Will ECF be the death of VC firms?
Will ECF be the death of VC firms?
As more startups opt to raise via ECF, will the middleman role of VCs cease to be a thing of the past? Or will VCs still play an essential role in the business of uncovering the next unicorn?
According to the Global Startup Ecosystem Report 2020, total early stage funding in Malaysia averages at USD99m (approx RM410,454,000). The Securities Commission Annual Report 2020 stated that the total amount of funds by Malaysian equity crowdfunding (ECF) platforms grew by 457% to RM127.73 million in 80 campaigns. This suggests that approximately 31% of funds for early stage startups are raised from ECF alone. With plans for ECF platforms like pitchIN to open its secondary market this year which will offer an exit option for investors, we can make an educated guess that the percentage of funds raised through ECF will only go upwards from here.
ECF shakes up the fundraising scene
There is no argument that ECF has changed the fundraising and investing game. Through ECF, startups and small and medium-sized enterprises (SMEs) today can more easily raise funds with the added perks of setting its own terms and having a shorter lead time to fundraise - without the added stressors of having institutional investors such as venture capital (VC) firms breathing down their necks, pushing for bottomline performance.
With the Securities Commission Malaysia in the midst of revising ECF deals to go up to RM20 million, we may also see larger companies going down the ECF route for its funding needs. Retail and institutional investors now have more opportunities to diversify their investments beyond traditional asset classes, more easily access a democratised startup ecosystem and invest in ideas that they feel passionate about.
This raises the interesting question - what role do VCs play now?
As startups clamour to raise funds fast, are VCs being axed out as middlemen in that process? Or does their role remain largely the same with the added advantage of getting more sustainably profitable startups entering their deal flow?
VC fundraising pre-ECF era
Traditionally, VC firms have played a key role in providing value-add knowledge and resources to the companies it invests in. This can range from business strategy, go-to-market activities, technical know-how, financial advice and people management. They also provide a gateway to extensive networks of potential customers, corporate partners, financial institutions and government connections to name a few.
Do VCs hold the same amount of power today than they did a decade ago?
With ECF in the fundraising mix, the reality seems to be that VCs have to play in the same game as retail investors. Coupled with the challenges of finding startups, difficulty in attracting new investments and fewer opportunities to negotiate deals in their favour, VCs seem to be experiencing a loss of its once formidable power.
VCs have notoriously been known to play hard-to-get, putting themselves on a pedestal that can exhibit unfavourable behaviours. According to input collated by Inovasi Venture from various founders who have been approached by VCs, some unsavoury practices include restrictive one-sided terms, either setting meetings just to achieve deal flow KPIs or dangling a carrot without any real interest in investing and not having enough credibility nor track record in place. Other reasons that have been cited include demanding for more equity than preferred, setting undesirable business goals and having unrealistic expectations of performing in the same manner as other traditional asset classes such as stocks and bonds.
Despite some of the horror stories, it isn’t all bad news. As many startups have shared, there is real value in what they can provide to growing businesses. It’s all about penetrating the VC world with a strategy that lends itself in the right place and at the right time
As VCs make decisions on who to invest in based on market trends, many will argue that if a company doesn’t solve for efficiency, then they are unlikely to succeed and would not be investible. So what’s the one thing that VCs look out for when making a decision?
“There’s no one thing. It would depend on the investment mandate, the field of interest of each VC firm and how VCs see themselves providing value to the startup. All of these lead to the fundraising objectives,” said Angel Low, Principal at Inovasi Venture.
Looking on the bright side of ECF for VC firms
The ECF wave has presented its fair share of silver linings. VC firms can take advantage of it as a form of early validation and an effective funnel for future deal flows. With a proven and validated business model from an ECF round, there is more confidence in the growth and trajectory of a startup which reduces the risk of VCs signing on deals that are not investible nor profitable in the long term. This also puts VCs in a better position to negotiate terms for a subsequent funding round in hopes of generating greater returns on its investments. Ultimately, VCs stand to build a more profitable investment portfolio for themselves with the likelihood to result in more successful exits down the line.
“If anything, ECF has now raised awareness among the public regarding investing into startups. This has also raised the profile and interest in VCs among startups who have fundraised via ECF look to further accelerate their business, and wish to bring on board VCs as a strategic partner so they can get to their goals,” continued Angel.
Dr Melissa Foo Suyin, Vice President of the Malaysian Business Angel Network shares, “Our monthly pitching sessions called Enter The Tigers’ Lair are curated based on the deal flow that is most relevant and interesting to our membership database. This has led us to work with ECF platforms who share startups that are currently fundraising on their respective platforms which we then highlight to our investors. This provides startups raising via ECF the opportunity to get the word out about their business and attract more investors. What we’ve seen in the past are startups who either choose to receive direct investments from angel investors or crowd investments via an ECF platform, with some opting for a combination of both. This would largely depend on check size and how much involvement or mentorship an investor would like to have and dedicate to startups.”
Key considerations when fundraising via ECF and VC
When choosing between fundraising either via ECF or VC, startups need to firstly understand the differences between both and what their objectives are at their current stage of business.
“As a founder that has raised funds via both ECF and VCs, I would say that each presents different opportunities and challenges. Raising a round via ECF is better suited for pre-seed, seed and early stage startups with little to no traction, a much shorter track record and looking to validate its idea. On average, you can fundraise via ECF in a matter of 6 months, which is far shorter than raising through a VC. Through my ECF exercise, I was able to hire more people, explore various go-to-market strategies and expand my business network to cater to different interest groups. The challenge with ECF that many founders probably don’t realise is that you end up having to pitch to more people to attract potential retail, angel and sophisticated investors. In order to do so, you’ll need to proactively market your campaign which is time and energy consuming. So it’s not as seamless as one would expect,” said Pennie Lim, founder of Homa2U.
“On the other hand, growth and expansion stage startups are better positioned to seek funds from VCs. Founders can tap into the vast, more specific and in depth experience of VC partners, which is whom you’d want as strategic partners for your business as they can help with things like vertical growth strategy and regional expansion. I found the process smoother but definitely longer as it requires more forward planning from laying out your business trajectory, identifying VCs to speak to, negotiating on terms and ironing out the finer details. In order for VCs to decide on who to invest in, they put potential investments through their paces by scrutinising your entire business plans and questioning your every decision, which is understandable given that the level they’ll be investing in is far larger than an ECF round,” continued Pennie.
Ultimately, it’s important for startups to consider what they really want coming out of a fundraising exercise. “When we raised our first ECF round, we were two years young and initially targeted to raise RM1.8 million. After much thought, we decided to raise RM400,000 instead as we realised that our primary objective was to build an ecosystem first. Successfully raising a round on ECF also gave us the confidence that we could raise funds from VCs, so it was like a badge of honour that we can proudly wear. We managed to raise within 4 months and were fortunate enough to have already built a network of business partners and clients to invest in us via pitchIN,” said Pennie.
VC firms can still provide real value to the startup ecosystem
The real value of VCs is still entrenched in the strategic input that it can provide and this sentiment is unlikely to change even with ECF in the mix. What’s crucial is to align with a VC firm that understands the business potential.
As a founder who raised funds via VC firms close to two decades ago, Datuk Zainal Amanshah - former Group CEO and co-founder of REDtone, a Malaysian public listed telecommunications provider - shares his journey and experience of VC fundraising and bringing the company to IPO in 2004.
“Back then, we didn’t have to go through the very rigorous process of VC fundraising like companies do today which has become a beauty parade of searching, meeting, pitching, courting and convincing VC firms to invest in you. As one of the first companies to be accorded Multimedia Super Corridor (MSC) status, the then VC arm of Malaysia Digital Economy Corporation (MDEC) MSC VC automatically took an interest to us. Though we had explored some options, we felt that the strategic nature of MSC VC could provide real value-add to our business. We also had the VC arm under The Kuok Group as a strategic investor on board with us. For both VCs, the fundamentals they looked at were similar including solid business and assumptions, interesting proposition, technology roadmap and being in line with MSC’s goals. With The Kuok Group specifically, we even looked at a vision to go into China. Given their strong links into China, they saw the growth opportunities with a clear path to profitability and listing. We were fortunate to find good synergy and chemistry with these two partners with a business model that made sense to them and strategic value that made sense to us. In terms of the paperwork, we had a more formal agreement drawn up with MSC VC, much like those you’d see today, whereas we had a more simple agreement drawn up with The Kuok Group because the trust factor was already there,” said Datuk Zainal Amanshah.
As a mentor with the leading community of high-impact entrepreneurs Endeavor Malaysia, Datuk Zainal Amanshah advises startups to seek VCs who can provide strategic value to their business. “Look for those of equal footing and trust your gut. As business owners, you need to have a good feel and trust factor in place when selecting a VC to work with. Getting the right synergy and chemistry is extremely important,” he continued.
Here’s to us catching the ECF waves
Until there is a new solution in the market which will once again upend the way we do things in the fundraising world, VCs can either attempt to stop the waves which runs the risk of missing out on opportune deals, or simply learn how to get on a surfboard and enjoy the waves. We will take that surfboard, if you please.
Startup Events and Happenings
Prepare yourself to enter the fundraising game with Endeavor’s second EndeavHER webinar series happening on Tuesday, 8 June 2021!
Catch Rosaline Chow Koo (CXA Group), Sarah Chen (Beyond The Billion), Jackie Carmel (Endeavor Catalyst), and moderator Ryoko Manabe (Endeavor Japan) as they share their thoughts on fundraising: the do’s and dont’s, challenges both from the perspective of investors and entrepreneurs, what investors look for in entrepreneurs, and many more!
EndeavHER is a program to support, elevate, and help female founders accelerate the growth of their companies and inspire the next wave of female entrepreneurship around the world. This webinar is open to the public and created by the Endeavor APAC network (Endeavor Indonesia, Endeavor Malaysia, Endeavor Philippines, Endeavor Japan, Endeavor Vietnam).