PE-fication in Southeast Asia Venture
People have been asking me on my thoughts on the recent “PE-fication” of early-stage venture in the SEA region. Basically some VCs are shifting their mindset and are increasingly gunning for 3-5x outcomes rather than 100x bets (e.g., see here).
I understand where they are coming from - in a capital-constrained regional ecosystem with lower liquidity founders need to manage expectations on valuations, and for investors, especially given current market conditions, some DPI is better than none.
But my worry is that being content with small outcomes is detrimental long term and will not do anything to grow the ecosystem.
My first concern here is that it makes it really hard to get the flywheel going without large exits, which is what ultimately sustains an ecosystem. (A) It is very hard to attract top talent if the endgame is a small exit that will give a good outcome to founders and investors but a mediocre outcome to the early employees (why should the very best engineers and salespeople join you?). Without top talent it then makes it difficult to build a really strong company because talent drives culture which drives growth. (B) A small exit doesn’t sufficiently build the “mafia” - early employees who became wealthy enough to become LPs/GPs/angel investors themselves, or motivated enough to start their own companies creating the next wave. This is what supports the multiplicative effect alongside the exited founders and investors.
It also breaks the venture funnel. You create a tension between pre-seed/seed and growth investors. You really cannot accept 3-5x eventual outcomes for the early investors because the volatility/dispersion is just too high, it is very hard to make the economics work by concentrating your bets. Later-stage investors encouraging smaller outcomes in their portfolio will make it even harder for the early-stage investors to make their model work. Yes, from an individual perspective you can say “not my problem” but from an ecosystem perspective you stifle innovation, which is not great. You need someone to be willing to take bets on talent and brilliance when they have close to nothing. Disruptive innovations come from there and I don’t think you should disincentivise the behaviour. (Yes, I know there’s venture studios and also the hope that AI will accelerate bootstrapping without early capital but they are topics for another day).
*To my economics point above, the concern is that you can’t make the numbers work without some level of power-law outcomes. A typical power-law feature - for every ten companies an early stage investor invests in, five will be written off and three will maybe return 1x outcomes. You hence need one or two companies to cover your losses, return your fund and more. Let’s say you opt for small bets. For every ten companies, a reduced risk profile will maybe give you two companies that will be written off and three 1x outcomes (very generous especially for pre-seed/seed). That gives you five companies that gives you 3-5x return on invested capital. My worry is that this is not enough to cover the losses, return the fund and on top of it provide >2X DPI. And if they can’t provide that then LPs will be better off investing in another asset class, which is also the last thing we want.
So I get where these VCs are coming from in that it’s good to manage expectations on exit valuations in this market and I also don’t think we should stop founders from exiting at an outcome that they are comfortable with.
But at the same time I hope VCs are not actively convincing ambitious founders to “tone down their ambitions” and/or purposefully engineer smaller outcomes when they can be much bigger because at the end of the day I think you still need some level of moonshot outcomes for a healthy venture ecosystem. Might not be a 100x, but definitely not a 3-5x.