Why LPs Should Be Paying Attention to VC in Southeast Asia

2 September 2015

Dmitry Levit, Partner
Digital Media Partners

Region over-reported yet under-invested

Although Southeast Asia is a comparable economy to India—both in terms of size of population that can be effectively addressed and in terms of diversity and fragmentation—it currently receives much less VC investment compared to India. Despite all the buzz, Southeast Asia will continue to see less VC activity for a while, as the market is very opaque and much less understood by global research and venture communities compared to India and China. Furthermore, most venture investment in the region has been concentrated heavily in Singapore, which is developed to a point of having very little to do with emerging markets’ dynamics. Singapore effectively represents a stand-alone investment destination separate from the rest of Southeast Asia, to an extent mirroring the position of Israel in the digital markets of MENA. Venture capital investment in Southeast Asia has also been concentrated in the later-stages of the ecosystem (Series C and later), leaving most of Series A and B space severely underfunded and therefore mispriced.

Steady stream of liquidity

While public market options are very limited for companies hailing from Southeast Asia (with a notable exception of Australia’s stock exchanges), trade exit opportunities are both plentiful and highly predictable. Southeast Asian markets sit right next to several mature markets—Australia, South Korea and Japan—with hundreds of digital companies rapidly running out of growth options. Southeast Asia is also next to India and China, two highly over-invested emerging digital markets where internet companies are receiving valuations that are hard to justify without an expansion overseas in the very near future. Naturally, an increasing stream of M&A interest is hitting just about every company in Southeast Asia that can prove the ability to execute across the region’s diverse markets.

The opportunity

The tremendous opportunity facing the VC community in Southeast Asia—above and beyond empowering the digital ecosystem that has the potential to catch up with India, Russia and Brazil at the very least—is rethinking the venture capital model (economics, deal flow generation, portfolio management practices, exit expectations, etc.) to adopt it to the world outside of mature markets and major emerging economies, i.e., the world heavily fragmented legally and linguistically; the world of unstable internet connection and very low cost devices; and the world of highly inefficient economies and little to no institutional support of entrepreneurship. A sustainable venture investment model that thrives in such environments can be piloted in Southeast Asia today, but tomorrow will be applicable to the Middle East, Indian sub-continent outside of India, Latin America outside of Brazil and most of Africa, and will create tens of billions of dollars of value in the markets that currently do not even register on the radar of the VC/PE community.

The challenges

The challenges for VC investment in Southeast Asia revolve mostly around the high level of market fragmentation and the frequent but limited size of liquidity events. In effect, to generate outsized returns, the VCs in the Series A and B space have to be exceptionally good at enabling the creation of regional companies—ones that generate the most acquisition interest—with minimal capital outlay while keeping all stakeholders’ expectations commensurate to the level of M&A interest in the region. While hundreds of corporate players are prepared to pay US$50 million to US$250 million for access to the Southeast Asian market, almost none are prepared to pay more. Thus, the dynamics of how VCs add value and negotiate and drive exits in Southeast Asia differ dramatically from Silicon Valley and other tech hubs where optimizing for the outsized returns from a few outliers is the fundamental principle.

Research