‘Growth at any cost’ has shifted to ‘growth with reasonable unit economics and a path to profitability’: White Star Capital’s Sanjay Zimmermann

In its latest report, White Star Capital (a transatlantic fund investing in Series A and B) found that Southeast Asia is exhibiting very favourable demographic and economic trends. VC funding in the region has reached record levels over the past two years. Funding rounds pipeline of high-quality seed and Series A-stage startups have been driven by a large number of less than US$100 million funds.

However, with the absence of larger funds to finance later stage Series B+ rounds, there remains a clear opportunity for international funds to build a presence in the region, finds the study.

In this interview, Sanjay Zimmermann, Associate at White Star Capital, talks to e27 about the Series B crunch, the VC investment ecosystem in Southeast Asia and the challenges it faces.

Edited excerpts:

Your survey finds that only less than 15 per cent of the companies that raised Series A funding go on to raise Series B and beyond. Does this suggest there is a lack of Series B funds in the region or is it that there lack quality startups?

The lack of conversion from Series A to Series B and beyond is mainly driven by a lack of Series B-plus funding that is available in the region and as a result of the relatively young nature of the industry, which leads to more risk aversion amongst founders and micro-exits.

The upshot is that the funding gap has been well observed for the last one to two years now and several funds have come up or are in the process of being raised to address it, such as EV Growth, Asia Partners, and Vickers Venture Partners.

Also, as the ecosystem matures and we start seeing an increasing proportion of second-time founders, risk-taking and experience amongst founders will increase as they turn down initial offers to get acquired and aim for billion-dollar outcomes.

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For example, think of Elon Musk who sold his first business Zip2 shortly after founding it for US$300 million but then refused multiple offers to sell Paypal, his other business, and only sold after getting a US$1.5 billion offer from eBay.

I assume the Series B funding crunch is a global problem. What do different stakeholders do to plug this gap?

It is indeed a global phenomenon that we have also observed in both our Canadian VC Landscape report and our UK VC Landscape report. It appears to be a growing pain of any thriving ecosystem and fortunately, a situation that the market tends to resolve over time.

Young demographics in Southeast Asia offers massive growth opportunities for consumer startups. But this often comes at the expense of B2B companies, which are also crucial to the growth of any economy. Do you see an upward spiral in the B2B sector as well?

I would argue that the rapid scaling of consumer startups across Southeast Asia is leading to increasing demand for B2B startups to support their scaling when it comes to logistics, payments and several other tangential sectors. This, in turn, supports the overarching theme of the rising middle-class and young millennials beginning to consume online.

On top of this, as certain markets are starting to get oversaturated with B2C startups, there is increasing investor appetite appearing in B2B startups, which are tackling what is referred to as the digitisation of SMEs by offering B2C-like solutions.

Funds such as Wavemaker Partners and Cocoon Capital in Singapore have been driving investments in B2B successfully for a while now, and at White Star Capital, we will be on the lookout for both B2C and B2B opportunities in the region, especially looking out for companies that tie the two together.

Most domestic funds and foreign funds are obsessed only with major countries like Singapore and Indonesia. Several reports show that there is massive potential in markets like Vietnam and Myanmar, but they are not getting as much attention as Jakarta or Singapore do. Is it changing? Do you think Vietnam and Myanmar, etc. will also witness significant growth in the recent future? And what role foreign VCs play to change this scenario?

While it is true that Singapore and Indonesia have received a lot of attention in recent years, we realised in doing our research for the report that there are a number of factors that will make places like Vietnam, Malaysia, the Philippines and Thailand quite interesting markets over the next decade. This is part of the reason why we chose to go for a broader country deep-dive and evaluate the state of each of these countries in our report.

Myanmar is a market that I find very exciting as well — I had the chance to visit through the eyes of a local, with one of the collaborators who worked on the report’s impact investing section, Grace Su Lei Naing.

I think that it is still very early days to tell how the VC ecosystem will evolve in the country, but one thing I can say is that there are some active players on the ground such as Anthem Asia, Delta Capital and TPG.

On the later stage investment end, we also noted a landmark deal towards the end of last year with the Ayala Group entering the region and strengthening pan-regional bonds.

It is good to see the emergence of Unicorns in the region. In 2017, three companies became unicorns, and in 2019, the number was four. But in 2018, only one startup entered the coveted list. Does it mean 2018 was a bad year for the region?

Not necessarily, I would focus more on looking at the overarching trend of the growing number of unicorns in the region.

Do you see any new unicorns emerging in the region in the foreseeable future? Any candidates?

Our survey seemed to indicate that the majority of investors who responded expect to see between two and five unicorns over the next decade. I would lean towards the tail end of this forecast and would not be surprised if the number would be higher than five.

In terms of candidates, we will soon be announcing our first investment in the region, and we certainly believe that this may become a candidate in the years to come.

Is the ‘super app’ mania among startups good or bad for the ecosystem? Isn’t killing competition and creating a monopoly?

We think the focus on building ‘super-apps’ has been critical in helping build regional champions in circumstances where otherwise there would have been a risk of the US or Chinese players coming in and taking over the ecosystem. By expanding beyond a core product vertical, they have been able to build greater moats and justify higher levels of funding to compete with these global players.

There is a down-side though. Not every startup can be a ‘super app’, and even Grab/gojek are less well-positioned versus Alibaba or Tencent, as social/messaging/payments apps are simply more sticky and have higher daily interaction levels than ride-hailing or food delivery. Other verticals such as e-commerce have even lower user interaction levels which means that there can be a finite number of super apps.

It is unclear if super-apps necessarily kill competition — in China, the dominance of the original Chinese super apps (‘BAT’ – Baidu, Alibaba, Tencent) didn’t stop the next generation (‘TMD’ – Toutiau, Meituan, Didi) from emerging, nor will they be the last. It does make it more difficult — requiring greater innovation and tenacity, but that’s the nature of all business, particularly in tech.

Despite the strong growth in the region, business exits are still rare, and exits via IPO is the most limited. What do you think are the reasons for this? Will we see more exits as the industry matures?

There will need to be more mature capital markets in the region to make IPOs locally more viable, until then, we expect to see more and more acquisition activity from northern Asia.

Some experts say there’s no founder ecosystem yet like there is in Silicon Valley, and former successful founders don’t re-invest in startups yet, mostly because there aren’t that many successful founders that exited yet. If this is true, what is discouraging former successful founders from investing in startups in Southeast Asia?

We believe that this is simply a function of there not having been a critical mass that is large enough of founders that had large exits to be re-investing in the system. The good news is, however, that amongst those who have been successful, we are seeing angel investments trickle in as well new funds being created to invest back into the ecosystem.

Related to this point, looking at raw funding round data from the various data platforms, one may also conclude that the angel network here is not as vibrant as in other parts of the world.

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The reality, when talking to investors and angels in the region, is that a large number of angel investments intentionally or unintentionally do not get reported to these data platforms, which makes it a lot harder to comment on the funding activity from angels.

Some entrepreneurs feel there are no active female players either as investors or founders in the region. Is gender discrimination playing a role here? Does there exist gender discrimination in the startup ecosystem?

This is an important question that we also tried to assert in our survey. The good news is that over 75 per cent of the funds and organisations that answered the survey have some form of strategy in place to help promote more diversity and inclusion within their firms and portfolio companies.

The lack of female players as investors and founders is, unfortunately, a global issue that is prevalent across ecosystems, and that is fortunately increasingly being recognised and acted on.

In Southeast Asia, we would argue that addressing it can have even more significant positive multiplier effects by creating female-led startups to increase gender inclusiveness across sectors and industries in the region.

A recent report by the Asia Women Impact fund outlined that while 56 per cent of women in SEA work, over 70 per cent f these work in the informal economy which precludes women from accessing the social protection gains of formal employment. Tech startups can go a long way here to lead the way to a more gender-inclusive Southeast Asia.

Until last year it was all about user acquisition and generating revenues. Is profitability now becoming a goal for startups? Is there pressure from VCs on startups to become profitable?

We indeed see a move towards profitability over growth, especially at the later stage investment level. This sentiment stemming from a few missed IPOs is to be seen, in some sense, as a healthy correction in the market.

Nonetheless, at the Series A and Series B stages, the story remains around growth but has shifted from “growth at any cost” to “growth with reasonable unit economics and a path to profitability”, not necessarily immediate profitability.

The post ‘Growth at any cost’ has shifted to ‘growth with reasonable unit economics and a path to profitability’: White Star Capital’s Sanjay Zimmermann appeared first on e27.