Investment activity in the Southeast Asia region will continue in 2023 but investors are expected to scrutinize valuations more closely, according to Southeast Asia venture debt provider InnoVen Capital SEA.
“Fund-raising is projected to get tougher in the following year and this will force companies to be disciplined in their expenditure, prioritizing spending on activities which are accretive to the bottom line and minimizing cash burn rates,” its Partner Ben Cheah told TechNode Global in a recent interview. “This financial discipline will not only help companies survive tough times but will put them in a better position to grow even faster when the market recovers.”
His comments come as financial markets across the globe have experienced valuation shocks due to rising interest rates, causing private market investors to become cautious about the valuation levels.
This risk-adverse behavior, he said, coupled with the wariness of not overpaying, has caused the pace of investments to slow down. A lot of startups that have sufficient capital on hand are also postponing raising funds given these market conditions, Cheah noticed.
To weather the forecasted slowdown in venture capital funding, he opined that early-stage companies can incorporate venture debt into their equity fund raising rounds to increase the size of the round while keeping equity dilution minimal.
“Companies can then use this debt funding to fund a wide variety of purposes such as working capital, inventory, capital expenditure or acquisitions, ultimately helping companies to not only extend cash runway but also to sustain their growth,” he added.
Southeast Asia was introduced to venture debt only six years ago, Cheah said. As the technology ecosystem grew and flourished in the region, knowledge and demand for venture debt grew steadily over the past six years. The appeal of venture debt has also been accelerated by current market conditions. More companies are starting to explore minimally dilutive funding options like venture debt as equity valuations come under pressure, he said.
“With Southeast Asia’s continued attractiveness as an investment location and rising venture capital activity over the past decade, we will only continue to see an upward momentum for venture debt,” he shared.
InnoVen Capital SEA is the leading venture debt provider to start-up and growth stage companies in the region. It pioneered the concept of venture debt in Southeast Asia, and are the trusted partner for companies to accelerate growth and extend cash runway while optimizing equity dilution, according to its website.
InnoVen Capital is Asia’s leading venture lending platform providing debt capital to high growth, venture-backed technology companies. It is established as a joint venture between Seviora (a wholly-owned subsidiary of Temasek) and United Overseas Bank in 2015. In June last year, InnoVen Capital announced that it has closed an investment from Japan’s Aozora Bank into its South East Asian Venture Debt fund.
Meanwhile, from InnoVen Capital SEA’s point of view, Cheah said venture debt should always be an option for all startups to consider regardless of market conditions, as it allows founders to raise more capital to grow their companies at a less dilutive cost.
“The current macro environment allows companies to raise capital without having to set a valuation, and we have observed that more companies are interested in venture debt in Southeast Asia. InnoVen Capital continues to see strong interest in venture debt, not just from early-stage companies but later-stage companies that have closed large rounds of funding but still want to use debt to raise even more capital to extend their cash runway,” he added.
In the interview, he also shared his views on how can startups strategically leverage venture debt to extend their cash runway, advices and suggestions to startups on how to decide the suitable ratio between equity fundraising and venture debt, among others.
Below are the edited excerpts:
Southeast Asia venture capital landscape for 2023 – what do the continued Fed rate hikes spell for the venture capital market in 2023 and how will both investors and startups be affected? Will the market see any form of stability in the year?
Financial markets across the globe have experienced valuation shocks due to rising interest rates, causing private market investors to become cautious about the valuation levels. This risk-adverse behaviour, coupled with the wariness of not overpaying, has caused the pace of investments to slow down. A lot of startups that have sufficient capital on hand are also postponing raising funds given these market conditions.
However, many startups still need to raise money for a runway extension, and we have observed that much of the capital raised for Southeast Asian venture capital investments has not been deployed. Hence, although the region is not immune to the global macroeconomic situation, we believe that investment activity in the region will continue but with investors scrutinizing valuations more closely.
What are some of the positive impacts companies will gain as they reassess where and how they spend in the coming year?
Fund-raising is projected to get tougher in the following year and this will force companies to be disciplined in their expenditure, prioritising spending on activities which are accretive to the bottom line and minimising cash burn rates. This financial discipline will not only help companies survive tough times but will put them in a better position to grow even faster when the market recovers.
How can startups strategically leverage venture debt now to extend their cash runway in order to weather the forecasted slowdown in venture capital funding?
Early-stage companies can incorporate venture debt into their equity fundraising rounds to increase the size of the round while keeping equity dilution minimal. Companies can then use this debt funding to fund a wide variety of purposes such as working capital, inventory, capital expenditure or acquisitions, ultimately helping companies to not only extend cash runway but also to sustain their growth.
How should startups decide the perfect/ suitable ratio between equity fundraising and venture debt? Do you have any advice/suggestions?
The appropriate ratio for each company is different and specific to the business model and situation of the company. Some factors companies should consider are whether the debt can be secured by tangible collateral, whether the projected debt repayment is from profits or future fund raise, current cash runway, use case for the debt and how it will help the company raise a subsequent funding round or achieve profitability.
In what kind of circumstances venture debt is a better option? Or is it just a matter of preference?
Generally speaking, venture debt could be a better financing option as opposed to equity financing if there is high certainty that it can be used to generate future cashflow that can be used to fully repay the debt. However, because there is always an element of uncertainty in business, a mix of debt and equity is always recommended.
What is the general view on venture debt these days? How is the trend like in the Southeast Asia region as compared to other regions? Is it getting more popular? Why or why not?
As venture debt has been available in Silicon Valley since the 1980s, raising venture debt is a reasonably common financing strategy for startups and technology companies in the US and even Europe as those markets are more mature.
Southeast Asia was introduced to venture debt only six years ago. As the technology ecosystem grew and flourished in the region, knowledge and demand for venture debt grew steadily over the past six years. The appeal of venture debt has also been accelerated by current market conditions. More companies are starting to explore minimally dilutive funding options like venture debt as equity valuations come under pressure.
With Southeast Asia’s continued attractiveness as an investment location and rising venture capital activity over the past decade, we will only continue to see an upward momentum for venture debt.
From InnoVen Capital SEA’s point of view, what is the potential of venture debt?
Venture debt should always be an option for all startups to consider regardless of market conditions, as it allows founders to raise more capital to grow their companies at a less dilutive cost. The current macro environment allows companies to raise capital without having to set a valuation, and we have observed that more companies are interested in venture debt in Southeast Asia. InnoVen Capital continues to see strong interest in venture debt, not just from early-stage companies but later-stage companies that have closed large rounds of funding but still want to use debt to raise even more capital to extend their cash runway.
How do you manage risks, especially when there are many uncertainties, such as the startup job-cuts and potential slowdown in many economies?
We will continue to be rigorous in our due-diligence process, looking at companies which are backed by strong investors, show strong unit economics and sufficient cash runway.