For a while, I want to sketch out some perspectives on venture capital in Asia, given that I have been observing the flurry of fundraising activity happening in Southeast Asia and how the venture capital scene has evolved. Recently, reading an interesting book on venture capital by an author who was both a venture capitalist and academic during my travels to Kyoto has given me food for thought. Lastly, I decide to share my own thoughts in laying out what I call the three conditions for myself if I should ever decide to go into the venture capital business in the far future.
Staggering Fundraising in Southeast Asia
In 2014, there has been a flurry of fundraising activity happening here in Southeast Asia. Recently, various companies have raised huge amounts of cash in Southeast Asia. The stellar examples include GrabTaxi’s latest series D round of US$250M,Tokopedia closing a round of US$100M, and Lazada from Rocket Internet raising US$249M a fresh round of financing led by Temasek Holdings, a Singapore sovereign wealth fund. What is interesting from this flurry of news, the valuations for this round of financing are completely undisclosed.
There are only two potential reasons on why the valuations are not revealed in public compared to their Silicon Valley counterparts. The first reason is that the valuations are low for these companies who have raised this stockpile of cash. For example, rumours on GrabTaxi’s latest round speculated that the investors for this round took 40% equity which priced it somewhere close to US$900M. The second reason is speculative on the basis that the companies are working on the strategy that their competitors or clones would not be able to use their valuation as a basis to raise the same amount. In a fragmented market such as Southeast Asia, the investing climate would allow one regional winner against the global counterpart. In the GrabTaxi case, they are raising this amount to compete against Uber. With the fundraising reaching at a peak, the market can mount itself towards a bubble. If we are to extrapolate from the present trends, the only way towards a bubble is excessive capital in the market empowering over weak companies.
Perspectives on Venture Capital
During my trip in Japan, I took the time to read an amazing book “Doing Capitalism in the Innovation Economy” written by William H. Janeway which was highly recommended by Marc Andreessen in the a16z podcast. As an academic and also a practitioner of venture capital, the author is able to integrate economic concepts into how venture capital is deployed in the innovation economy. He drew some insights from economists such as Braudel and Keynes. Braudel drew on the argument that “capitalism does not invent … the market or production on consumption, it merely uses them” to summarize the relationship between capitalism and the market economy.
There are two crucial parameters for every entrepreneur and venture capitalist look at in every investment round: economics and control. Usually, in the course of building the company for the future, the entrepreneur is forced to choose between these two forces. If an entrepreneur want to build the company aligned to the original vision, he or she can sacrifice economics (money) for control. Conversely, the entrepreneur might prefer economics over control, and in the process, sacrifice autonomy to the investors which gain the ability to impose change management in the company if things go south. Very few entrepreneurs can have both because everything is negotiated on the table. Janeway added an interesting corollary to the interplay of the economics vs control dilemma with the following: “cash buys time to find out what is going on; control permits the player to use that time to shift the parameters of the problem.” The added perspective he offered to entrepreneurs in the book is that assured access to sufficient cash in time of crisis can help the entrepreneur buy the time needed to understand the unanticipated & sufficient control to use the time effectively.
From his experience in venture capital, he formulate two laws of venture capital:
- First law of Venture Capital: “All entrepreneurs lie“. Underlying that reasoning, Janeway argued that entrepreneurs often start with lofty goals to change the world. The only issue is that the promises they made to their financiers, customers & employees are unlikely to be realised. The only way to success (with a very small probability) is that the investors have to understand that the entrepreneurs’ confident assertion often challenges any conventional definition of the absolute truth. In contrast, if you have read Peter Thiel’s “Zero to One“, the only mitigation to this law is that the entrepreneur observes a “secret” in the industry that no one else in the industry believe and seek to make a successful business based on that “secret”.
- Second law of Venture Capital: “No news is never good news.” If you are an investor and hear nothing from the entrepreneur you invest for a long time, then it is likely that the company is going south as they will not reveal news such as “we lost the deal” or “another revision for the product is needed but we are running out of cash”. Hence to mitigate this risk, it is in the responsibility of the venture capitalist “to follow the cash with intense focus in order to observe in timely fashion when the entrepreneur’s vision & the recalcitrant reality of the market deviate too far from each other”.
The Three Conditions
I have enjoyed my stint in early stage investing. For a portfolio of ten companies I have invested resulted in two exits and one still ongoing with seven gone south. I am often asked about pursuing a career in venture capital As an observer of the venture capital scene in Asia, I have seen many failures in the market. Typically, most venture capitalists in Asia have no operating experience or have not started their own companies. Those venture firms which has succeeded, has three important advantages over the rest: access to great talent, strong network with access to excess capital and understanding of how financing works and operating a company at massive scale. As I leaned stronger towards being a business operator or entrepreneur, I have laid out three conditions that I must fulfil if I want to go into the business of venture capital:
- Building a company valued at least US$100M (or exit either by sale or taking it public) or running a public company of at least US$1B market capitalisation. The reason to impose this condition is that I am equipped with the ability to manage a company in a massive scale. On that scale, I would have developed the capability to understand and manage a profit & loss statement for a business (P&L), perform mergers and acquisitions and resource deployment & capital allocation not just within a large company but across geographies.
- Operating an organisation with a manpower size of between 500 to 5000. Operating on this scale will give me the insight to help the entrepreneur to scale their organisation or recruiting the right people to scale the organisation. One important learning for me is that on that scale, you learn to put systems and processes in place to structure the company against risk in the early stage. The reason for this condition is two-fold, with one helping to scale early stage employees into managers or bring in managers for change management.
- Funding sizes above US$150M: If you perform the time value analysis of the current venture capital and building different financing models to ensure that the internal rate of return of 15-19%, the amount of capital raised to ensure home runs should be about US$150-200M. Anyone who wants to start a venture capital should try to build a model based on assumed hurdle rates and the number of exits based on potential exits (on a 1 in 10 odds). Once you have seen how this modelling of your fund works independent of the industry, you will realise that it is difficult to run a venture capital firm.
Until all three conditions have been met, it is unlikely that I will ever enter venture capital. I do have a very strong opinion on what a great venture capitalist should be, similar to my opinion that technical product managers are far more superior against business product managers. I am inclined to believe that venture capitalists who are former entrepreneurs are far more competent against financially trained investment managers. In today’s terms, they are called “operator VCs” or if you want me to name one successful example: Andreessen Horowitz.