In exploring the ‘new normal', VCs “raise the bar” in their startup search

Student-led Protege Ventures shares their insights on how VCs will tread carefully.

As Singapore gradually reopens, businesses are embarking on another major set of adjustments to keep up with the abrupt shifts in consumer demand. But Lionell Loh, former managing partner of Protégé Ventures, cautioned that it is too early to say what defines the ‘new normal’ and that businesses need to monitor the situation on a macro level and 'a practical level.'

These shifts also drove venture capital firms (VCs) to raise their standards, as they search for the next big thing that would cater well in an ever-changing environment.

“I suspect the ‘new normal’ entails a stronger focus on quality. On average, with what is happening to the economy, the probability of success has definitely reduced. What was previously probable may now be improbable. Investors may also have raised their bar, adopting the “Hell yes or no.” philosophy,” Loh said.

Delving more into how startups should be equipped in conducting funding rounds, Singapore Business Review had a chat with Protege Ventures’ Loh and current managing partner Theodora Boo.

Protege Ventures is Southeast Asia’s first student-run venture, established in 2017 by the Institute of Innovation and Entrepreneurship at Singapore Management University (SMU IIE) and Kairos ASEAN to address the gap in the youth entrepreneurial landscape by partnering with seasoned venture capital funds such as Wavemaker Partners.

Loh shared that it was founded after observing significant success and viability in the US and UK university startup ecosystems with the likes of Dorm Room Fund and Creator Fund over the last decade. Such student-led networks have grown in both their presence and the significance they play in the startup ecosystem, especially for student founders and campus startups.

Protege Ventures invests into student or graduate startup founders. Boo added that over the past three years, they’ve trained 78 students from various universities in Singapore and 70% of them obtained internships and job placements in VC firms such as Wavemaker, Qualgro Partners and MDI Ventures, as well as private equity firms such as Blackrock and Temasek.

Has the pandemic urged you to make any changes into your investment mandate?

Boo: Though the pandemic created a unique situation, impacting lives and economies worldwide, technology was one of the sectors that was fortunate to benefit from it as digital adoption accelerated as a result. Hence, our goals to invigorate the student startup space and invest in the next generation of entrepreneurs did not change despite the pandemic. We are still actively meeting founders and evaluating new deals with our current mandate.

Nonetheless, the team is paying more attention to startups offering validated products or services that harness the opportunities presented by the new normal. With the change in consumer habits and practices, there has been an increase in demand for products and services that are delivered digitally, including categories such as education, media and entertainment, communications and ecommerce.

In being in touch with your portfolio companies, what advice are you telling them in coping during the pandemic and on facing the new normal?

Boo: A crisis such as the COVID-19 pandemic only proved how important the peer-to-peer network and support is for student founders. Amidst the tighter capital landscape, Protege Ventures is actively connecting startups to our investment partners for additional funding opportunities regardless of whether they are part of our portfolio or not.

We believe that if startups have a chance to thrive in the midst of this pandemic, it will help the ecosystem to grow even stronger in the long term. This is why we want to be as inclusive as possible in our support.

Loh: I think what constitutes the new normal has not settled down, and is not definitive at this point. At the moment, it is important to monitor and understand the impact COVID-19 has on the business both on a macro level and a practical level.

The former may be more theoretical and is informed by learning from the reported experiences of others, reading news about new trends, whether transient or not, that emerge as a direct or indirect consequence of the global pandemic. The latter is more empirical, derived from observing the metrics that are important to the founders’ business pre- and post-COVID.

There are probably many businesses that are adversely affected by the pandemic. On the flip side, there are some fortunate companies that saw an uptick in users because its digital form inoculates it from the pandemic. Regardless the key advice for our portfolio companies has been to stay on their toes, hold a strong bias towards action and be quick to adapt. As assumptions change, founders will be forced to take a hard look at the situation that they are in, and reallocate resources according to each businesses’ individual needs.

Some businesses may see the need to make operations more efficient by eliminating redundant processes or adopting new technologies whilst others may realise opportunities to pivot and serve new needs of the market. Founders could keep in mind that since the pandemic situation is constantly evolving, such plans should also be equally flexible to accommodate for changes that come up along the way. This will involve informed speculation as well as cost-benefit analysis in different scenarios.

What are your observations on Singapore's current startup landscape that are worth noting?

Loh: I think the consistent observation is that the local startup landscape has caught up with the “deeptech” hype. I think some factors that contribute to this hype include the government’s support in this category, as well as the high education standard we have that grooms and attracts talents in the field, making Singapore a fertile ground for Deep Tech incubation.

There are many startups working with AI, Blockchain and Robotics, just to name a few examples. It seems the appeal of deep tech is the implicit promise that it can solve previously unsolved problems or solved problems at a fraction of the cost. For investors, the harder the tech and the more expertise it requires, the higher the barrier to entry and defensibility, and the fewer the competition. Of course the pursuit of “Deep Tech” ventures is informed by its increasing feasibility, thanks to hardware advances and software advances from a surge in research fervour.

However, beyond the facade of deep tech, there is a wide spectrum in terms of what is actually happening. On one end, there are startups who have the right solution, and the right people to make it happen. On the other end, there are companies who believe in “fake it till you make it”—often masquerading a potentially simple programme to be powered by AI, or any other trending technology, in their bid to attract customers and investors.

Sometimes the high level idea may be feasible, but they lacked the right team to build it. It is thus important for investors, especially in the tech scene, to derive the right signals from a sea of noise.

I suspect the “new normal” entails a stronger focus on quality. On average, with what is happening to the economy, the probability of success has definitely reduced. What was previously probable may now be improbable. Investors may also have raised their bar, adopting the “Hell yes or no.” philosophy.

Boo: It has been heartening to see how supportive the startup community has been of one another. When the circuit breaker was first enforced in Singapore, many businesses were forced to either delay or shut down their operations.

Whilst some startups could continue delivering services online, those which were highly dependent on physical interactions were not as fortunate and saw demand fall dramatically. In response to this, some VCs came up with curated websites containing offers and discounts from such startups. There were other initiatives to help offline businesses make a smoother transition into gaining an online presence.

These efforts not only helped to increase awareness for the startups but also provided an opportunity to increase much needed cash flow to help them tide over the situation of low demand. Similarly, COVID-19 had resulted in massive layoffs as businesses have been forced to cut costs and make operations lean, but the tech ecosystem came together to find opportunities and place job-seekers in companies that had the capacity to hire.

This not only showcases the innovative and collaborative culture that Singapore’s startup scene has cultivated, but also more importantly demonstrates how each individual’s willingness to extend a helping hand could make a difference to the eventual fate of the startups.

What verticals are gaining traction and which suffered the most during COVID-19? And which verticals are likely to be the fastest and the slowest to recover and why?

Loh: This is a difficult but important question investors will have to grapple with, because one’s opinion and projections will guide one’s investment decisions.

At the risk of saying the obvious, I think verticals that support digital transformation, remote work or remote delivery of traditional services will see a strong recovery, if they even suffered a dip in the first place. VC firm 500 Startups recently conducted a survey where they saw an increase in investor interest in the healthcare and digital solutions sector.

There are also certain verticals like retail that continue to fill a fundamental need in us or have adapted to use a different method of delivery that will recover fairly well, all things considered.

Last weekend, I went out to NEX in Serangoon and there were snaking queues outside the mall, which seeded this impression. Of course, this is contingent on the pandemic situation and the regulations around mall traffic. I also think F&B businesses will be relatively resilient.

For one, they continue to serve a fundamental need, and secondly, many have adapted well—offering take-out services and delivery alternatives. Finally, I believe there will be a greater demand for mental health products and services as people struggle with the uncertainty and anxiety the pandemic has brought upon.

Unfortunately, I think businesses that involve tourism, transportation and heavy crowds would face a much slower recovery. This covers tourist attractions, airlines, ride-hailing, public transportation, cinemas and nightclubs. The aversion of consumers play a part, but the bigger factor stifling the recovery lies in the prevailing regulations on crowd size, travel restrictions etc. It is also hard to imagine these services offering a viable digital alternative without a complete pivot, whilst still serving to fulfil the original need well.

During the pandemic period, a number of startups were still able to nab funding from VCs. How are these startups able to do this?

Loh: For one, VCs cannot be dormant and conservative in response to the pandemic. How the situation evolves is largely outside of our control. So for a VC, adapting to the situation can be a superior strategy to biding time—which means funding will continue to happen, albeit at a slower pace. In other words, it is not surprising that some startups still get funded.

Across the board, I think investors will have a higher bar. The difficulty of succeeding, on average has increased. I think some startups are able to get funding decisively if the need or relevance of what they provide has been accentuated by the pandemic. For example, Protege Ventures recently made an investment in Intellect, a mental health startup. Regardless of the pandemic, mental health has been fundamentally important with increasing awareness of it.

The importance of mental wellness in the workplace had been even more pronounced with the pandemic, given the uncertainty of the employees’ livelihoods hanging over them, causing anxiety and stress.

Similarly, if the relevance or viability of the business is not too severely impacted by the pandemic, startups that have been doing well can probably still attract funding. This has much to do with the points discussed above—what the investor believes to be the new normal and how the founders position themselves on their strategic vision as well as the operational measures undertaken.

Boo: Even before COVID-19 hit, the WeWork and Softbank saga has caused investors to shift from investing in “growth at all costs” to “growth with sustainable cashflows”.The funding climate had already become tighter, as investors’ risk appetite was decreasing whilst valuations of startups remained very high regardless of whether they were profitable or not. Even if the startup was perceived to have potential, the price might not have been justifiable for an investor to enter the deal.

What the pandemic has caused is declining revenues for startups, which in turn affects cash flow. This is especially serious for startups that had not recently raised any capital and had their cash runways abnormally cut short. In light of this, founders are much more likely to raise at lower valuations if their priority is in helping their company survive rather than negotiating for the best price.

Even though VCs have become more concerned about profit sustainability when investing, the availability of capital to be deployed from their funds has remained largely unchanged. Lower valuations offered by startups is an opportunity for VCs to get into deals at much lower prices compared to pre-COVID times, which may make them more willing to consider doing a deal especially if the startup’s business model and unit economics are fundamentally sound.

Furthermore, startups that have managed to thrive in spite of the pandemic may be very attractive to investors as their performance signals either resilience or growing opportunities that should be tapped upon.

During a knowledge exchange with Paul Santos, managing partner of Wavemaker Partners and an advisor to Protege Ventures, shared with us crises like these trigger a flight to quality. He said that startups who stay prudent and prove their value to their customers will be ultimately rewarded. Investors may have more bargaining power today when cash is a bit tight, but this will shift back in favor of the few startups that show the most progress coming out of the pandemic.

On the investor side, describe VCs' strategies in choosing which startups to invest prior to COVID-19? What has changed during the CB period and what changes are you expecting to see as these measures ease?

Loh: I think the strategy before, broadly speaking, has been to establish certain circles of competence, in terms of industry, geography and technology, that the fund collectively specialises in. The fund then invests more heavily in those areas.

This focussed approach allows them to grow their advantage in terms of experience, network and potential synergies. For each investment that falls within their circles, the fund additionally considers the calibre and track record of the founders, the economics of the product or service, the market, traction, growth, competition, defensibility and exit prospects, of the business, among other things, before they make a decision.

At the height of the pandemic, these circles of competence may lose their viability or relevance. For example, if I had been specialising in the travel industry, the pandemic would have forced me to pivot and look into adjacent industries, or perhaps even something radically different that emerges as stronger opportunities in light of the pandemic.

Pivots aside, I think the uncertainty of the pandemic has made the risk profiles of start ups, again on average, less favourable for investors. So even as the measures ease, investors will have to evaluate even more carefully the opportunity cost of investments - in other words, raise their bar. There should also be caution directed at the potential changes in regulation that can disrupt the business. Basically, the world is a lot more volatile now and there are more checkboxes for an investment. I suspect across the board, the investment appetite has reduced and investors may expect more favourable valuations when investing.