Tech & government: Living laboratories

The size and rapid growth of Southeast Asia's emerging markets have always been a major attraction to VC investors, but historically, government-related uncertainties have usually proven to be the critical impeding entry factor. Now, though, the industry is beginning to justify its moves into these countries, citing real cultural and regulatory milestones as much as commercial potential.

After reaching a final close of $60 million close on its second Southeast Asia-focused fund, Golden Gate Ventures emphasized governance conditions as an important investment incentive, noting in particular the various start-up programs of Indonesia and Malaysia. Meanwhile, US-based accelerator 500 Startups, which has launched a $50 million vehicle targeting the region, referred to these two countries as part of a "golden triangle," alongside Singapore.

"The regulatory stuff is not as restrictive as people think," says Khailee Ng, managing partner at 500 Startups. "In both countries unicorns have been created - Grab from Malaysia and Go-Jek from Indonesia - and new start-ups continue to get funded by foreign funds at an unprecedented rate."

The challenge for venture investors going forward is to recognize which steps forward will translate into the next unicorn-producing ecosystem, which ones will fizzle and which ones will merely build on a transgenerational growth process that bears few short-term rewards. Although governments in the region appear to be of one mind when it comes to modernization, they represent independent, imperfect laboratories, tracking sporadic progress toward that ultimate goal.

Going local

The most recent traction of note in Indonesia's policy environment has been a tightening up of VC registration rules that has opened up more opportunities for foreign investment. The new regulations essentially crack down on convertible instrument workaround structures that had previously allowed international companies to maximize foreign ownership thresholds by falsely registering as VCs.

Under the revised system, foreign VCs are able to set up in the country and manage bespoke funds on a case-by-case basis so long as the manager is Indonesian. This allows any number of unit holders to be foreign parties but sidesteps many of the taxation and permitting inhibitors related to foreign ownership. Although the move does little to streamline the country's often discouraging red tape, it is being interpreted as part of a new government recognition of VC.

"There are now starting to be conversations between the regulator and the core community of VCs, which is getting a sympathetic ear," says Joel Hogarth, a partner at Ashurst who specializes in cross-border transactions involving Indonesia. "I'm expecting new regulations to come out that will provide further incentives for investing this way and providing venture capital. There is a strong desire in government to say the homegrown start-ups ought to have as much access to funding as possible."

One of the main concerns in this context is that the country's most successful companies are vulnerable to being bought out by international competitors before they can establish a resilient, globally relevant presence for Indonesia in any particular end segment. Domestic lobby groups have anticipated this threat by pushing for tax breaks, but such concessions remain a highly politicized matter that the industry's regulatory body is powerless to act on independently.

The bureaucracy machine that underpins this struggle for government favor helps color Indonesia's stewardship of the VC industry as high-altitude stratagem, with broad-stroke rulings that set nationwide agendas around control parameters and decisions on which sectors will be chosen for development. Malaysian government involvement, by comparison, appears much closer to the ground.

Praise for Malaysian venture policy typically cites the government's seed funding mechanisms and direct contact with start-ups via a variety of mentoring programs and specialized agencies. The most effective of these have been Cradle, an organization that offers grants and networking services, Magic, an accelerator program which has recently shifted focus toward non-tech business models, and MSC, a special economic zone near Kuala Lumpur.

MSC companies benefit from a range of tax benefits and foreign ownership-oriented concessions such as offshore hiring flexibility and relaxed income repatriation rules. However, the costs associated with relocating to the MSC zone has kept many cash-strapped entrepreneurs unserved until the creation last year of a special sub-program for start-ups that doesn't require moving headquarters.

"MSC for Startups will definitely have a big impact because it's more holistic in terms of tax breaks, attracting capital and bringing in foreign talent," says Andrew Wong, founder of MAD Incubator. "But start-ups will still have a problem getting talent from the existing pool because most of Malaysian universities are backdated in terms of the technology they teach their students. The government is trying to do something about it, but we will only see the results in one or two generations."

Recruitment issues

This inability by the government to make short-term impacts on the talent pool is echoed in Thailand, where much of the necessary infrastructure and political will are in place, but the start-up ecosystem remains uninspiring. The cultural inhibitor in this case is a familiar tendency for the best minds to gravitate toward less risky, established industries that are still growing rapidly.

The predominant blueprint for transcending this impasse has been to leverage the country's appeal to educated foreign entrepreneurs, who are often living in co-working spaces and illegally operating tax-free outside of the formal workforce. Industry rumor often suggests Bangkok is Asia's third most preferred destination for this group after Hong Kong and Singapore.

"The government needs to get these people into the system so they can play a part in society - and that can only be done if it's an easy process. You get tax benefits and so on, but you don't get initial funding, and some entrepreneurs who live under the radar here may not be prepared to pay the legal costs of a complex application to the BOI [Board of Investment], says Johannes von Rohr, founder of local venture builder and accelerator Rabbit Internet. "Imagine if they incentivized these people who are now illegal with a grant that let them give back to the country. The more these people consume, the more they invest locally."

While the Thai government is not expected to embrace illegally active entrepreneurs, it has demonstrated an awareness that setting the cultural agenda is an important aspect of establishing a venture ecosystem. This work was recently punctuated by the launch of the Technology Ministry's Startup Thailand program, which coincided with the unveiling of a $568 million venture fund aiming to create 10,000 start-ups in the country by 2018.

Skepticism around such moves, however, remains rooted in the lack of detail and the notion that policymakers are not fully aware of the industry's needs. These concerns are evident in the Philippines as well, where the government is believed to be prioritizing capital-based solutions for a VC ecosystem more troubled by systemic, non-financial roadblocks.

"The good news is there is clear political will to modernize the environment. The bad news is that much of the support is oriented towards events, which are one-off in nature, rather than policy changes, which have structural impact," says Minette Navarrette, president of Manila-based Kickstart Ventures. "The government perspective, at least for now, is guided by a desire to broaden inclusion and stamp out poverty - worthwhile goals to be sure, and necessary, but not sufficient when one considers that the opportunity, especially with asset-light tech start-ups is to aim for massive success."

Moving forward

Popularly recommended policy changes for the Philippines include revised visa and residency permits for start-up founders, a review of the foreign investment negative list which currently prohibits involvement in media and telecom, and a streamlining of the process for starting a business, receiving investments, scaling and closing down. Simplified labor laws are also in need for allowing greater mobility across companies and flexibility for hiring and right-sizing.

The latest practical progress was the submission earlier this year of legislation intended to provide government support for young companies mainly in the way of subsides and grants, but also through a better alignment of relevant government agencies. Forums have also been established that bring together government and industry players in an effort to define common positions and actionable support initiatives.

The Philippines' momentum can be seen as a microcosm of Asia's broader emerging markets situation since it overlaps the election of a new and unproven administration, eager to break with tradition but bound by a stubborn socioeconomic inertia. With no expectation that a universal formula for the creation of a successful VC community will come to light, the industry is anticipating more experiments with liberalized policies and deepening lines of communication.

"We don't know how much government assistance is helping start-ups in Southeast Asia because it's still too early to say in countries like the Philippines, Vietnam and Thailand," says MAD's Wong. "Generally, there isn't much assistance, especially when it comes to internationalization, but the governments in Southeast Asia are starting to take notice of entrepreneurship. Within the next 2-3 years - ¬even in Indonesia - you'll start to see a lot more government policies and interventions that will help these start-ups grow."

 

CASE STUDY: Indonesia - Orami

The creation of Amvesindo, Indonesia's venture capital and start-up association, earlier this year has cemented the country's status as a robust early-stage investment environment, at least by the standards of emerging Southeast Asia. It also highlights the suddenness of this ecosystem's arrival since most of the 12 GPs that started the lobby group were founded more recently than many of their portfolio companies.

Orami, an online retailer for the mother and baby market, is one of the start-ups currently enjoying the perks of this newly energized climate with fresh memories of a more difficult policy environment only a few years ago. The company traces its Indonesian roots back to 2012, when local venture funding opportunities were considerably scarcer and policy support was lacking.

"The last couple of years have been a lot easier for venture capital, but my old mantra is that it's better for the government to stay out of it," says Eka Himawan, CFO at Orami. "Their intentions have always been good, but the execution is normally pretty troublesome. That's what happened in 2013¬ - the policymakers wanted to help local start-ups, but in the end, it just made life more difficult."

That 2013 episode included a 100% ban on foreign ownership of e-commerce companies - a move aimed at clearing the way for local start-ups to take a leading role in the country's rapidly expanding online markets. Orami's Indonesian predecessor, Blina, was trying to raise funds at the time and was therefore obliged to explore a range of convoluted legal workarounds.

The key turning point in this narrative was the 2014 election of President Joko Widodo, who has been regarded by venture players as a more competent technocrat, especially after his administration appointed private equity veteran Thomas Lembong as trade minister. The change precipitated a full reversal of the e-commerce restrictions of 2013 as well as a number of other negative-list liberalizations.

This backdrop helped set up Blina's merger with a Thailand-based Moxy and a $15 million Series A round led by Amvesindo co-founder Sinar Mas Digital Ventures. The investment included participation by China's Gobi Partners, US-based Velos Partners and Facebook co-founder Eduardo Saverin.

The regionally anomalous availability of such sizeable and diversified Series A rounds, however, is not usually attributed to Indonesia's recently relaxed policies as much as to the sheer size of the local economy, which is considered the world's eighth largest by GDP. As such, Orami and other players in the country's nascent digital economy are still calling for improvements including a technology tax holiday.

"It's better to feed the fish before you eat them," Himawan explains. "Right now, we're still all small fish in the ocean, and they're already trying to harvest these companies. We're not profitable so we don't have to pay corporate taxes, but we're paying a lot of taxes like VAT and service tax. Singapore and Malaysia are more advanced in this."

 

CASE STUDY: Malaysia - Touristly

When Malaysia-based travel start-up Touristly launched in June 2015, it knew that networking and partnerships would be as critical to its success as an initial injection of capital. Achieving practical milestones, however, is never an easy task for digital companies in a country where traditional manufacturing and natural resources remain the principal economic drivers.

In a one-year surge, the company - which focuses on providing activity itineraries rather than hotel and flight bookings - has expanded its offering to include some 7,000 deals across 72 destinations in Asia Pacific. This growth spurt culminated recently in pre-Series A investment from local accelerator Tune Labs as well as collaborations with travel brands under the Tune Group such as AirAsia and Tune Hotels.

The progress has been underpinned largely by a number of government start-up support mechanisms, including accreditation within Malaysia's MSC special economic zone, a MYR500,000 ($120,000) commercialization grant under the Ministry of Finance's Cradle Fund and professional direction under Cradle's Coach and Grow program. "We've been quite fortunate with the way the local ecosystem is growing, and there is a lot of interest by the government to support young start-ups through grants," Sarma says.

Cradle was established in 2003 as a MYR100 million program and received an additional MYR50 million under the government's latest budget plan. Beyond funding, it offers mentorship, competency building trainings and access to strategic connections with various industries and government bodies.

Touristly cites the agency's Coach and Grow support as a valuable resource in pitching events to meet investors. The program - which operates in association with the Malaysian Venture Capital & Private Equity Association and the Securities Commission - focuses on helping pre-seed businesses scale and source early adopters.

The company also benefited from its MSC status, notably greater flexibility in hiring foreign talent and an invitation to establish contacts with the Ministry of Tourism. Attaining MSC status, however, remains a cumbersome procedural obstacle for young companies that are preoccupied with core business-building activities. In order to make the service more accessible, the government recently launched a sub-program known as MSC for Startups, which offers a reduced tax holiday in exchange for networking privileges and applications protocols more in line with early-stage needs.

"They understand that start-ups are small teams of less than 10 people - at least in the early days - and at that point, you're not really at the stage where you're going to spend eight hours filling out a form or going through the red tape just to get a status. You're more focused on making the business and product work." Sarma says. "Right now the process is tedious, but we did have an opportunity to air our concerns. I think they're listening and we'll see some improvements soon."

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• Topics
• Southeast Asia
• GPs
• Regulation
• Technology
• Indonesia
• Malaysia
• Thailand
• Philippines
• Golden Gate Ventures
• 500 Startups
• Sinar Mas Digital Ventures
• Gobi Partners
• Velos Partners
• Venture
• seed
• TMT