 1). Despite this positive development, a slowdown in capital availability within the venture sector is expected to impact 2024 figures. Estimates suggest a potential decline to a range of $14-16 billion but the outlier driving strong venture debt demand could push figures up to 2018 level of $27 billion.

A deeper analysis of venture debt deal count by startup stage sheds light on the allocation of venture debt capital (Figure 2, next page). PitchBook data indicates that seed and early-stage companies have experienced the most significant decline in deal volume. This aligns with the fact that SVB, which previously held a 50% market share in early-stage bank venture debt, has seen its lending shrink to roughly 20%. Conversely, late-stage loan activity has seen resilience and exhibited minimal decline, with 2023 emerging as the second-most active year in terms of deal count. Interestingly, PitchBook believes that there will be a continuation of the overall trend, predicting that venture debt in the US will exceed $30 billion for a fifth consecutive year in 2024. This optimistic outlook stands in contrast to the prevailing market sentiment, and only time will tell if it materialises when the first-quarter data of 2025 becomes available.

Figure 2: Venture debt loan count by stage

New Normal For Venture Debt: Proven Performers Welcome, VC Backing No Guarantee

The current economic climate has left many startups’ balance sheets in a less than ideal state compared to just a couple years ago. This tough environment has prompted investors and lenders to offer founders advice that may differ from what they’re accustomed to hearing. The message from Conference participants was clear: take the capital you can get – even if it’s at a down round with a liquidation preference – if that’s the only way to keep fighting.

Major venture and growth debt lenders are signalling a notable shift in their priorities. They are now open to financing established businesses with proven revenue models, even if they haven’t secured a recent equity round. In contrast, companies with dated equity rounds, limited traction, and a failure to reduce cash burn are the least preferred borrowers.

The focus for lenders has shifted to evaluating a company’s fundamentals – strong products, revenue generation, and a clear plan to bridge their funding gap. Profitability is seen as a major plus. Interestingly, the prestigious pedigree of a startup’s venture backers (e.g. Sequoia, Khosla Ventures) now carries less weight. As one lender put it, the key question used to be “Who’s backing you?”, but now a solid business case and financial runway are paramount in addition.

This evolving funding landscape requires startups to adapt their approach and messaging to appeal to the new priorities of investors and lenders. Those that can demonstrate financial discipline, revenue traction, and a clear path to profitability will be best positioned to secure the capital they need to weather the current economic storm.

Partnering With The Right Lender

When it comes to securing venture debt financing, the choice of lending partner is a crucial decision for startups. Considering that 76% of venture debt loans require amendments throughout their lifetime, startups must focus on finding a lender who can truly work alongside them as a strategic partner for the best possible outcome.

Lenders that take a “full platform approach”, tracking not only the financial performance of its portfolio, but also the holistic relationship and overall support provided to each company and founder are ideal partners. This level of commitment and consultative approach is key for startups navigating the complexities of the venture ecosystem.

Lenders with deep relationships within the venture capital community are also an important factor when choosing a reliable debt provider. These lenders are often involved in the debt raise conversation, providing valuable insights and alignment with the startup’s investors. Startups must be fully aware of the debt terms, such as meeting cash runway covenants, and understand the reporting requirements and third-party items demanded by the lender. The management team (and their key equity stakeholders) must be well-versed in navigating the positive and negative covenants.

Building trust and confidence in the counterparty relationship is paramount. Startups should seek lenders with a proven track record of working through challenging cycles and decisions alongside stable management teams. Forging these relationships proactively, and picking the lender’s brain on debt structure, can give startups an advantage. Creativity and sophistication in negotiations can also help bridge gaps, as the terms of warrants and other financing events can vary. Thorough due diligence is key, as startups can expect longer and more involved processes when selecting a venture debt partner.

Here’s a summary of the key points discussed by Conference participants:

Venture debt is more art than science – it’s crucial to find a lender that truly understands your business and the innovation economy;
Look for lenders with the right “Four Cs”: Capital, Commitment, Consultative approach, and Consistency through economic cycles;
Venture debt should be used judiciously, not as the sole source of runway – it needs to be part of a balanced financing strategy;
Startups must perform extensive due diligence on potential lenders, not just the other way around;
Venture debt can provide benefits like non-dilutive capital, runway extension, and acquisition/CAPEX funding – but the right lender partnership is key.

Navigating Venture Debt In A Challenging Funding Climate

As startups navigate the current funding landscape, the consideration of venture debt has become increasingly important. However, startups must approach this financing option with strategic foresight, balancing the benefits with the potential risks. In the current climate, the priority should be on securing access to capital and maintaining flexibility, rather than getting too caught up in the mathematical details.

One key factor to consider is the interest rate environment. While most lenders anticipate that interest rates will start to fall towards the mid-to-late 2024 timeframe, this could affect the repayment burden if rates are kept flat or for unforeseen circumstances begin to rise. This shifting rate landscape should factor into a startup’s decision-making process when evaluating venture debt.

Overleveraging debt can lead to negative outcomes, so startups must take the appropriate amount of leverage and have a clear repayment plan. Lenders view a “Hail Mary” situation as a red flag, so startups should aim to have a clear path to new equity or an M&A term sheet to make the venture debt more viable.

Companies seeking large debt raises may be a concerning signal, as it could suggest limited equity availability. Combining equity and debt can provide working capital and growth capital, but the management team must carefully consider and align with their board on the best approach.

Building strong borrower-lender relationships is crucial, looking beyond just interest rates. Startups should prioritize choosing lenders with specialized expertise in their industry and focus on cultivating a strong partnership, rather than solely optimizing for the lowest rate. Preparing quality financial statements in advance is also key, as lenders have become more sophisticated in their scrutiny. Startups should aim for audited financials, if feasible, to streamline the due diligence process and potentially facilitate deal-making.

In summary, navigating venture debt in the current funding climate requires startups to be strategic, discerning, and proactive. By carefully considering the trade-offs, building strong lender relationships, and ensuring financial readiness, startups can leverage venture debt to fuel their growth while mitigating risks.

Dealing with Distress: Lenders’ Approach to Troubled Startup Borrowers

When dealing with distressed startups that have raised venture debt, lenders must take a collaborative and pragmatic approach to achieve the best possible outcome. Despite any initial dissatisfaction, a successful workout requires all parties – lenders, management, and other stakeholders – to work together transparently and recognize the inherent value in the company’s assets.

Lenders should be proactive in identifying signs of financial distress, such as a startup’s failure to meet key milestones or its inability to raise fresh equity. When these issues arise, lenders should be upfront about their concerns and work collaboratively with the startup’s management to find a mutually agreeable financial solution that supports the company’s growth and path to cash flow positivity.

Employees and the management team are the primary stakeholders in a distressed startup scenario. Ensuring their motivation and satisfaction is crucial, as they are the ones who will ultimately drive the company’s turnaround efforts. Creditors must be willing to take a collaborative approach with management, even if it means accepting a less-than-ideal outcome for equity holders.

The concept of “management carve-outs” can be a useful tool in guiding distressed startups through this challenging period. In these situations, management teams may be unfamiliar with the complexities of insolvency and financial distress. Experienced general partners from the venture capital world can play a valuable role in helping management navigate these uncharted waters and align their actions with their fiduciary obligations to all stakeholders.

The emphasis is on having sponsors with strong track records and a proven ability to navigate these complex distress scenarios effectively. A single sponsor may be more efficient and have a distinct risk perspective, while a syndicate may face greater challenges in reaching consensus, potentially carrying slightly more risk.

While lenders must adopt a cooperative and pragmatic mindset, the key outcome is to maximize recovery. By prioritizing the needs of key stakeholders, leveraging management carve-outs, and maintaining transparent communication, lenders can increase the chances of a successful turnaround and maximize the value of the company’s assets

The Golden Age Of Credit: The Landscape Of Venture Debt And Bank Capital

Private credit as a broad asset class continues to attract significant fundraising dollars, with the venture debt category following suit and resulting in an ever-growing lending landscape. In recent years, there has been a notable compression in the cost of capital across various types of lending, including traditional bank facilities and venture debt. The increase in overall interest rates has led to a narrower pricing spread between these financing options, making bank capital more competitive in the current environment.

The emergence of larger, traditional investors exploring venture debt as an asset class has further validated its importance. For example, BlackRock’s acquisition of Kreos Capital, a European venture debt platform, highlights the growing prominence of this financing avenue. Kreos Capital has invested more than €5.2 billion through nearly 750 transactions across 19 countries since 1998. Another notable acquisition is Monroe Capital’s purchase of Horizon Technology Finance (NASDAQ: HRZN), a non-banking leading specialty finance company that provides venture debt financing. Monroe Capital, a $18.4 billion private credit firm with a 20-year track record in direct lending, has directly originated and invested more than $3 billion in venture loans to over 315 growing companies. These high-profile acquisitions by major players like BlackRock and Monroe Capital underscore the increasing significance of the venture debt market. The influx of larger, traditional investors validates venture debt as an attractive asset class, ushering in a “golden age” of credit with favorable conditions for investors.

In the aftermath of SVB’s collapse, major global banks have been jockeying to position themselves as the new preferred lender for startups globally. Institutions like JPMorgan Chase, HSBC, and Deutsche Bank have all made concerted efforts to capture this lucrative market. JPMorgan, for example, has been actively expanding its venture banking division, seeking to leverage its deep pockets and extensive resources to attract startups. The bank has touted its ability to provide comprehensive financial services, from lending to treasury management, to cater to the unique needs of high-growth companies. This trend has been driven by the increased capital formation within the venture capital community, allowing companies to stay private and grow for longer. As this trend reversed, leading to greater need of venture debt, traditional lenders have improved their underwriting capabilities to facilitate larger transactions.

Mature venture debt markets, such as the US and Europe, have demonstrated that both private venture debt funds and venture debt banks can coexist harmoniously. This provides startups with access to different lender profiles, allowing them to choose the most suitable option – a private lender with more flexibility in their lending criteria or established venture banks that provide tailored banking solutions. The coexistence of private venture debt funds and venture debt banks has proven to be beneficial for startups, as it provides them with a diverse range of financing options to support their growth and expansion plans.

In the burgeoning venture debt markets of North Asia, excluding China and India, Japanese banks have been actively establishing a foothold to lend to Japanese startups. Major players such as MUFG, Mizuho Bank, Aozora Bank, and Tokyo Star Bank have been aggressively pursuing opportunities in this space, recognizing the growth potential of the local thriving startup ecosystem. Over in South and Southeast Asia, HSBC recently announced the launch of a $1 billion ASEAN growth fund and a $150 million venture debt fund dedicated to the Singapore market. This followed two other $100 million HSBC single market venture debt vehicles – a MYR$500 (~US$104) million fund for Malaysia, and AUD$227 (~US$147) million fund for Australia.

Venture Debt In Southeast Asia: Fueling Growth, Mitigating Risk, Embracing Sophistication

The venture debt landscape in Southeast Asia is undergoing a transformative phase, driven by several key factors regionally and globally. Firstly, the region is witnessing a surging demand for alternative financing options, fueled by the burgeoning startup ecosystem and the need for capital to fuel growth. This growing demand has attracted competition from traditional banks and specialized venture debt providers, giving rise to co-lending opportunities, enabling lenders to collaborate and share risk.

These factors are collectively shaping the trajectory of venture debt as an alternative financing option in Southeast Asia’s burgeoning startup ecosystem. Private lenders, such as Genesis Alternative Ventures, are well-positioned to capitalize on this evolving landscape. As startups adapt to challenging market conditions and prioritize profitability, private lenders can continue to grow alongside the ecosystem, deploying debt financing to support lean, efficient, and profitable ventures.

The venture debt landscape in Southeast Asia is dynamic and rapidly evolving, presenting both opportunities and challenges for lenders and borrowers alike. Those who can navigate this landscape adeptly, balancing risk and opportunity while embracing sophistication and collaboration, will be poised to thrive in this exciting and promising market.

References:

The term “funding winter” has permeated discussions from panels at tech conferences to casual cafe conversations over the last twelve months. The fundamental question pertains to venture capital liquidity constraints induced by prevailing macroeconomic and political challenges. Will these constraints persist in Southeast Asia, or can we anticipate a resurgence in funding levels to reach heights achieved in 2021? During that year, the tech sector in the region witnessed a historic high, with investments exceeding the unprecedented milestone of US$20 billion.

Let’s review the global funding trend over the past decade, encompassing venture capital investments into startups across the Americas, Europe, the Middle East, Africa, and Asia, including Southeast Asia. The chart below illustrates a consistent upward trajectory in funding from 2012 through 2022. Notably, 2021 emerged as an exceptional year, marked by an unprecedented surge in capital deployment with investments nearly 1.5 to 2 times higher compared to the preceding and subsequent years. As we approach the conclusion of 2023, it is important to acknowledge that the full-year funding figure is still awaiting final tallying. However, a preliminary estimate, based on a rough calculation, suggests that approximately US$340 billion may have been invested during this year. This would represent a dip from 2021-22 but on par with 2018 through to 2020 funding levels.

In retrospect, the venture capital landscape witnessed an unprecedented bull run in 2021, characterized by a substantial influx of investment dollars from both corporate and venture tourist investors into the startup sector. If we were to eliminate the 2021 funding spike from the chart above and draw a trendline across the past ten years as shown in the chart below, a compelling narrative emerges. Over this period, invested capital has displayed a consistent and progressive growth pattern, expanding by a noteworthy factor of 5 to 7 times.

What sets this trend apart is the discernible shift in capital allocation, with an increasing proportion being directed towards the Asia and EMEA (Europe, Middle East, and Africa) regions. This transformation in the funding landscape signifies a fundamental reorientation of global investment priorities within the tech and venture sectors. The significant surge in investment activity in 2021, driven by both corporate and venture investors, underscores the industry’s dynamic evolution and its resilience in the face of economic challenges.

In the context of venture funding in Southeast Asia, the second quarter of 2023 saw a notable increase, reaching a total of $2.1 billion. It’s worth observing that despite the increase in total funding, the deal count was lower during this period. According to CB Insights, Indonesia emerged as the leading recipient of funding in the region during 2Q 2023, with its startups securing $1 billion, an extraordinary 233% surge compared to the preceding quarter. Singapore (a base for Southeast Asia startups) closely followed with $914 million in funding, although this represented a 15% decline quarter-over-quarter.

The past quarters also witnessed an uptick in exits within the Southeast Asian startup ecosystem. This was particularly evident in the increased number of M&A exits for the second consecutive quarter. In this evolving economic landscape, more tech companies are grappling with the challenge of managing their liabilities and raising funding. As a result, an increasing number of these companies are opting to pursue mergers with larger competitors as a strategic move to sustain their operations and keep their businesses afloat. Startups are adapting to the challenges posed by evolving market conditions, which may include increased competition, funding constraints, or changing investor sentiment. Mergers and acquisitions can offer a viable path forward for startups seeking stability and growth, while also presenting opportunities for larger companies to expand their market presence and capabilities in the region.

In the current funding landscape startups are facing the imperative of planning for an extended runway as the process of closing financing rounds has become considerably protracted. Notably, earlier-stage companies, ranging from Seed to Series A, are finding it necessary to allocate up to 2 years for fundraising, representing an increase from the 16-month average observed just a year ago. Meanwhile, statistics reveal that later-stage companies, specifically those at the Series B stage and beyond, experience even more extended timelines, with fundraising cycles stretching to as long as 34 months.

Several factors contribute to these extended timelines, with one significant reason being the heightened focus of global VCs nursing their existing portfolio companies. Many VCs have slowed down their pace of new investments, with some openly admitting that they have not committed to new deals over the past 12 months. This trend has particularly impacted fund deployment, which has contracted by 25-30% in the current year, especially in regions like Indonesia and at the Series B+ stage. However, VCs remain active in earlier-stage cycles, notably at the Seed and Series A stages.

Despite these challenges, there exists a prevailing sentiment of cautious optimism regarding the future. VCs believe they will gradually increase their investment activities toward the latter part of 2023 and into 2024, provided that macroeconomic conditions continue to improve and unforeseen disruptive events are avoided. In the midst of this downturn, industry insiders, like Oswald Yeo, CEO of recruitment startup Glints, underscore the resilience and growth potential of the Southeast Asian startup ecosystem. Across various industries and verticals, a positive outlook toward sustainable growth persists, with a significant percentage of surveyed companies (86%) expressing their intentions to continue hiring in 2023. This challenging period is also expected to cultivate the emergence of strong founders who can weather such adversity, building businesses that can withstand even the most challenging circumstances.

Tech IPO Window Resumes Business, But Not Wide Open

Despite these challenges, there are positive offshoots returning to the public markets with several high-profile IPO listings leading the charge, which hopefully would trickle down to the private markets. The month of September 2023 witnessed a series of notable IPOs, underscoring the enduring interest in technology-driven firms seeking public equity. Among these, Arm Holdings plc, a Softbank-backed entity, stands out, with an IPO that initially valued the company at approximately $54.5 billion and at one point surging to nearly $72 billion. Arm Holdings specializes in the architecture, development, and licensing of high-performance, energy-efficient IP chip solutions, integral to the functioning of over 260 technology companies worldwide, including major smartphone manufacturers such as Samsung, Huawei, and Apple.

Another prominent tech IPO in the same period featured Instacart, a grocery delivery service, which, having been previously valued at $39 billion, debuted on the NASDAQ with a fully diluted valuation just surpassing $11 billion. Concurrently, Klaviyo, a marketing automation firm under the umbrella of Shopify, made its debut on the New York Stock Exchange, achieving profitability and obtaining a $9 billion valuation, substantiated by $345 million in raised capital.

Conversely, some startups have opted to defer their IPO plans. VNG Ltd, a Vietnamese internet company with backing from Tencent, chose to delay its $150 million U.S. IPO until 2024, citing the prevailing volatile market conditions. VNG was established in 2004 and hailed as Vietnam’s inaugural unicorn, operates across diverse sectors encompassing online gaming, payments, cloud services, and the preeminent Vietnamese messaging application, Zalo.

Singapore-based cancer diagnostics firm Mirxes has submitted an application to the Hong Kong Stock Exchange for an initial public offering, potentially becoming the first non-Chinese and non-Hong Kong-based biotech company to list under a specialized provision. This decision follows a $50 million Series D funding round, which ascribed a post-money valuation of approximately $600 million to Mirxes.

Industry analysis by PitchBook indicates a queue of nearly 80 IPO candidates including TikTok, Stripe, Discord and more who are lining up to go public. While there exists a discernible opening in the IPO window, investors are currently leaning toward a cautious stance for the remainder of 2023. Venture capitalists are advising their startups to consider deferring their IPO plans until interest rates have stabilized. The possibility of further interest rate hikes in the year, coupled with reduced expectations for rate cuts in 2024, could further influence market sentiment. Moreover, volatility in share prices for both Arm Holdings and Instacart underscore the necessity for prudence in the prevailing listing environment.

More Dry Powder Reason For Optimism In Thawing Of Equity Winter

In 2022, while the number of newly established funds experienced a decline, the total capital amassed by global funds reached an unprecedented pinnacle, totaling a staggering $162.6 billion. This achievement marked the second consecutive year in which capital inflows surpassed the significant milestone of $100 billion, defying challenging economic conditions.

According to DealStreetAsia’s 2Q 2023 report, Southeast Asian investors successfully raised an impressive US$3.72 billion in the first half of the year. Notably, the recent announcements have catapulted Southeast Asian venture capital firms beyond last year’s fundraising record of $4.14 billion. Pitchbook reported that the US largest public pension scheme, Calpers, which manages some $444 billion in capital, intends to increase its venture capital allocation by more than sixfold, from $800 million to $5 billion. These developments highlight a robust investor sentiment in the region.

Vertex Ventures, for instance, substantially exceeded its expectations by closing its fifth fund at a substantial US$541 million, surpassing its initial target of US$450 million. This achievement notably exceeded the US$305 million garnered for the firm’s previous fund, which concluded in 2019. Similarly, Monk’s Hill Ventures concluded its second fund at a remarkable US$200 million. Additionally, Singapore’s Temasek announced its strategic collaboration with the National University of Singapore and Nanyang Technological University Singapore, committing US$55 million to foster the commercialization of deep-tech ventures emerging from the research pipelines of these esteemed institutions.

The VC market landscape has undergone a notable transformation, shifting away from its traditional startup and founder-centric ethos to one that is more favorably inclined toward investors. Several key drivers underpinning this transformation include the widening gap between capital demand and supply, coupled with a discernible decrease in valuation upticks across various developmental stages.

In light of this evolving landscape, VCs are poised to continue deploying their capital; however, the terms of these deals are expected to skew more positively towards investors. Consequently, entrepreneurs are faced with the imperative to refine their business models and present a meticulously delineated roadmap toward achieving cash breakeven and profitability. Those entrepreneurs who can exhibit robust unit economics and pragmatic growth projections will find themselves in the most advantageous position when competing for coveted VC investments.

Developments In The Venture And Private Debt Sector

Smart money continues to flow into private debt, drawn to the favorable risk-adjusted returns and with plenty of headroom for future growth. The collapse of Silicon Valley Bank (SVB) in March 2023 did not dampen the appetite for venture debt, a subset of private debt. Banks across the world have jumped into direct lending to startups, seizing opportunities in a post-SVB era. HSBC picked up some of SVB’s assets and its team and went on an aspirational strategy to become the next SVB. HSBC announced a $3 billion Hong Kong/China fund and separately a $105 million (RM500 million) Malaysia New Economy fund that will be dedicated to providing high-growth, innovative companies with a suite of tailored debt solutions in their respective jurisdictions. In Japan, Aozora Bank announced its third $60 million (¥9 billion) venture debt fund for local start-ups, while MUFG launched two new venture debt funds worth $400 million for Japanese and European startups, reflecting strong funding demand as the market for initial public offerings remains dull.

BlackRock Inc estimates that between the end of 2018 and the end of 2022, the private credit market doubled in size from roughly $750 billion to $1.5 trillion. To further deepen its private credit offerings, BlackRock acquired Kreos, a provider of growth and venture debt in technology and healthcare in Europe and Israel who has committed around $5.6 billion in over 750 debt transactions, demonstrating strengthening investor demand for exposure to venture debt and private credit.

Venture Debt Dealflow

In the US across all stages, startups closed $6.34 billion across 931 venture debt deals in the first half of 2023, compared to $20.07 billion across 1,513 deals in the same period last year. The diagram below shows the debt committed to startups across different stage of development. While the debt commitment has reduced across all stages, it is more evident for early-stage startups. One possible reason could be the collapse of SVB who primarily operated in the early-stage market, sometimes lending to pre-revenue companies, while its new owner, First Citizen Bank, does not expect to step up to fill that void.

Debt capital remains in high demand among startups as companies turn to alternative financing. The number of new and repeat debt financing conversations has certainly increased. Lenders are however becoming pickier and seek more favourable covenant packages and warrant coverage, in addition to higher interest rates. Lenders also wants additional comfort that startups are on track to receive future investment and that their investors remain committed to the company. While lenders can benefit from a rise in interest rates, the converse is an increased loan repayment risk as increased cost of borrowing and tighter covenants means that borrowers need to operate within their means.

Funding Outlook For The Next Six To Twelve Months

The million-dollar question is how the rest of 2023 and 2024 looks like for the venture and tech sectors? Not to oversimplify things, there seem to be two groups of startups in the market currently: those that have raised funding in 2021/2022 (albeit at a high valuation) but that have adapted to the volatile market, conserved cash and growing sustainably; and another group that has continued to trailblaze growth but that has run out of funding and struggled to raise capital. Valuation expectation will need to be moderated and lenders are certainly witnessing an increase of queries for debt financing with or without new equity injection. In all certainty, entrepreneurs will need to start funding conversations much earlier in anticipation of the longer process.

Venture investors that take the brakes off and continue to invest in startups that have undergone business and capital rationalisation at an attractive entry point valuation may be capitalizing on being ahead of the herd with significant de-risking as the company has demonstrated added traction. The revival of startup funding over the next 6-12 months is intrinsically linked to several key factors reshaping the entrepreneurial landscape. As venture capital firms find themselves flush with more dry powder, they are eager to channel these resources into startups that have proven their ability to survive a major down cycle. This surge in available funding, combined with a slowly opening IPO market, creates a symbiotic relationship where startups have a clear path to exit strategies that appeal to investors. Moreover, startups are emerging from recent challenges as leaner and more efficient entities, well-equipped to maximize the capital they receive. This newfound efficiency not only instills confidence in investors but also ensures that the funding received is utilized effectively, ultimately fuelling the remarkable resurgence of the startup ecosystem.

The technology industry has been one of the most dynamic and fastest-growing sectors of the global economy in recent years. 2022 was a tale of two halves. The first half of the year (and even into Q3) continued on a positive note and benefited greatly from the COVID-induced growth on the user and innovation front. Globally, startups benefitted from the preceding year of funding strength which saw investors plough $621 billion into startups globally, including $20+ billion record funding for Southeast Asia startups.

Towards the second quarter of 2022, we surveyed our portfolio founders on the fundraising environment and business outlook. A clear majority of them were optimistic about the future, observed business growth but were already noticing the slowdown in fundraising. Amidst these uncertainties, three of our portfolio companies Deliveree, Believe, and Trusting Social raised approximately $180 million of funding (April to June 2022).

Source: CB Insights State of Venture 2022 Report

As we rolled Into the second half of 2022, and certainly more towards Q4, a new reality set in for the tech industry clouded by an array of challenges ranging from economic uncertainty, market volatility, geopolitical tensions and reverberating ripples from the pandemic. Venture investors slowed their pace of investing, due diligence took longer, valuations retreated, and we started seeing signed term sheets being delayed or even revoked. Round sizes also began shrinking and later stage startups struggled to raise growth capital while holding on to lofty valuations set during their prior fundraising rounds. Funding for tech companies globally declined to $415 billion, -35% YoY but remained healthy compared to pre-pandemic levels.

According to Carta and as a benchmark on valuation, 22% of US venture-backed companies in the US, both private and public, reduced their valuations in Q3 2022, nearly tripling year-over-year. Meanwhile, as the maxim goes, “flat is the new up” with 34% of companies witnessing a rise in their valuations — the lowest increase in five years.

While the weakening fund raising environment became more evident as the year progressed, robust fundraising in the first half of the year more than compensated for the slowdown in the second half of the year with 887 funding rounds totaling US$28.8 billion in 2022 (compared to $25.7 billion raised in 2021), according to a TechinAsia report.

Referring to a joint DealstreetAsia and Enterprise Singapore report, Singapore-headquartered startups closed 517 deals in the first nine months of 2022 raising $8.11 billion, a little shy of the 487 deals and $8.28 billion raised in the same period of 2021, and with less dealmaking as the year prior.

VCs Prefer Early Stage, Late Stage Deals See Declining Investment Interest

Investment statistics from the earlier report also indicate VC preference towards early stage deals, which are defined as seed through Series B rounds. Late stage are attributed to Series C and above rounds. From the graph below extracted from the DealstreetAsia and EnterpriseSG report, investors have shifted their investment dollars into a larger number of smaller, earlier venture deals. The median size of seed rounds have doubled from $1.2-1.5 million in 2021 to $2.5-3.0 million in 2022. For later stage deals, the report also highlighted a contraction of deal value for Series D and E companies by 30-50%.

In the United States, startups seeking late-stage funding are failing to attract investors as dour sentiment in the public markets and dull exit conditions make it tougher to justify higher valuations. As valuations slip to reasonable levels and startups begin to trim operating expenses to get closer to cash or EBIDTA positive levels, they may once again start to look attractive to venture and PE investors who are keen to deploy their fund capital to work.

M&As & IPOs

We observed a notable rise in private-to-private mergers and acquisitions, as publicly-listed big tech companies saw a steep decline in their share price and valuation which in turn affected the SPAC and IPO listing opportunities. Completed venture-backed acquisitions in the first three quarters of 2022 totalled $81.7 billion, according to PitchBook data, down 40.7%, from $137.8 billion in the same period the year before. No significant venture-backed tech startups went public. In total, IPO deal proceeds plummeted 94% in 2022 — from $155.8 billion to $8.6 billion — according to Ernst & Young IPO report. Looking at 2023, there is an air of optimism that the IPO drought will “un-thaw” and favorable market conditions will return to allow the growing pipeline of IPO filings waiting to list – including Instacart (US), Vinfast (Vietnam), Tiktok (China), Stripe (US) and Epic Games (US).

On the M&A front, Microsoft reportedly acquired Fungible, a Santa Clara maker of data centre chips and storage device for $190m, about $134 million less than Fungible had raised in funding since its launch. Closer to home, according to a Tech in Asia report, Singapore-headquartered Amplify Health – a joint venture between AIA Group and Discovery Group – has announced its acquisition of AI-powered data analytics firm Aida Technologies. GoTo Group, the Indonesia-based tech giant, has acquired Swift Logistics Solutions for 583 billion rupiah (US$38 million).

Cryptopocalypse

A year in review would be incomplete without mention of the events that took place in the crypto space which was rocked by high-profile scandals through the year. Terra Luna for example, a cryptocurrency that was launched in 2019 as a stablecoin pegged to the U.S. dollar, witnessed a crash of its Terra (LUNA) crypto token in May 2022 from $120 to $0.02, a 99.9% correction. Forbes Digital Asset estimated that nearly $60 billion was wiped out of the digital currency space.

Three Arrows Capital (3AC), a crypto hedge fund founded in Singapore and believed to be managing around $10 billion in crypto assets, incurred significant losses due to its staked Luna position. 3AC has since filed for Chapter 15 bankruptcy proceedings in the US Bankruptcy Court for the Southern District of New York to protect its US assets from creditors. And this triggered a contagion of Chapter 11 bankruptcy involving Voyager, BlockFi, Genesis Global and Celsius who had dealings with 3AC. And just before the year ended, the crypto industry experienced a Black Swan event that saw crypto exchange FTX valued at $32 billion based on its most recent funding round declared bankrupt. FTX Exchange was the world’s third largest cryptocurrency exchange specializing in derivatives and leveraged products. News around FTX’s leverage and solvency involving FTX-affiliated trading firm Alameda Research triggered a liquidity crisis when FTX’s customers demanded withdrawals worth $6 billion. FTX Token (FTT) is a utility token that provides access to the FTX trading platform’s features and services. The value of FTT fell by more than 80% within two days. The crypto industry is still reeling from a brutal 2022, having lost over US$2 trillion of its value throughout the year. Crypto companies still managed to raise a total of US$21.3 billion in funding in 2022, down 42.5% from the previous year.

Recalibration in 2023

The general consensus is that 2023 will remain challenged but with green shoots on the horizon. Negative macro conditions are set to continue into 2023 – sustained inflation, raised interest rates, Russia v Ukraine, China-Covid slowdown etc. However, there has also been positive news flow on many of these fronts in the past weeks (e.g. inflation levelling off; China emerging quicker than expected from Covid-slowdown, China tech reawakening etc).

Taken together, and as it relates to the tech industry, it seems 2023 will provide the backdrop for a healthy recalibration period for startups globally. In Southeast Asia, for example, where most founders have not yet experienced a significant market downturn, this has been (and will continue to be) an opportunity for founders to adjust internal KPIs towards a more sustainable growth and fundraising future. Creativity loves constraint and we believe that great startups, with solid fundamentals, will emerge winners in a tight operating and funding environment.

Cash is king. VCs are encouraging their portfolio companies to conserve cash and extend their cash runway into 2024 so as to be able to operate through some of these macro headwinds. To that end, it’s worth noting that the companies in Genesis Fund I Portfolio have a weighted average cash runway of approximately 17 months this quarter (up from 13.5 months in Q3 2022).

Profit before growth. Founders are expected to be more disciplined around spending and investors are edging these startups to turn “profitable”, the definition of which is wide, but in these times has come to prioritise a meaningful and sustainable business model.

Talent stocking. Hiring exceptional talent used to come at a premium but with many startups downsizing, startup founders can now hire more prudently with less pressure on the P&L. In Southeast Asia, it’s been reported that retrenched executives from tech companies (and new job seekers) are actively in the market looking for opportunities but with more modest salary expectations.

Dry powder. Venture firms have continued to raise record capital, even as startups received far less money than they did in 2022. Dry powder was estimated to be as high as $1.3 trillion globally for private equity and $580 billion globally for VC. While we do not expect VCs to invest at a pace comparable to 2021, there is pressure stemming from fund size, duration to deploy and the need to put capital to use. As previous downturns have clearly shown, investors with dry powder will find it a rewarding time to deploy capital, amidst more reasonable valuations and the ability to set better deal terms.

2023 Hot VC Target Sectors

January is a hotbed for new tech innovation unveiled to consumers through the annual Consumer Electronics Show held in Las Vegas USA. The 2023 show is focused on a number of areas, including the metaverse and Web3, digital health, sustainability, automotive and mobility, and human security for all. There was strong participation from Asia which include those from South Korea, which number more than 500 and include the likes of Samsung, SK, Hyundai Motor and LG, while just under 150 exhibitors hail from Taiwan. We highlight some interesting technology showcased at CES:

- Sony teamed up with Honda to exhibit a new brand of electric vehicle called the Afeela. The Afeela logo appears on a narrow screen, or “media bar,” on the vehicle’s front bumper. This can also interact with people outside the vehicle and share information such as the weather or the car’s state of charge. Unlike the car Sony showed off at CES 2020, this car is expected to hit the North American roads in 2026. Japan and Europe will follow.
- The battery-operated WasteShark by the Dutch firm RanMarine Technology is an autonomous surface vessel designed to remove algae, biomass, and floating pollution such as plastics from lakes, ponds, and other coastal waterways. At least 14 million tons of plastic end up in the ocean every year, and plastic makes up 80% of all marine debris found from surface waters to deep-sea sediments. Marine species ingest or are entangled by plastic debris, which causes severe injuries and death.
- Canadian-based eSight Eyewear plans to display a headset designed to help people with visual impairments such as age-related macular degeneration (AMD). AMD is an eye disease that can blur your central vision. It happens when aging causes damage to the macula — the part of the eye that controls sharp, straight-ahead vision. The macula is part of the retina (the light-sensitive tissue at the back of the eye). AMD happens very slowly in some people and faster in others. If you have early AMD, you may not notice vision loss for a long time; hence the importance of regular eye exams. Once the user puts on the device, they will be able to see distinct features such eyebrows, mouth and eyes.
- Singapore-based Igloo Company will show off its second generation of smart padlocks at CES, including a slimmed-down fingerprint-based model and another featuring enterprise-grade security. The latest smart padlocks will ship in the spring. The keypad-based Padlock 2 builds on the company’s original Bluetooth-enabled smart lock by manufacturing it to military standards, including a hardened steel case. The Padlock 2 gets eight months out of a single charge of its lithium battery (the original relied on disposable batteries), and its shackle can withstand up to 15kN of cutting force, 5kN of pulling force, and 100Nm twisting force.
- And last but not least, there has been immense interest in generative AI since ChatGPT came online and mesmerised consumers with its ability to provide real-time chat responses (see below). In 2019, Microsoft invested $1 billion in OpenAI, the tiny San Francisco company that designed ChatGPT. Microsoft is now poised to challenge Big Tech competitors like Google, Amazon and Apple with a technological advantage as it is rumoured to be in talks to invest another $10 billion in OpenAI. See the picture below (right column) where we tested Open AI’s ability to write a short paragraph on electric vehicles. Try it at https://chat.openai.com/chat

Tech has been through a rocky patch so far this year, what with the gyrations of the stock market, delayed IPOs, depressed valuations, renegotiated term sheets, and layoffs. How does this align with what we’re seeing on the ground in the tech and venture ecosystem in Southeast Asia?

Our observations in the first half of the year are that investors continued to bankroll their fundraising activities and pressed on with new and follow-on investments into Southeast Asian startups despite current market conditions. Surprisingly, as at the date of this report, the pace of investments coupled with ever-growing deal sizes suggest an inverse correlation to the market correction.

For example, three Genesis portfolio companies announced strong follow-on Series C rounds in the first half of 2022, registering between a 1.78x to 2.92x increase in their enterprise value. In April, Sequoia-backed Trusting Social, an impact-driven Fintech focused on creating unique, personalised financial credit scores for the unbanked and underbanked individuals, announced its initial close of $65 million led by Vietnam’s consumer-focused conglomerate Masan Group.

A month later, Believe, a direct-to-consumer (D2C) startup specialising in consumer beauty products and backed by Accel India, raised a $55 million Series C financing led by Venturi Partners. In June, Deliveree closed its $70 million Series C led by Gobi Partners and SPIL Ventures (the CVC arm of Salam Pacific Indonesia Lines). Deliveree has been focused on creating a dynamic marketplace for the trucking industry across Indonesia, Vietnam and Philippines, matching independent truck drivers and customers with cargo.

And this was on the back of various other deals announced publicly. Indonesia’s Fintech Flip raised $100 million Series B (Tencent, Block, Insight); eFishery $100 million Series C (Temasek, Softbank, Sequoia);, Bibit $80 million (GIC); Astro $60 million Series B (Accel, Tiger Global); Singapore’s ShopBack $80 million Series C (Asia Partners); BioFourmis $300 million Series D achieving unicorn status (General Atlantic); Neobank Stashfin $270 million equity/debt Series C (Uncorrelated Ventures); Neuron Mobility $43 million Series B (GSR Ventures, Square Peg); Multiplier $60 million Series B (Tiger Global, Sequoia); Thailand’s Fresket Series B $23 million (PTT Oil, Openspace) and many more.

We also observed a continuation of Seed and Series A funding closes for startups across Southeast Asia. For example, Eratani, an Indonesia-based agritech startup raised a $1.6 million Seed round while Li Ka-Shing’s Horizons Ventures co-invested $7.5 million into Ilectra Motor Group, a 2-wheeler EV targeting the Indonesian market.

A Return to Profitability With Leaner Companies

Growth, especially growth at all costs, requires significant capital to take market share now and worry about profitability later. More often than not, customers and revenue acquired in such fashion are far from ideal, leading to higher churn rates, lower retention rates, and driving up costs even further. Raising too much capital at early stages can result in undisciplined spending leading to layoffs and other painful reactions when the burn rate skyrockets and future funding becomes scarce.

It is sobering to see news on startup layoffs across US and Asia including Southeast Asia (here are some dedicated websites tracking these statistics) and casualties such as Kaodim, an 8-year-old startup in Malaysia, which means “take care of it”, that shuttered its services as Covid halted the home-services industry. Softbank Asia’s Propzy, which bagged a $25 million Series A in 2020, dissolved a major part ofits business and reportedly laid off 50% of its employees.

On the flipside, good founders understand the value of a long-term mindset and the importance of building startups with the right values and structure so they can grow into lasting companies. The “exuberant climate” for start-ups has turned and investors are demanding to see financial metrics that are in line with the company’s stage of development. Therefore, it is prudent for start-up leaders to make adjustments in order to enhance operational efficiency and to focus funding resources to achieve important key performance indicators so as to reach the next funding round.

And there are certainly opportunities for resilient founders and companies in a market correction. As with prior downturns, we believe there is a correlation between economic cycles and the formation of category-defining companies. Companies such as Uber, Airbnb, Square, WhatsApp, MailChimp, and Adobe were all founded during recessionary periods. Moreover, today’s founders have an arsenal of tools ready for them to launch their disruptive companies in a cloud-based world with less capital required for growth and the ability to operate with no hard assets. And venture capitalists are still hunting for startups that could well become tomorrow’s category-defining companies.

A great example is Deliveree. Genesis visited Deliveree at its South Jakarta office in June to catch-up with Tom Kim, Deliveree’s Chief Executive. Tom was wrapping up Deliveree’s Series C fund raise and shared how Deliveree had been keeping a tight rein on hiring and marketing expenses which is why the company was able to garner an industry-leading gross margin in the mid-teens, compared to better-funded competitors, some of whom have low, single-digit to negative gross margins.

Brisk Pace of M&A Transactions

A “buyer’s market” has emerged as deep-pocketed acquirers pick up targets of good value. Acquiring targets in order to bulk up seems to be more attractive as the IPO window remains closed, keeping exit valuations depressed.

For example, India’s Pine Labs acquired Southeast Asian startup Fave for up to $45 million. Singapore’s Funding Societies announced it is acquiring digital payment provider Cardup to expand its payments offering.

In fact, Genesis has been receiving requests from founders who want to strengthen their balance sheet with venture debt for the sole purpose of acquisitions – a smart way to raise lower dilutive capital and add breadth and depth to their business.

We expect the pace of M&As to gather further in coming quarters given the conversations we have been having with founders who want to leverage on venture debt to buy up smaller competitors.

Abundant Dry Powder Globally For Venture Capital Investments

Preqin estimates there is more than $497 billion of global venture capital dry powder as at May 2022 (dry powder being the amount of capital that has been committed to funds minus the amount that has been called by general partners for investments).

Quarterly funding levels in 2022 remain above quarterly funding levels in 2020 and prior, according to CB Insights (July 2022) with $108.5 billion raised across 7,651 deals. This is despite the fact that quarterly funding has slowed in 2022 amidst tightening liquidity and a global meltdown in technology stocks.

US VC fundraising tops $120 billion for the second consecutive year, according to Pitchbook. A strong showing from established managers in the first half of the year has pushed capital raised to a record pace. These managers have closed 203 funds worth $94.7 billion through the first six months of the year. Already, 30 funds have closed on at least $1 billion in commitments, eight more than the previous full-year high of 22 recorded last year. While this activity is most likely a continuation of momentum from 2021, it’s still an encouraging sign around the level of capital availability through the uncertainty that the next few years may bring.

In Southeast Asia, fund investors have increased allocations to the Southeast Asia venture corridor. Southeast Asia and India-focused VC funds have raised $3.1 billion in the first 5 months of 2022, eclipsing the $3.5 billion these funds raised in all of 2021, according to a Nikkei Asia report in May 2022.

Established Southeast Asia players like Sequoia, Accel, Jungle and Mass Mutual have raised larger, multi-stage funds. Sequoia raised $2.85 billion, which includes its first dedicated fund for Southeast Asia with a pool of $850 million. And despite the shaky short-term outlook in tech, Sequoia remains optimistic about Southeast Asia’s start-ups, as do new entrants White Star, Antler, and Altara. From our conversations within our network of General Partners (GPs), it is evident that companies that can demonstrate financial discipline and prioritise healthy topline growth with manageable bottom-line expenses will be rewarded in this investment climate.

While GPs believe that the pace of investment may slow compared to 2021, this does not also mean that investing into new deals will come to a halt; rather the deal selection and diligence process will take longer as GPs will now insist on observing certain metrics and may choose to sit on the sidelines while monitoring progress.

On the topic of valuation, we also notice that GPs have already lowered their WTP (willingness to pay) and this is a common theme across funds globally. Seed and pre-A startups are likely most impacted and may see as much as 50 – 75% reduction in valuation as investors prefer not to take very early-stage risk. Series B, C and D startups remain attractive for GPs to continue investing in given their life-cycle and more reasonable enterprise values, and as highlighted above, there remains a barrage of early growth startups that have raised $50-200 million in a single round of financing with little to no discount to valuations. It also appears that funding has shifted away from late-stage pre-IPO mega deals which has resulted in the declining minting of new unicorns into the tech sector (which mirrors the global phenomenon).

Summary

While we recognise this will be a tough period for investors and companies alike, we equally believe that this will be a rewarding time for investors and GPs who have stuck to their investment thesis of backing mission-driven founders who are building sustainable businesses and aiming for market leadership positions.

The medium to long-term outlook of venture capital investing will improve as valuations and investment pacing return to more sustainable levels. And not forgetting the abundant VC dry powder waiting to pounce on attractive deals in the shorter term.

All of this should also lead to more robust dealflow for venture lenders like Genesis. Investors are now more focused on more sustainable companies with a path to profitability, healthy gross margins, lower burn, more reasonable valuation ascents etc. These are the very companies that Genesis has always invested in. In fact, in the last 2 quarters, Genesis reviewed more than $100 million of deals, and since inception, our total dealflow has crossed the $1 billion mark, which is a significant milestone.

House View: Startups Embrace Venture Debt as VC Markets Shift

House View: Southeast Asia’s Tech and Venture Sectors Rekindles Cautious Optimism Amidst the Thaw

Reflecting on 2022 and Looking Ahead Into 2023

The Bulls & Bears of Venture Capital Investing