From whales into guppies: When money moves upstream

By Justin Hall May 29, 2015

Tremendous uptick in new venture capital funds devoted to SEA
There’s a reason why they are investing in early-stage deals

From whales into guppies: When money moves upstream A FUNNY thing is happening in South-East Asia’s startup scene. More amazing than the seemingly endless new investment rounds and funds; stranger than the number of accelerators being formed or industries being disrupted; and as certain a trend as rising Internet penetration rates and e-commerce volume across the region: More late-stage funds are frequently finding their way into earlier stage startups.

As venture capital moves upstream, whales are turning into guppies.

Venture funding follows a very linear pipeline: You have your pre-seed level investment, from accelerators, incubators, and angels, which generally write cheques of around US$50,000 per investment; then your seed-stage investors, who can write anywhere from US$50,000 to US$500,000 per investment; Series A funds follows with US$1-million cheques written up; and finally your growth stage investors that invest US$5 million and higher per cheque.

These are extremely broad generalisations, but it’s easy to understand the gist.

And if you haven’t been living under a rock, you’ll know that there has been a tremendous uptick in new venture capital funds devoted to South-East Asia.

Perhaps less notable is the slow but steady emergence of growth-stage funds, both regional and international. The new ones are generally regional in origin, whereas the international funds tend to originate from the United States.

Regardless, these funds write much larger cheques into more mature companies.

Naturally, one might think the more funds there are, the more investments will be made. And on a very basic level, this is true: There are significantly more rounds of funding now than there were five years ago.

But if you take a deeper look at the quantity of companies receiving investment, you’ll note that there doesn’t seem to be a proportionate increase in funding rounds relative to the amount of funds being formed – especially in growth-stage rounds.

This last point is especially important. The reasons for that are numerous, the simplest being that venture capital and startups across South-East Asia – with a few notable exceptions – haven’t reached the level of maturity to require the kind of cheques written by growth-stage investors. This is true.

But that doesn’t mean growth-stage investors aren’t investing. They are. But they’re investing in early-stage deals.

From whales into guppies: When money moves upstream Family offices, corporate venture capital, and even institutional funds: These whales are all moving upstream into smaller, earlier deals. They keep it quiet, they rarely advertise it, but it’s happening.

This doesn’t sound like such a big deal. Money is money, right? A billion-dollar fund would surely invest US$50,000 into a pre-seed company if they think the opportunity is good, right? Wrong.

The economics of deals aren’t especially hard to understand: The earlier the investment, the smaller the cheque but the greater the risk.

Contrast that with late-stage investment, where the risk is much lower, but the cheque sizes are orders of magnitude larger.

In the former, the greater risk results in much greater rewards; again, the exactly opposite can be said for later stage investments.

But while the relative gains for successful early investments might be higher than late stage (think a multiple of 10x versus 3x), the absolute gains of successful late stage investments will almost always be larger (think a return of US$100 million versus US$10 million).

For late-stage funds, they need to make investments that produce unimaginably large returns, both relative and absolute.

For an early-stage fund writing a small cheque, seeing a 10x return on a US$1-million investment is an unmitigated, glorious success. For a large, billion-dollar fund? That’s a rounding error. And I mean that literally.

And yet we’re seeing exactly that: Gargantuan late-stage funds writing small cheques and participating in early-stage rounds.

So why are they wasting their time on deals that, even if they become home runs, barely move the needle?

Because they’re keeping tabs on deals.

This is why venture capital moving upstream is so important. It takes a lot for a multibillion-dollar fund to take the time to look at deals that make up less than a percent of a typical cheque.

As an investment it doesn’t make sense, but as a way to access deals and identify tomorrow’s Ubers and Facebooks? That’s another thing altogether.

By investing in these small rounds, these funds are implicitly signalling their belief that the next billion-dollar company is eventually going to turn up.

From whales into guppies: When money moves upstream By following early-stage investors and writing small cheques, late-stage investors not only get a better appreciation of what’s happening on the ground, but they have immediate access to these companies if and when they raise those large US$5-million cheques.

By keeping tabs on these deals, these whales are showing that they firmly believe that the financial opportunities in the region are so great that they’re going to jump through numerous hurdles to get involved.

The venture capital and startup ecosystems in South-East Asia continue to be validated time and again. From the frequency of funding rounds to the quality of companies, it’s clear that something is happening here, and it’s going to be big.

But the validation of whales moving upstream is perhaps one of the strongest and least understood signs that the region is going to transform.

Because remember: Where there’s one whale feeding, you can bet that many more will follow.

Justin Hall is a principal at Golden Gate Ventures, an early-stage fund based in Singapore. A former Rakuten Network manager and scholar at NUS, he sources investable early-stage technology companies from South-East Asia. You can reach him via Twitter at @JVinnyHall.

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