Genesis: What is broken with the VC 2+20 model in Southeast Asia

Dear investors,

Welcome to the first investor update of [Capital z] (a placeholder until we find the right name).

Thank you for putting time aside to speak with us over the past couple of weeks. We intend to keep you regularly updated as part of our commitment to being transparent in our operations. While we sort out our mailing tech stack, please let us know if you do not wish to continue receiving such updates. We welcome your guidance and advice as we embark on this new journey. Genesis: What is broken with the 2+20 VC model in Southeast Asia
Eric and I have been in Southeast Asia’s VC ecosystem for a long time. Eric spent the last decade operating startups while I spent the last 7 years investing and managing portfolios. As we caught up earlier this year, we contemplated how the ecosystem has evolved over the past 10 years. We both came to the same conclusion that despite billions poured into the ecosystem, the Southeast Asia VC remains an unproven asset class that is disjointed from the “real” economy.

Taking stock of the VC ecosystem VCs seek a multi-billion addressable market when considering an investment, yet these opportunities are far and few between in this region. Unicorns, where any, are limited to the tired narratives of B2C ecommerce, ride hailing and fintech, while other sectors remain largely unexplored. As the early-stage investment industry has little moat, competition in these “obvious” sectors has been and continues to be intense. Sometimes, up to half a dozen VCs aggressively compete to invest in a “hot” startup. Some further numbers back this up – there are 158 VCFM licenses in Singapore as of 2022 – and this has yet to take into account other Capital Market Services licenses, family offices and overseas investors. With the tsunami of capital flooding into Southeast Asia, valuations will only be inflated. Such unbridled enthusiasm persists despite the lack of sound fundamentals, i.e. product-market fit. Alas, with the benefit of hindsight, we have all witnessed too many startups shuttering recently with investors writing off millions of dollars for each of these failed startups.

While the issues above already paint a bleak picture, we have barely started addressing the biggest challenge - the lack of liquidity and exits. Exit events in Southeast Asia are extremely rare. M&A activities in this region tend to happen in the $50-100m valuation range, leaving “successful” startups above $100m in valuation highly challenged when finding a buyer. An exit via IPO in the region is almost unheard of. Conversely, startups need to be valued at least $5b to even be considered a strong candidate for an US listing. Further, the window to list in HKSE is closing as the bourse is increasingly focused inwards towards Chinese companies. This is a structural problem that is unlikely to be resolved in the short term.

Yet the irony stands where VC managers continue to earn chunky fees in spite of the continuous abysmal capital returns. A 2-3% management fee p.a would equate to 20-30% over the 10-year life of a fund or translates to $20-30m for a $100m fund. This amount is not insubstantial, especially when there is little capacity for the asset to return capital to investors.
Are there any alternatives? While startups and VCs are struggling to find product-market fit, micro, small and medium enterprises (MSMEs) are thriving. MSMEs are, and will continue to be, the backbone of the Southeast Asian economies and are key engines of growth in the region. They make up 97% of the private sector, account for 85% of the labor force, 45% of regional GDP and 10-30% of exports. I personally benefited as my parents are SME owners and single-handedly afforded to finance 3 siblings and I through overseas universities to ensure we are equipped for high social mobility. Many of these MSMEs generate recurring free cash flows yet operate in very “boring” niches. Their micro size has kept them out of the radar of most private equity funds so far.

Anecdotally, we have heard the old tales where the ultimate goal of the MSMEs founders is to pass on a thriving business to their successor – typically within the family line. The reality is that taking over these businesses is less exciting in comparison to the aspirational lifestyles that come along with consulting or investment banking jobs. Other exit paths are unlikely – these MSMEs are too small to be listed in the public market, nor do any owners wish a winding-down of their business. The only economically viable path is to sell, and we are starting to see a wave of these companies hitting the market.
How do we reconcile the 2 worlds of companies? Eric and I pondered over whether we could apply some of our VC and startup operation experiences to the more traditional MSME space. Our lengthy brainstorming discussion brought us to these conclusions:

1. Starting a business from zero is inherently the riskiest and least efficient. The majority of resources are spent achieving product-market fit. Making things worse, many startups latch onto wrong false positives and scale pre-maturely, burning millions of dollars in the process.
   2. Many high quality founders struggle with fundraising. Fundraising and operations are highly differentiated skill sets. It is very rare for both skills to exist within a single person; at least, these are not common in Southeast Asia.
2. The only way to exit or achieve liquidity is to build a sustainable, value-generating business, Specifically, this translates to (1) high recurring revenue, (2) strong margins and (3) an enduringly profitable set-up. Unfortunately, many founders confound successful fundraising as a yardstick for business success – hence spending too much resources on fundraising and too little resources on building to the detriment of their business.
3. A fund management structure may not be the best setup to align incentives as its fee structure creates the classic principal-agent problem. We think it is best to be laser-focused on building sustainable, value-generating businesses helmed by talented operators. It is imperative for our investors' successes to be tied to our own success, and it has to be a collective, collaborative effort - both in terms of the upside and the risks. Above are the reasons why we have decided to start a self-funded search company.

Our vision is to preserve and grow the life-long legacies of Southeast Asian SME owners. With (1) support from values-aligned investors, we will (2) acquire a high quality business, (3) create a succession plan to operate and govern it well, bringing technology into the process as appropriate, (4) led by the next generation of high caliber operators, (5) sustainably harvest its value and (6) create a path of equitable return for our investors.

Through this, we avoid taking the “zero-to-one” risk, acquiring businesses in which products and business models are already proven in the market and using digital tools (e.g. ecommerce, digital marketing) and processes (NPS, OKRs) to strengthen and transform these businesses.
Organization Update: Why we believe we are best positioned to tackle this problem. Eric and I are both Southeast Asian natives who know this region like the back of our hands.

Eric is a serial operator, having been a Chief Operating Officer at 3 consecutive startups across B2B SaaS, Advertising and Payment Infrastructure for 10 years. He had turned around a failing business from -80% to +30% gross margin and successfully collectively raised US$10m, in growing startups from Seed to Series B stage and exited 1 of these startups to a European MNC. He led the expansion of his team to 50+ FTEs across Singapore, Malaysia, Indonesia, Thailand, Vietnam and India. Eric is armed with an EMBA from Quantic School of Business & Technology and a Mechanical Engineering graduate from The National University of Singapore.

I have a more generalist background, most recently a private equity investor having evaluated 1000+ business models across Southeast Asia, deployed $150m+ capital across early-stage to pre-IPO companies in Singapore, Indonesia, Vietnam and The Philippines, with 2 profitable exits over 7 years. I started my career with The Procter & Gamble company, with regional and global roles in supply chain management, distribution, media and consumer research. With these skills, I co-founded a food services SME, grew it to 7 outlets, generating an annual revenue of S$1.4m but humbly lost it all to Covid-19. As a CFA Charterholder, I have an MBA from Insead and a B.Eng from The National University of Singapore.

Eric and I had known each other for over 7 years. We work well together, complementing each other. He has an operational background while I possess an investment perspective. Importantly, we are bonded in a shared discipline - we are both builders and engineers at heart. Growing up as children of middle-class parents, we are hands-on people - love to engage in tangible work and abhor performatory work that is plaguing many companies and governmental organizations today. Yet, we have our own limitations and we intend to establish a strong enabling and advisory team to help us realize our vision. Together, we believe we are the best team to tackle the problem of SME succession across Southeast Asia.

Our Key Asks: Thank you for looking out for us If you have made it this far, thank you for reading. We would very much like to stay engaged with every one of you as much as we can. Please reach out to Eric or me if you:

• Have a related topic in mind that you would like to hear our views on in the future,
• Know of anyone who may be helpful to our vision and business,
• Know of any potential investors keen to invest in private companies and do not have the capacity to run,
• Have in mind, an awesome name for us to consider!

Upcoming update next week: Investment Thesis: What we are looking for. Please stay tuned!

Thank you very much, and have a stellar week ahead!

Best Regards, Eric and Zachary