2018 musings — continued

Deeper dive into what 2018–19 might look like in Asia

A few days ago Joji, founder of DealStreetAsia, wrote to interview me for a piece in the Mint. The piece was later published here. I thought of reposting the unedited excerpts from the interview here in case you haven’t had a chance to read the Mint or DSA piece.

On a side note, I feel DealStreetAsia is doing a wonderful job of covering the private investments sector in Asia. The other company doing justice to tech journalism in my opinion is The Ken in India. It’s no coincidence that the founders of both these companies have their roots in business journalism at Mint. Their love for no-nonsense deeply-researched good stories is quite evident in the content on the two platforms, probably the only two that I consistently read for getting my latest in Asian tech news.

Q. Venture debt appears to be taking off in India — a lot of firms (including several VCs) are raising capital to offer venture debt. Is this space robust enough to see such heightened activity?

Second, while traditionally, it has been startups in the Series B and later stages that opt for venture debt, we are now seeing a scenario in India where companies are looking at this route even at the Series A stage — so, is there a gap to plug here (Series A venture debt). Also, with other funding options drying up, are startups underestimating the risks in taking venture debt?

A. Venture debt has its benefits and there are business models where it makes a lot of sense. However, I don’t think it’s being done all correctly yet. The risk assessment by most venture debt investors is not so much by the cash flows and business models of the startup, but more based on which large investor is backing the startup. This way the debt investor rests assured that the startup will (most likely) not go bust due to lack of capital and given that debt sits on top of equity, the debt investor will always get the first piece of the pie at the time of liquidation/payoffs. There is a case to be made that this approach will be made smarter and more democratic in the future. Currently though, I don’t believe that a startup that is not seeing interest from strong equity investors in the market can go out and raise comparable amounts of debt.

Series A venture debt has always been very active with investors such as Innoven. In fact Innoven claims to have invested $75M in the market in 2017. The debt amounts per company in the A rounds are smaller but it’s also a way for the debt investor to build a relationship with the company so as to increase leverage in the future. Further, most debt investors ask for warrants and getting warrants at Series A stage on a potential unicorn company can be a big cherry on the cake for the investor.

From the point of view of larger funds raising venture debt, it’s about getting more payoffs from the same deal. Just like investors are getting more and more sensitive to ownership so as to see good returns at the time of exits, they are trying to increase returns in any way possible. By starting to issue venture debt as well to their portfolio they can potentially return at least some capital back to the LPs in an exit-strapped market while still earning management fee from a larger fund size. Win-win all around for LPs, GPs, and maybe startups, as long as the business can support taking debt.

Q. Take out the SoftBank-backed exits and India’s venture capital industry doesn’t look in terribly great shape — how do you see the road ahead?

A. If you mean the exits are still to come, yes you are right. I do feel this will change. We have had strong capital markets in the last few years and last year was exceptionally crazy for the public market, albeit in the traditional sectors. A lot of fresh capital has been unlocked for the public markets due to a combination of demonetization and low interest rates (which is likely to be a new norm rather than exception). This capital is hungry for yield and you can make that yield in tech, even in late stage companies. VCs such as IDG Ventures have managed to receive liquidity through IPOs (see Newgen Software that just went public this month).

As for Softbank, they have taken a long term bet on the country and given the quantum of this fund along with the planned future funds, they won’t be going away from the market any time soon. In fact, with other late stage funds now trying to raise more capital to compete against Softbank, this is just going to become an even more active market, a good thing for secondary exits. All of these are good signs for the industry, but if you ask is all solved on the exit front, then the answer is no, and it will take a few more years for the real picture to emerge.

Q. Related question — Looking back at 2017, the responsibility for the downturn in startup ecosystem lies as much with investors as startups — yet, we’ve not seen much of a shakeout in India’s VC industry — why is that? When do you see LPs start asking VC firms tough questions about the chronic lack of exits in India’s startup business?

A. We don’t have US and Indian LPs in our fund, so it’s tough for me give you an insider view point on this. However, the shakeout that you mention seems to be happening already and the media has covered this enough in the news. Top tier VCs seem to be having to answer tough questions, some partnerships have broken up, junior partners are stepping out to raise their own funds with a sounder and more innovative thesis. The next couple of years will be interesting ones in the venture capital industry in India.

As for the LPs, I can tell you that Japanese and Chinese investors are increasingly looking to get exposure to the Indian market in search for yields. Some of them tried to do investments directly but are not achieving much success. I see this capital coming in to the Indian startup sector indirectly through local/regional funds in the next couple of years.

Q. You are of the view that going forward, India will now see strong early sage companies being built, from all the learnings of previous failures in 2016–2017 — what are these learnings? Also, do you see a scenario where the same mistakes are repeated with investors and VCs rushing in to fund any sector that is hot — for instance, we are now seeing several VCs, even those who have traditionally avoided the space doing consumer.

A. There were two key learnings from the 2016–2017 cycle. First, that the India that buys 1000 rupee T shirt from Flipkart/Amazon or books a 300 rupee Ola/Uber ride daily is different from the India that buys a 200 rupee T shirt from a neighbourhood store and rides a 10 rupee public bus every day. And there are very few people (less than 30M) at the top of the pyramid. Second, businesses need to focus on economics from day one rather than wait to hit scale and let economies of scale achieve the right margin structure.

As a result of these learnings, I do believe that 2018–2019 will be a very strong cohort of startups in India. We’ll be more tech oriented, we’ll be solving real problems, and we’ll be solving local problems. All of this due to our learnings from past mistakes (I won’t go so far as to say failures). Companies such as PayTM are paving the way to reach the Indian-mass consumer. I see more companies targeting the mass consumer and more importantly with stronger business fundamentals coming up in the next couple of years.

It’s likely that we’ll repeat some of the mistakes that we made in the past, it’s human tendency, as we can even see in the American capital markets. But I’m hoping that we’ll remember at least the most important lessons from the past few years.

Q. Singapore government is going all out to ensure that the country comes out on top for AI and fintech startups — but apart from capital, a lot more is needed to become global leaders in this space — and so, what are the challenges? Second, can government-led initiatives really lead to success here?

A. Achieving global domination in tech is a bit difficult for Singapore, as the country is so small and it’s difficult to compete against the quantum and quality of existing talent in US, China or even India. The intention of the government, to my eyes, seems to be tuned towards staying relevant. Singapore has always been a services and trade-led economy, with financial services being a key contribution to the country’s success. The government is smart enough to see that the financial services sector is likely to get disrupted by fintech and the services economy by advent of AI. In such a scenario, the country has to try and stay at the forefront of these two emerging sectors.

True, capital is only a small part of the equation. The bigger challenge is human capital. The race for AI domination is really at this point the race for AI talent. Singapore is in good stead due to strong research focused universities such as NUS and NTU. The challenge ahead is how to bridge academia with technology that can be commercialized, and how to continue attracting foreign talent to come and setup their fintech/AI hubs in Singapore. The government has done this before with the services economy, and can potentially do it again with the tech economy.

Q. There is a lot of excitement around Indian Saas startups. India is now home to more than roughly 500 SaaS startups. But considering that for most SaaS startups, over 80% of their customers are abroad, is India just a place to build and base a SaaS startup, taking advantage of cost arbitrages? Second, in the long run — with most customers being based abroad, what are the business prospects, because increasingly these companies will have to hire more resources at pay scales of that of their global competitors or even higher to drive sales — plus they will have to factor in increased costs of servicing, building distribution channels…

A. Yes I agree with you there is a lot of excitement on the Indian SaaS story. Some of these companies such as Freshworks and Zoho have so far relied on cost arbitrage as their primary competitive advantage, but this is now changing. The tech salaries in India have risen astonishingly in the last couple of years and new startups cannot take the same route as that of their predecessors.

Going forward, in my opinion, we’ll start seeing more domestic focused SaaS. The challenge there is that enterprises in India (small or large) are usually unwilling to pay for software, hence the companies using the SaaS model will have to find newer business models. SaaS-enabled marketplaces are one of those ways, leveraging and monetizing data collected through software embedded in organizations is another such way. The good thing is that there are huge inefficiencies in the Indian enterprise sector, there is so much to be done that I am confident the sector will shape up well in the next few years.

Q. A lot of Indian VCs have started looking at SEA. Similarly, SEA-based VCs are now looking at India. We have a scenario, where each side thinks that deal flows in their particular regions are not good enough and want to expand their geographic area of focus? Is this strategy flawed? Often without feet on the ground, can you source good deals in other geographies?

A. I am a big believer in cross-border synergies between SEA and India. I have been living in Southeast Asia for 4 years now and I see huge similarities in markets such as Indonesia, Vietnam, and India. People in these countries are ambitious, infrastructure is lacking, and there is availability of good talent. I tend to see many businesses in SEA that are growing on similar lines as those in India and finding similar success while making similar mistakes. We need to learn from each other’s mistakes and collaborate to achieve success. The next few decades of global growth WILL come from Asia, it’s time that we unite together to achieve this.

Yes, it is necessary to have feet on the ground to source the best deals. But that doesn’t mean you cannot build cross-border knowledge within the fund. Just like companies scale regionally and then globally, VCs need to also, only then can we learn from what we see in different markets and reduce inefficiencies in each market. This is why GREE Ventures as a fund covers three markets: Japan, Southeast Asia, and India with individual sourcing and management teams but a centralized investment committee. We learn from each other’s successes and failures, and apply it every day to our portfolio to build better companies. As long as the fund can strike a balance between scaling and management, I only see the positive points of scaling.