Startups: Dont get caught in the missing middle

Can you find a place on this planet where it is easier to start a venture than Singapore? Thanks to various schemes by government bodies like National Research Foundation, Spring Singapore and other agencies, you at least have 25 different sources of seed capital. You can even get enough grants to keep your company alive for first few years. In my personal view, if you can’t raise seed money here, you do need to seriously think about your chances elsewhere.

But the real drama starts AFTER you have raised the seed money. Most people believe that half a million dollars is enough to take the company to the next level. Hard to disagree if you are a couple of graduates working on a cloud based application or a mobile app. But not all startups fit that bill. If we want to build serious technology based startup companies in Singapore, then we are looking at much higher monthly burn rates and/or much longer incubation periods.

If we look at emerging markets around us, there is so much opportunity in solving real needs of the masses. But all we are busy doing is creating these lite web and mobile based products which most of the times are clones of startups in America. Hard to see solutions around that can have real targeted impact.

One of the reasons why we don’t see innovative technologies around is because those few who tried in the past failed miserably. Some of them failed because they had poorer technology but some failed because all they could develop with seed money was a prototype or a not so commercially viable product. Most sensible people would now ask - " Why were they not able to raise more money to continue developing or marketing their product?". This is what gives me a pause. Try raising a follow on funding with a prototype in hand. Most follow on investors in Singapore are "Growth" investors and their first question: "How much is your revenue?". Most rejection letter would be worded around these four words - “too early for us”.

We either have lot of seed stage investors or lot of growth stage investors. Who is going to invest in between? Can government do something about either enabling seed stage investors to move beyond this half a million limit or encouraging growth stage investors to take more risks by de-risking their pre-growth investments?

Until something happens at the government level, what would you do if you are thinking about starting up a company that needs more capital and time. I dont have the perfect answer for you. But you can try creating a syndicate between everyone who you can rally together. Find angels and/or strategic corporate investors who are willing to co-invest with incubators. There are some exceptional firms like Walden who do invest in pre-growth. Infocomm investments probably would be willing to co-invest if you have a lead investor. You could try some GIP funds listed here http://www.edb.gov.sg/etc/medialib/downloads/why_singapore.Par.9434.File.dat/LIST%20OF%20GIP-APPROVED%20FUNDS.pdf because they are required to make some early stage investments in Singapore based companies to get tax exemption. You can also think about leveraging research assistance from agencies like A*Star.

It is not easy but you can't do ordinary things to build extra-ordinary stuff. The effort required would also be extra-ordinary. Just be mindful of the missing middle.

Why is VC money relatively scarce in Asia?

"What are you doing here in ....., you should be in Silicon Valley". Do these words sound familiar to you?

In Asia, it is not very uncommon for Founders with great ideas to either run their companies in boot strap mode or relocate to Silicon Valley. Even great talent is expected to take huge pay cuts when they plan to join a startup. We dont need a scientist to figure out the primary cause of this issue. This is primarily because of the scarcity of risk capital in Asia. Good ideas have to slog for cash. One of the key factor that gives wings to the dreams of most Silicon Valley startups is the free flow of capital that lets them dream big...really big. Silicon Valley is blessed with excess capital. And, that is probably why failure is embraced. How do they get that kind of money? What is the source? Who are these Limited Partners (LP)?

As per Wikipedia, the sources of funds are Public pension funds, Corporate pension funds, Insurance companies, High Networth Individuals (HNI) / family offices, Endowments, Foundations, Fund-of-funds and Sovereign wealth funds. In addition, there are many cash rich corporates that have their strategic investment arms hunting for opportunities.

Compare that with the sources of funds in Asia:

1. Do you think any government in Asia would allow pension funds to become LPs in Venture Capital funds?

Certainly not. At the most, governments would allow use of pension funds to be invested in real estate and approved listed equities. CPF Board of Singapore allows a portion of provident funds into property, gold, selected equities and top 25 percentile managed funds. All the usual suspects of low risk investing. Nothing wrong with that. I also view that as prudent considering the fact that venture capital industry as a whole is a loss making industry. Of course, we hear everyday about the success stories of Facebook, Google, Twitter, etc. But we choose to ignore the stories of failures. I read a report recently ( http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.pdf) that mentioned that the average VC fund in US fails to return investor capital after fees.

2. Do we have foundations and endowments who can risk a portion of their money?

No. Most endowments and foundations outside America would choose to place their money into fixed deposits with highest rated banks or managed funds. In Singapore, the three local universities (SMU, NUS and NTU) together have about $2.7 billion in endowment funds plus another $1.7 billion in accumulated surpluses and operating funds, some of which is actively managed. Portfolio allocation to venture capital is probably close to zero. Compare that with Yale and other educational institutions in USA. Yale allocates 33% of its portfolio to private equity (venture capital and leveraged buyouts). Average actual allocation of an american educational institution to private equity is around 10.5%. Since 1976, Yale participated in a number of startups that helped define the technology industry including Compaq computer, Oracle, Genentech, Dell Computer, Amgen, Amazon.com, Yahoo, CISCO, Red Hat, Juniper, Google, Facebook, Linkedin, Twitter and Zynga. Its investment policy document says : Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management.

3. Do HNIs have any incentives to back risky tech startups?

Not at all. High net worth individuals are so busy doubling and tripling their money every year in emerging economies and traditional sectors that no one has any bandwidth left for technology. Recently met some HNIs who were busy buying hotels and warehouses in Myanmar and Srilanka. What kind of IRR can GPs offer to beat emerging market returns? What I mean to say is that the traditional sectors are growing at such a fast rate that HNIs have no incentive to look for other alternative investments. The society is highly entrepreneurial but unfortunately no incentive yet to try out tech entrepreneurship.

So what are we left with? How can tech entrepreneurship flourish in Asia?

In my view, corporates can play a big role here. In South East Asia, SingTel has shown leadership by launching their fund Innov8 and sponsoring an incubator called JFDI. If top 10-20 corporates in each country can launch similar funds and sponsor incubators, it would certainly create a demand. And may be that demand for investment opportunities would act as a catalyst for some of the wannabe entrepreneurs as well as angel investors.

In addition, if University endowment funds can also allocate 5-10% of their portfolios toward venture capital, it would be a great boost for the entire tech startup ecosystem.

Hope for the best,
Piyush

Risk Management for Early Stage Venture Investing

Andreessen Horowitz recently revealed that its investment of $250K in Instagram became $78 million. Thats a multiple of 312. Investing in early stage ventures is indeed very rewarding yet inherently risky. It thrives on multiple high risk bets out of which one or more would achieve high rewards. But that certainly does not mean putting blind bets on anything that comes your way. Those who believe in "Spray and Pray" kind of investing are often losers in the long term. Most VCs through their experience would have developed some sort of an internal braincloud (mental) checklist which gets ticked during the pitching sessions. Relying on mental checklists again is risky. Some or more of those check points might get sidelined if the idea falls into one of the soft spots of the more influential team members. So how can venture capital funds systematically mitigate undue risks?

Here is a list of risks inherent in Venture investing along with practical risk mitigation strategies and if needed a Jugaad. Jugaad colloquially means a creative idea, or a quick workaround to get through commercial, logistic or law issues.

1.     Risk of the Unknowns : Most people think a business is after all a business whether it is hi-tech or low-tech. If it makes money, why shouldnt one be part of it. Some argue that if one understands the need of such a product/service, one qualifies to invest. But most would forget that it takes a lot more for a venture to succeed than just a great idea. Devil is always in the detail and execution. If you come from an e-commerce background and are offered an opportunity to invest in an orthopedic surgical device, think twice. How would you figure out what is the right amount of field trials you need to carry out before pitching it to potential acquirers? What makes more sense - licensing the technology to an existing player or go solo?
Mitigation: Invest ONLY in areas where Fund Managers have some domain knowledge.
Jugaad:  If you are excited to support an idea where the investment team does not have relevant expertise, the fund management should think about appointing an advisor who knows that domain and is willing to work closely with one of the investment team members.

2.     Risk of loss of visibility: This is something I have learnt from my own and my partner's experience. I am a firm believer in technology and remote working when it comes to Shared Service Environments in large multinational companies where job descriptions are clearly laid out and roles are well defined. However, it just doesn't work in startup environment with founding team sitting in a different time zone. Having a development centre alone in a different time zone can create headaches and delays.
Mitigation: Invest LOCAL.
Jugaad: Appoint local advisors as representatives and enhance corporate governance measures by inviting -local independent directors to the board.

3.     Risk of Founder's fatigue : Starting up is hard enough. Doing it alone makes it even harder. What would you do if the key founder throws in the towel? It is indeed very difficult for a startup to find a CEO material to pick up and run.
Mitigation: Invest in TEAMs not Individuals. Also, test individuals in the team by offering them less salaries than their expectations. This would be a small test for them to prove that salary is not their motivation and they understand the big common goal.
Jugaad: If the founder has prior track record, that can be viewed favorably.

4.     Risk of running out of cash: Most startups before getting proper funding are in boot strapping mode. Spending is conservative and revenue prediction is optimistic. Who hasn't seen those hockey sticks and the great magic of excel? But as soon as they get investor funding, startups tend to shift modes. They think more like a real company with real overheads.There is nothing wrong with that except the fact that monthly burns suddenly shoot up to such an extent that there is not enough time left to pivot. If the idea spreads virally, it works. Otherwise, founders are happy to treat this as a learning opportunity on the scholarship provided by VCs.
Mitigation: Assess how much cash is required as per the most reasonable forecast. Multiply outflows by 1.5 and inflows by 0.5. Scott Anthony says: "It always takes longer and it always costs more." Fund the company with at least 20% more than the number you arrive at. An early stage company needs at least 18 months runway.
Jugaad: Syndicate with someone who can do follow on investments. You are going to need that money whether the company does well or not.

5.     Risk of post marital blues : It is very common to have disagreements whether it is among co-founders or between founders and investors. Being humans conflicts are inevitable. Most of the time people manage to settle these issues by a little give and take. But there are instances where there are gridlocks and relationships become so sour that the parties can't even stand each other.
Mitigation: Investment lead should be identified and allocated to the investment opportunity even before the first pitch. This person, through the course of due diligence, must pose some difficult questions in front of the team and observe the team's reaction. If the team shows any signs of arrogance or denial, this must be looked into greater detail.
Jugaad: None. Stay away if you see such early signs.

I sincerely believe that there really is a science to nurturing successful startups, and that it has to do with methodically knocking down risks to get to the rewards.

Happy Investing,
Piyush