Cradle’s new investment product DEQ800 timely for a maturing ecosystem

• Aims to stimulate growth of tech-based startups
• Government reduces dependence on grants

EARLY-stage startup fund and influencer Cradle Fund Sdn Bhd (Cradle) on Feb 27 announced a new investment product called Direct Equity 800 following an investment portfolio expansion effective February 2017.

Equity investment initiative DEQ800 will see Cradle taking a step up from its role as a co-investor by allowing it to also make direct equity investments. This programme is part of the Malaysian government’s intent to wean the local market off grants in funding early-stage startups.

DEQ800 offers a capital injection of between RM300,000 and RM800,000 for local tech startups in the pre-commercialisation, commercialisation and early growth stages.

According the Cradle chief investment officer Juliana Jan, half of the Ministry of Finance’s allocation for Cradle – RM22 million – will be used for the co-investment programme, while the other half will be used for grants.

Cradle plans to invest in up to 10 startups under direct equity and close three co-investment deals this year. In his speech at the launch, Cradle group CEO Nazrin Hassan said that although 13 deals may seem ambitious for the introductory year where the Malaysian economic scene “is not in great shape”, Cradle is optimistic that it will achieve this goal.

Value proposition

Both the startup ecosystem and Cradle has evolved significantly since the latter was formed 13 years ago. Back then, it filled a funding gap in the area of developing ideas into prototypes, moving on to funding for prototype-to-market in the form of the CIP500 programme.

“Eight years on, we’ve found that local startups are beginning to mature and it is time for them to share the burden of result-oriented funding. This is why we’re moving into direct equity and slowly weaning Malaysian startups off grants, especially when it comes to commercialisation,” said Cradle vice president for investment Azman Hood.

Nazrin added that the government’s stance on reducing dependence on grants should allow DEQ800 to serve as an alternative to stimulate the growth of high-potential Malaysian tech startups and eventually make the early-stage funding ecosystem in Malaysia more robust.

He also said that this is the perfect time for the shift to direct equity investment as the local startup ecosystem is now mature enough for this step.

“Government- and Cradle-backed prototype grants will always be available as there is always a need for that type of risk taking, startups still need to learn how to get private investments or they will continue relying on grants.”

Commenting on DEQ800, Jes Min Lua, CEO and co-founder of Malaysia-based service platform RecomN, agreed that the market is now more ready for Cradle’s move from grant-giving to equity investing but opined that while there are more local startups becoming Series A and Series B ready, Cradle’s challenge will be in balancing its role in catalysing innovation at the very early stage, which has a de-risking effect on the startup’s founding team, and providing growth capital, which encourages the founding team to take risks but overlaps with the role of venture capitalists.

“It’s also important for Cradle to differentiate its contribution to the startup from that of a typical venture capital fund,” she told Digital News Asia via email.

Co-founder of Malaysia-based service design startup Hyperlab Vic Sithasanan (pic above) told Digital News Asia via email that the new programme is a more sustainable long-term view to invest in future startups and will benefit the ecosystem as a whole, especially if there is a high volume of deal flow from.

“By providing a higher margin of funding compared to the grants, Cradle is providing an opportunity for an entrepreneur to get an equity partner that is well connected and get more money at the same time. By having equity, and potentially exiting at a later stage, the fund pool is replenished and goes on to fund other entrepreneurs,” he said, agreeing that the startup ecosystem is mature enough for this new programme.

A strict criterion for Cradle’s co-investment is that it is looking to avoid investing with government agencies; Cradle has already signed up more than 30 co-investment partners, including local and regional venture capitalists, angel groups and equity crowdfunding platforms.

When asked how Cradle will encourage more private investment, Azman said that given Cradle’s experience in the early-stage startup scene, it hopes that its decision to invest in a company will validate the quality of the company and business plan, which may spur more support from private or individual investors.

How it works

Cradle is introducing a 2:1 ratio for the co-investment exercise as opposed to its previous 1:1 ratio, meaning that it will double the matching contributions for every ringgit invested by partners in co-investment deals up to a limit of RM800,000.

Startup eligibility will be judged on several criteria: the startup must be incorporated in Malaysia and owned by at least 51% Malaysian shareholders, own or hold all intellectual property rights, titles and interests relating to prototypes for the purpose of commercialisation, have a total revenue of not more than RM5 million and be incorporated for less than five years.

Cradle’s previous initiatives have required startups to be less than three years old, but Azman said that in Cradle’s experience, startups take about two to three years to discover the perfect product market fit before being able to fully commercialise, hence the change.

The investment horizon for DEQ800 is between seven and 10 years; Azman said that this is a good time range as Cradle gets involved at a very early stage and a potential exit cannot be forced for at least seven years.

Juliana said that ideally, Cradle will hold less than 30% of the stake in the startups. “We want the founders and team members to run the business while we are there to support them.”

Focused investment sectors under DEQ800 include areas within Malaysia’s National Key Economic Areas: financial services; tourism; business service; electrical and electronics; wholesale and retail; education; healthcare; communications content and infrastructure; oil, gas and energy; and agriculture. Cradle is also including ICT and non-ICT sectors in the programmes.

DEQ800 will bring more to the table than capital injection; Cradle will provide mentorship, training and commercialisation support, among others, to startups in the programme. Startups will also have access to other investors and angels. According to Nazrin, Cradle’s diversified local and regional ecosystems will give startups the opportunity to place themselves into new markets and possibly raise regional or global funding to scale.

While Azman said that Cradle has already been looking at potential startups for DEQ800 since last year, Juliana clarified that Cradle is not focusing on any one tech area but rather wants to provide support to areas that have good growth potential.

“We look at any new tech and innovation and any startups that have the ability to scale and go beyond Malaysia,” she said.

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