Coronavirus dislocation funds: Runway watchers

Southeast Asia's rapidly expanding but small venture capital space puts the region in a unique position during COVID-19. While a mixed track record among ASEAN countries in containing the virus has cast doubt on the reliability of consumer sector rebounds, investors still see the patchy, undeveloped nature of the market as more opportunity than liability.

This may be especially true of capital supply. VC funds in Southeast Asia are small, with third vintages – some of which surpass $100 million in size – only appearing in the past two years. Most of funds from the early boom years of the 2010s are tapped out, unable to continue supporting viable portfolio companies struggling with coronavirus pressures.

At the same time, cross-fund conflict rules prevent these managers from using later vehicles to pick up the slack, while many prospective investors from outside the region are hesitant to commit based on remote due diligence. The perceived result is an ecosystem teeming with VC-validated start-ups starved of capital despite high levels of investor interest.

To some extent, bridging this liquidity gap is the natural domain of governments and corporates keen to keep the broader economy afloat. Recent activity on this front includes Singapore's state-controlled Seeds Capital and EDBI committing $204 million to a special situations fund and a group of international VCs and corporates, including Korea's SK Group, backing a $280 million COVID-19 fund launched by the Malaysian government.

Independent investors with a more returns-focused agenda have been active as well, but usually with smaller funds rallying existing LPs or newly defined dislocation strategies for existing pools of capital. The main risk here is that execution involves a timing arbitrage relatively unfamiliar to VC: access reduced valuations now and exit 3-5 years down the line when the macro supports recover.

"This is different to a cycle play," says Kiki Yang, a partner at Bain & Company. "If you've been following a certain sector and think that undervalued assets are in need of liquidity, that's fine. But if you're looking at a company just from a liquidity point of view, that's really more of a credit play, which has almost nothing to do with the fundamentals of a company or industry. It's a completely different skillset."

Fleet of foot

Nevertheless, VCs are embracing COVID-19 special situations plays in Southeast Asia without launching credit strategies. One of the key factors in making this work is being able to move quickly. The window of opportunity could range anywhere from six months to two years depending on market and industry specifics, and visibility as to how the relevant variables will play out remains poor, perhaps especially in Southeast Asia.

Singapore-based Vulpes Investment Management, a multi-strategy investor increasingly geared toward VC, is the latest actor to take on the challenge. The firm launched its open-ended Special Opportunities Fund last week with a view to making about 10 investments during the next 12 months in start-ups said to be dropping valuations by 25-35%. It plans to realize returns within three years.

Speed is important to Vulpes, which claims to have hedge fund DNA. High net worth investors were approached for the new fund in favor of institutional LPs as a way of mobilizing immediately; the first investment is already being finalized. In order to outflank more traditional VCs, there is also a willingness to back founders without face-to-face meetings. 

The challenge of timing the macro recovery is partially offset by favoring business models that are likely to be survivors even if COVID-19 market conditions persist. Within this group, risks around maintaining entrepreneur alignment are more nuanced. Field Pickering, head of venture investing at Vulpes, notes that as founders under pressure see their ownership diluted, investors need to be careful not to squeeze them too hard.

"It's critical to have a good relationship with the founders, but there is a risk that there's a second wave after we invest, and the company will not be able to raise enough to survive. So it's about balancing a need to protect ourselves and not being too harsh on founders," he says. "We need founders who recognize the market has changed in favor of the investor. We're not looking to take advantage of an opportunity – we're just looking to access it."

There remain concerns, however, about how well the VC ecosystem at large can balance a hedge fund-style approach to special situations with the private equity-style company overhauls more commonly associated with turnaround investing. For non-control investors, straddling this divide will be mostly a matter of recognizing that there is more than one way for a company to suffer in the current environment. 

"The focus for minority investors should be disruption in businesses, not disruption in business models," says Soo Earn Keoy, who leads Deloitte's Southeast Asia financial advisory practice. "If the model has been disrupted, it will be very difficult for a minority investor to change that. They need to understand how COVID-19 impacts different industries and which categories to focus on based on the new normal."

Active engagement

TNB Aura, a Singapore-based VC that launched an open-ended special situations vehicle earlier this year as a sidecar to its second flagship fund, is taking this idea one step further. Described as bringing private equity-style investing to the VC world, its approach involves building a small portfolio of fundamentally sound companies, being hands-on in management, and working with founders whose ownership doesn't fall below 20-30%. TNB Aura leads 70% of its deals and insists on board seats to maximize post-investment impact. 

"Special situations is not only plugging capital gaps in safe companies. It's also about M&A, expansion plans, and being cash rich and ready to pounce on opportunities," says Vicknesh Pillay, a managing partner at the firm, adding that some of his existing start-ups are looking to acquire devalued competitors. "We see tons of potential M&A opportunities that are going to be happening in the later part of this year."

TNB Aura's value-add strategy requires investees scrap their pre-virus business plans, with new measures put in place and monitored monthly. If, for example, net burn targets deviate by more than 20% in any month, a board meeting is called to get back on track. Areas of consideration include staffing numbers, product-market fit, access to government grants, and especially financial metrics such as customer lifetime value versus customer acquisition cost.

"Unit economics will never lie," Pillay observes. "Whatever the business may be going through, if you're fundamentally strong in terms of unit economics, there are always ways to do a bridge and make sure you hit the right milestones to get through this period."

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• Topics
• Southeast Asia
• Fundraising
• Growth
• Credit/Special Situations
• Singapore
• covid-19
• coronavirus