Doing Deals Responsibly in A Crisis
April 27, 2020
Why seed is less risky than late stage, emerging trends in Southeast Asia’s tech and VC ecosystem, and the impact of Covid-19 on startups. Scott Krivokopich, Managing Partner at 1982 Ventures, discusses these topics and more with Kunal Thakur on the Geeks of the Valley podcast.
Doing deals responsibly in a crisis
Whether a seed stage company is worth two million or two and a half million, and at the next round is worth four or six, the real issue that we are solving for is how much dilution is that founder taking and is there going to be enough runway and upside for the next round of investors. It’s not so much an issue of “where does the value sit?” It’s about how we make sure that the company is well funded and keep founder alignment, so the company remains both liquid and fundable in later stages.
“Seed investors are investing for the next cycle”
Seed versus late stage investing in the post COVID era
Seed investors are investing for the next cycle. We’re not trying to flip a company to IPO in 12 months. Growth equity and late stage investors are getting hammered now. If you have a portfolio of growth companies, your portfolio is probably underwater.
When you price an investment, you look into the future and you put a valuation of where you think things will be and you discount that back by your target IRR. Late stage and growth equity investors were underwriting to thirty percent IRR, in some cases even less, and that thirty percent is based on a very rosy market. Their upside is significantly capped, while their investment could still go to zero. One or two under-performing investments is enough to sink the whole portfolio.
In seed stage, we’re underwriting to capture much higher returns. We’re looking for “MoC,” or multiples of capital. We expect a portion of our investments will go to zero, but our upside for successful investments is much higher. Enough so that we can still reach our return target for the whole fund with only one successful investment.
There’s a whip effect that happens in downturns, where repricing will occur across the board but is amplified in the later stages.
The fundraising game has changed. Who’s really ‘open for business’?
Deals that look like they were done are not done. Some of these companies are now facing down rounds, which are very tough to execute. Companies that have done back-to-back notes or been overly creative with financing structures will be in trouble. Founders and investors are going to discover the full impact ratchet mechanisms and that their investors’ interests are no longer aligned.
We’ve seen a lot of crossover investors in the later stage deals. These are strategic investors like large corporates, and many of their core businesses are reeling right now. They will not be making a Series F investment for a 5% stake in a company that has little impact to their core business.
We’re also seeing angels pull back. Most angels have a portfolio of public assets that have taken a hit and a day job with a bonus that is less certain.
For seed VC funds, like us, that means there are better opportunities available. After us, the Series A investors that will follow our investments are mostly professional investors, meaning they have to put money to work as closed-end funds. They’re still hunting for the best startups to fund, even if it seems like they’re not deploying as quickly.
“Being focused means we can go deep into the industry”
1982 Ventures is in a unique position now
1982 Ventures is really the first of its kind in Southeast Asia. We’re a sector focused seed fund. Fintech is the thing that we know. It’s ever-expanding and has the opportunity to permeate every aspect of our lives. Being focused means we’re able to go deep into the industry and it also makes it easy for startups to find us when we might be a fit for them.
Globally what we’ve seen in the past few years is specialized funds are becoming more of a trend. This is a function of the fund ecosystem becoming more mature. Early on, you would see specialized funds in niche sectors like biotech, where the skillset was so specific that you really needed a team of doctors on the team. Now you have funds that are exclusively focused on SaaS business models or funds that only want to fund marketplaces. This is a maturity factor and for VC’s, it’s about how to find some edge and carve out space.
In Southeast Asia, we’re not quite there yet. Most funds here are generalist or sector agnostic. We’re one of the first few that are truly specialized but we’re seeing more and more.
Room to run and coming soon to Southeast Asia
The great thing is that the whole market is maturing together, and for startups that’s a tremendous opportunity. The region has been a source of growth notwithstanding the COVID impact, and demographics and macros are positive.
There are other drivers that will push the ecosystem forward. What we see is, especially in fintech, that between banks/financial institutions and the startups, there was a bit of skepticism between those two camps. I think they were not sure how to deal with each other and that’s changing quickly.
We’re seeing large financial institutions now keen to partner with startups. Both camps need each other to be successful. The financial institutions in the region are not as digital as they could be or should be. There’s a push to be more competitive.
If we look at where the region is, you find we’re a bit behind not just developed markets, but also other developing markets. We can look at where Brazil is and there’s certain things that have worked there. In some fintech areas they’re further along. That’s not a negative thing, that’s a huge opportunity for startups in Southeast Asia.
If you flew from Beijing to Jakarta, you quickly feel the difference as how far fintech is permeating the economy. When you go to pay that first taxi ride or buy a SIM card, you’re not too far out of the airport before you realize a lot of transformation is about to happen.
“70% of e-commerce is still cash on delivery”
If you look at leading indicators like e-commerce, 70% of e-commerce is still cash on delivery. Many deliveries go undelivered simply because the person doesn’t have cash at that moment. There’s a lot of opportunities and progress to be made everywhere.
1982 Ventures investment size and strategy:
We typically invest around US$250,000, but we have some wiggle room to go as low as US$100,000 or as high as US$500,000. We aim to stay disciplined and in practice will avoid high variability.
We want to be the first institutional money in with the best founders and startups. That’s where we’re able to drive the most value and that’s where we see the best returns for our investors.
We’ve seen a gap emerge in the last few years with the maturity of the Southeast Asia VC ecosystem. A lot of the funds here are growing from seed stage investors to becoming Series A and B investors. They’re growing on the back of their past success. There’s a lot of liquidity in the Series A space but a gap emerging in the seed space, especially for Fintech. 1982 Ventures is squarely targeting that gap.