Venture debt, a new but growing form of funding, is attracting entrepreneurs and investors alike, at a time when venture capital funding has taken a turn towards a slowdown. Temasek-backed InnoVen Capital is a leading player in the field, which has started facing competition only recently, from companies like Trifecta Capital.
Started in India in 2008, the platform was re-branded InnoVen Capital following a buyout of the business led by Temasek Holdings and UOB Group in 2015. InnoVen Capital currently has investor commitments of $200 million. Late last year, the company established its office in Singapore to service the needs of its clients across the South East Asian market including Malaysia, Indonesia and Thailand in sectors across e-commerce, financial technology, logistics and big data.
In an interview with DEALSTREETASIA Chin Chao, Chief Executive Officer, Singapore and South East Asia, Innoven Capital, spoke about the evolution and challenges faced by venture debt in Southeast Asia. Pegging the potential market size at around $100 million a year, Chao explains what attracts investors and the need to educate entrepreneurs about venture debt. Edited excerpts
Today, VC funding has largely become synonymous with funding for tech-based startups. Do you agree? Does that leave a lot of sectors under-represented as far as attracting capital is concerned?
Definitely, there are certain sectors that probably are not getting the attention of the VCs in the market. A lot of them, I would say are non-tech, and they will probably continue to have difficulty finding financing, because VCs are focused largely on the technology sector. You would think almost any non tech sector is under represented – look at F&B industry for example – it doesn’t really have any VC funding. I think even advanced manufacturing type sectors are probably under-represented. All your traditional SME type companies don’t interest VCs. Same with companies in the construction sector, and probably healthcare – anything that really doesn’t have a pure tech angle probably is under-represented.
So how can startups or companies in these non-tech sectors get the attention of VCs?
They wouldn’t be able to get a meeting with a VC. Take companies in the F&B industry for example – something that I’ve looked at a lot in the past (during a stint with Singapore-based Sirius Capital, which largely does non-tech deals). The attraction to tech is largely due to the exit potential – that is what drives VC dollars. If you are taking risks, you might as well get paid and rewarded for taking that risk. So most VCs aren’t going to look beyond tech. But if you sort of peel the onion a bit in Southeast Asia, the traditional industries give you the possibility of better exits. The multiples may not be as great as the tech investments, but at the same time, you will have more potential exits. But, unfortunately, these companies are going to struggle to find people to fund them, and they’re going to have to go to banks for example, to help finance some of their growth. They’re going to have to go to friends and family. Just the traditional ways and bootstrap the company and grow it.
So VCs are never an option for non-tech companies?
It really depends on the geography. In India, some VCs have done non-tech type of investments. It could also be that just because the market is large enough, there have been certain VCs that have sort of stepped out a bit from the traditional tech and have done a little bit of, what I would say are, non-tech type deals, and InnoVen has also done some of those deals. So it really depends on the geography. In Southeast Asia, it is more difficult for InnoVen to be doing non-tech deals because one of the premises of when we invest is that, there should already be a strong VC behind the companies that we lend to. And if the VCs are not investing in non-tech companies, it’s very difficult for us to then lend to those companies.
Venture capital funding in Southeast Asia has matured over the last five years. Typically venture debt follows VC funding, going by the model in the Valley. Why did it take so long for venture debt to arrive in SEA?
If we go back to 2000, there actually was venture debt in Singapore back then. My former partner and I at another venture firm had a JV with a local bank in Singapore to do venture debt. So we actually did venture debt from 2000 to 2003. Then the bank got acquired by a bigger bank, and the latter decided against continuing with the program. So from 2003 and until probably last year, venture debt was not available in Singapore. Venture debt usually follows venture capital and there’s probably a delay – it seems like in this case, the delay has been for about four years. Everyone always knew there was a gap, and people always thought that the market of Singapore alone was too small. I know that a lot of financial institutions from the West have looked at Singapore for doing venture debt throughout the years, but they could never really get comfortable with the size of the market in Singapore. So now when you open it up to Southeast Asia, I think people start saying, “Ok it’s a much larger market.” That’s why venture debt took awhile because all the financial institutions in the West that were involved in venture debt never got comfortable with the fact that Southeast Asia was a big enough market.
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InnoVen has announced that it will provide $500 million in venture debt loans over the next five years to startups in China, India and South East Asia. Will all of this capital come from your promoters – Temasek Holdings and UOB? Will you have to raise capital from outside? What are your plans for China?
The original commitment from UOB and Temasek is $100 million each, and this shows they are supportive of venture debt. This commitment is for all geographies and not just for Southeast Asia. As those plans come together I guess we’ll find out how much of that capital we will need to build up the business. I don’t foresee having to raise capital, or to get additional capital to execute the plans that we have today. We have more than enough to address the opportunities that we are looking at the moment.
We are looking at China at present, where we’ll hopefully have something up and running probably by the end of the year. I am not involved in the discussions on China and therefore can’t comment on the size of the team we will have there, but I guess it will be a small team to start. The way InnoVen has addressed each of the markets is that, we’re pretty careful in terms of getting the right people, and also for us it’s not about the number of people – it’s really trying to get the right people with the right mindsets and for them to slowly build up their team. I don’t think we want to over extend just to be in a particular market.
How big is the venture debt space in Southeast Asia? Are companies aware of venture debt as an option – so does your job also involve educating companies on venture debt?
First question is the size of the market. If you look at Israel and the US, venture debt as a percentage of the venture capital market is around 10 to 15 per cent. So if you look at a billion dollars worth of deals done in Southeast Asia last year, and let’s say $800 million this year, you then say 10 per cent of that should be venture debt, you get around $80 to $100 million per year in potential venture debt transactions. This frames the size of the market to some extent. In terms of opportunities, it is a $100 million opportunity per year.
I think education will be a large part of what we will be doing. What we’ve done here in Southeast Asia for the first I would say six months, is really to reach out to a lot of the VC investors in town to explain what venture debt is, and how typical companies would use venture debt and how it would be beneficial for their portfolio companies. We have not reached out as much until probably last couple months to the entrepreneur community because we wanted to close a few transactions firs, and then at least point to those deals and say, “Here’s what we did for this company…or for that company.” So that the founders and the entrepreneurs will understand how it is used. And I think education will be a large part of it. If you look at what India’s done, they’ve had probably done a volume of transactions over the last couple years, and so it’s probably taken about 4 years to really educate the market of the benefits of venture debt, as well as introduce the concept to get the people comfortable with it – both the VC community as well as with the entrepreneurs.
Over the last couple of months – from the end of the last calender year, there has been a slow down in funding. Valuation markdowns, down rounds, business model pivots, shutdowns and investment write-offs have become the staple this summer. Has it increased awareness/interest in venture debt?
It is difficult to compare what we’re seeing now versus anything before because we (InnoVen) just sort of started in this environment. I would agree that it is taking companies a lot longer to raise funds. The amounts they want to raise or they thought they want to raise has been reduced in many instances. So I think companies are exploring all their options, and usually what will happen is that, there will be a referral through the VC for one of their existing portfolio companies, and they will reach out to us and say, “Take a look at this company. I think this one is something you guys should look at.” But I think we’ll get that in good times and sort of not so good times – so it’s very difficult for me to compare what I’m seeing now versus since we’re starting in this environment. It’s hard to say if venture debt will see more interest now, because in good times also you want venture debt as you want to minimise dilution. So if things are going well, equity values are growing at a much faster pace, then also there is more interest in venture debt because you want to make sure you don’t give away too much equity. In bad times I think venture debt is also useful because it’s an additional source of capital that you can use in addition to equity capital. So I think we’ll see venture debt in both good times and in bad. It’s tough to say that one would drive more deals than the other.
What InnoVen looks out for when it provides venture debt to startups? Do you have a ticket size?
It depends on geography. India is probably more geared towards the Series B rounds and Series C rounds. In Southeast Asia, we’re still trying to figure that out – It’s still early for us, but it seems to me at an early stage, we’ll probably see more of a Series A deals here. In China, we haven’t been on the ground there yet, so I really don’t know how that’s going to play out. So that’s for the stage. We will look at each company on a deal-by-deal basis.I mean there are common things we always look at, but I think it’s not specific to stage.
We like to keep granularity within the portfolio so we don’t want one deal, if it falls apart for example, to ruin the portfolio. So the average deal size for us is around $2 million, and I anticipate that remaining fairly constant in Southeast Asia. It will probably be a bit lower than that in Southeast Asia, and maybe a little higher India for example. We don’t really have an upper limit or sort of lower limit that we can do. It really depends on the size of the company, the size of the round that they have just raised….
We look at a lot of the things that VCs would look at, but our focus is particularly on two things. One is probably looking at the financial model, and with respect to cash flow in particular, and also determining how many months of runway the company has left before they have to raise additional funds. So that’s a metric that we typically use as a yardstick to say, ‘ok three months of runway is definitely something you cannot do’. As you get closer – probably 9 months, 12 months, 15 months, it looks better for us. That’s one thing we probably do.
Our investment amount is really targeted upon how much was the last equity round. We always advice companies not to take on too much debt – so usually if a company raises $10 million, I think we’ll be comfortable lending $2-2.5 million. I don’t think we would want to do much more than that, but in certain cases we would. So I think our greatest exposure has not so far exceeded $5 million on any deal but there are a couple of deals I think we’re around between $4 million and $5 million.
Has InnoVen looked at sectors such as healthcare and clean-tech?
We have not gone out to target specific sectors. For us, it’s really whatever the VCs have been investing in – we sort of are looking at those same sectors. So if there’s no investors looking at say clean-tech, for example, it would be very difficult for us to be involved in a clean-tech company. Because a lot of time, we look at the repayment sources for the loans that they take – it comes from two primary sources, revenue for one, and then also future rounds of financing for the company. So if there are no investors to potentially invest at the next round, that’s something we would consider when making our evaluation.
How bullish are you on the startup scene in Southeast Asia in terms of concepts and ideas? So far, a majority of the startups here have been clones of successful models in the West. Do you see that changing?
I’m bullish. Companies and founders will evolve. Right now you are beginning to see more business model innovations rather than just imitations from the West. Yes, a lot of startups are copying successful business models from the Valley, but I think that will change overtime. So every market will be different – but I am sure Southeast Asia will evolve, and I am bullish that eventually there will be a good mixture of real technology innovation, as well as business model innovation and also more efficient companies here. There is the opportunity to really develop certain unique technologies out of this region.
Southeast Asia is a thrilling frontier for the tech business, but increasingly we are seeing government across this region getting more and more involved – so many of them are creating funds to invest in local startups, hoping to foster new tech hubs. When civil servants put money into companies, what are the risks?
Overall it’s a good thing, but again, if there’s too much of a good thing it can become a bad thing – so I think the good thing is that the good intentions are definitely there. I think people understand that there have to be some steps taken to sort of initialise and start the process to get startups going and the ecosystem rolling. If the private sectors can’t do it for whatever reason, and the governments start thinking that this is important, then I am happy to see governments take that step and say,”Ok we’re going to give this a try to see if we can make this work.” Now if there is too much of government involvement, then I think I would agree that if it’s not working – either you need to change it and try another way. But if you looked at what the Singapore government has done, they’ve constantly evolved the model in terms of how are they trying to catalyze entrepreneurship in Singapore. It started way back in ’95 – they’ve gone through several iterations, every time getting a little bit better at trying different things and not repeating the same things in the past that didn’t work, and focusing on things that did work. So I think that’s been a positive thing, but I think just blindly throwing money at a problem is not the answer. But I do think that if you have some smart people in the government, and if you can spot the trends, then governments are in a great position to do kickstart the startup ecosystem going, especially if the private sector is not doing it.
Does Singapore have the potential to be the equivalent to Silicon Valley for Asia?
Singapore market is simply too small to be the Silicon Valley for Asia. People always talk about copying the Silicon Valley model – I don’t think you’ll ever be able to copy Silicon Valley. Everybody’s going to have their own hot spots of innovation, and those hot spots are all going to take their own shape and form. Each country will have their variations, and several such jurisdictions around the world will sprout up – for whatever reason and I think Singapore is doing well in that regard. Everybody uses Singapore for a test bed for innovation, a test bed to see if you can make it work and then from there expand it to the region, expand it to the world.
Be it venture debt, or VC, exits have been a huge challenge in Souteast Asia. As an investor, at some point, you need to look for exits. One of the routes is a IPO. But increasingly, there are very few takers for a listing on the SGX, or for that matter anywhere in Southeast Asia. How does this impact the ecosystem overall?
Exits have been the biggest challenge in Southeast Asia. You can go back 20 years, and really have not seen the huge exits to be fair. If you talk to people in Silicon Valley – this is probably outdated numbers – but I would say in the 1990s and 2000s you would have, for every company in a venture portfolio, there are probably three M&As to every IPO. So out in Asia, even today who’s acquiring tech companies? I mean you don’t have the Googles out here. You don’t have the Facebooks. You don’t have the Ciscos. You don’t have the big tech companies acquiring the smaller ones. So there are no exits out there. I mean China’s getting some of that you know with Baidu, Alibaba, Tencent, so that’s helpful. But I don’t know how much these Chinese companies are looking to do in Southeast Asia.
You’re seeing bits and pieces of exits over the last few years. I mean Alibaba’s acquisition of Lazada recently – that was a good thing for the market. We’re seeing smaller acquisitions – less than $50 million types. So we’re starting to see some. Once in a while you’ll see something that’s around the $200 million dollar mark in Southeast Asia. So I think there are hints that there could be some bigger exists, but I think that’s always been the challenge. If you look at the IPO market, there’s no exchange out here, except for maybe Australia Stock Exchange, that is seeing listings. We have no large tech companies here – we have no buying companies – so how do these guys exit? And that’s always been a challenge out here, not just now, but since the early 90s when the whole push for entrepreneurship in Singapore was started. So it’s a challenge – I don’t think you can get away with it. And that’s what I think is the biggest impediment to a lot more capital flow into the region because no one can see an exit. But once you have that, say a half a billion dollar exit, you’re going to have a lot of funds around the world going, “Ok maybe I can find the next one.” And then more money will come in. There will definitely have to be exits if we are going to get more LPs to invest – there’s no doubt about it. I mean the LPs have a lot of options in terms of where to put their funds, and if one geographical allocation to venture capital doesn’t work, they can switch that to somewhere else fairly easily. So I think exits are important to VCs because they need to justify why they took the money from the LPs.
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We’ve been celebrating the Singapore and Southeast Asia startup scene for some years now, but where is the region’s Google? China built its own Google – Baidu (helped by its government policies), and Alibaba has displaced Amazon there…When will we see such meta-level startups in this region?
I think they’re definitely possible. You see some companies sort of reaching that status fairly quickly, I will say. Grab would be definitely one and you’ve got several in Indonesia that have also sort of getting to that stage. The answer is definitely ‘yes’ – there is the opportunity to get there. It’s probably a little more challenging in Southeast Asia just because it’s not one homogenous market – you’ve really got several markets. It will probably be more difficult out here although Indonesia is seeing a lot of investor interest. That’s also potentially a very large market. So there are definitely those opportunities out there in Indonesia to build large startup companies.
With a 250-million strong population spread across 17,000 islands, Indonesia definitely offers a mixed bag of huge opportunities, but equally enormous on-the-ground challenges. PE has not have a great time in Indonesia over the last couple of years. We see a lot of investors rushing in, but will Indonesia deliver?
Definitely there’s opportunity in Indonesia. I think they will deliver – that country will definitely over time. It really depends on timeframe you’re looking at – just like China. If you are looking for a ‘quick in, quick out’ type of scenarios then it is tough. You really have to be patient and the timeframe is probably a lot longer than you would expect.