Some of Asia’s most experienced venture capitalists with fintech mandates are doubling down on their strategies, saying the Covid-19 outbreak is confirming their theses about what the world will look like.
That world is emerging at a faster rate, they say. Investment ideas based on digitizing financial services look as though they are bearing out at a faster pace.
“I’m even more excited about this space,” said Christiaan Kaptein, partner at Dymon Ventures Asia in Singapore (pictured, right).
But there is a divergence of views as to which corners of the fintech world will benefit or suffer – and worries about keeping portfolio companies alive long enough to reap the rewards.
Valuations of VC portfolios are also likely to decline, so fund managers are working more closely with companies in a painful process to sustain revenues – and relevance, as startups struggle to obtain new financing.
Ain’t seen nothin like it
In some respects this is not the most challenging time in venture capital: that would still probably be 2001, when the bottom fell out of the dot.com rush.
“Private markets dried up,” recalled Melissa Guzy, co-founder and managing partner at Singapore-based Arbor Ventures (pictured, left). “One day it just stopped, but people [in VC] were slow to react.”
Mark Munoz, managing partner at Vectr Fintech Partners in Hong Kong (pictured, center), recalled. “Silicon Valley was in denial for six months and didn’t think venture would be impacted. Then startups disappeared and didn’t come back for new rounds.”
Covid-19 is presenting something different: a prolonged threat to all businesses worldwide, which is crippling for businesses without adequate funding or solid commercial models. It’s not all doom and gloom: the crisis is also catalyzing digitalization, which supports many fintechs both operationally and in terms of winning sales. But if those trends take too long to be realized, many startups will go bust – and their backers will have to mark down the value of their portfolios.
Therefore this is also a crisis that will catch out those investors that lack enough cash or the operational skills to help their portfolio companies manage through the Great Lockdown. Asia has its share of dabblers – family offices, for example – that may be forced to write down their investments.
VCs like to point to the companies they support that are benefitting from Covid-19, from foreign-exchange trading platforms to insurtech companies that provide cover to gig-economy workers.
But these are exceptions. Previous crashes suggest that valuations in VC portfolios will inevitably decline. Experienced managers are scrambling to shore up their investee companies.
“We’re talking to our companies about revising their budgets,” Guzy said. “Do you have enough cash to last 18 or 24 months? How does the recession impact your business? Are you still relevant once we come out of this?”
Previous crashes have started with a decline in dealflow. In 2001 it took about nine months for pipelines to recover – but then it resulted in a valuation decline of up to 25%, because so many existing companies had gone bust or otherwise disappointed.
“Companies that have just raised financing are okay,” said Kaptein. “But if you were just about to raise capital and only have seven or eight months of cash left, you have to make some big decisions.”
Which may include selling the company: investors expect a wave of M&A in fintech once those companies use up their runway – although this may not become visible until late in 2020 or early 2021. That’s when VC portfolios will also have to start booking losses.
In an attempt to avoid this fate, VCs are encouraging portfolio companies seeking cash to issue convertible bonds that will transform into equity in the next funding round. That preserves the current equity value, although in many cases convertibles may just be delaying the reckoning.
Issuing convertibles assumes a company can get funding at all.
For companies that are a known quantity and have a business model that fits the zeitgeist, new financings may be possible – but probably at lower valuations or in much smaller amounts, so founders don’t dilute their equity.
But VC investors say this is a difficult time for raising seed money, particularly if startup founders don’t have trusted relationships in place with fund managers. VCs are also now going to be skeptical of companies with a minimum viable product and some clients, but which must now scale quickly in order to justify a Series B or Series C round.
Winners and losers
Those with a long-term view are therefore evaluating what fintechs will remain commercially viable on the other side of Covid-19. Those VCs interviewed by DigFin say the pandemic has only confirmed their bets.
“Long term, nothing has changed,” said Kaptein. “In the short term, we don’t know the virus’s duration, or what a return to normalcy looks like.”
For Arbor and Vectr, that means sticking to B2B plays, although their emphases vary.
Arbor prefers regtech, anti-fraud detection, and automated transaction ordering, as well as some digital payments plays riding on the back of ecommerce. “We’re not chasing a fad, but asking what technology is needed,” Guzy said.
Vectr is more focused on B2B infrastructure (such as credit scoring models or analytics for alternative data), private capital markets, and deep-tech convergence plays.
They are both cautious about neo-banking, suggesting that challenger banks will need a really compelling reason to exist other than just better interest rates or a slicker customer journey, at a time when brick-and-mortar banks can highlight their reputation as safe.
“We’re saturated with banks,” Munoz said, “although I can see the opportunity for a really innovative virtual bank serving SMEs.”
Dymon, on the other hand, is focused on open banking, which Kaptein says will become more viable with faster payment systems, digital identity databases, and better interoperability among banks and wallets. Dymon is backing companies providing the connectivity to support open banking and open APIs.