Venture capitalists sharpen focus on targeting startups’ profit paths

Deal activity in Asia Pacific fell 26.3% YoY in 2023, but an expert suggests that years after a ‘bad year’ are always ‘exceptionally good.’

Merely having a unique product is insufficient for securing funding from cautious venture capital (VC) firms that are now keen on prioritising investments with a clear return profile. 

“What is your growth path to profitability and what is your cash funding time horizon?” are now questions that VC firms are posing, said Stephen Bates, partner and head of Deal Advisory at KPMG in Singapore.

The decline in VC deals in 2023 mirrors the caution exhibited by investors. Data from GlobalData showed that last year, VC deals in Asia-Pacific fell 33.2%. In 4Q23, the Asia-Pacific region also experienced a slump, with investment falling to US$18.8b, which according to KPMG is the lowest level since 1Q17.

“VCs that have invested in the past are more cautious around the companies that they are investing into. They are acutely conscious of making sure that the performance of these companies is tracking towards their plans in a relatively difficult economic environment which we’re still facing. This means that companies need to be more focused and deliberate in their investment spending and be more agile and nimble to pivot, if the execution of the strategy demands it,” Bates told Singapore Business Review.

“VCs are acutely focused on building successful companies as they don't want to have a fund that doesn't return to the original investors. They're very cautious around making sure that within the fund investments that they've made, that there is a return profile that supports the original investment from those LPs (limited partners),” he added.

Aurojyoti Bose, lead analyst at GlobalData, said investors are looking at whether a startup is able to generate profitability or not. “They’re definitely going to look for return on investments,” Bose said.

Surge in deal opportunities

Whilst 2023 was a “concerning year” for the VC market, Bates is “cautiously optimistic” about 2024, especially in the second half of 2024 when he expects a surge in deal opportunities, noting that years after a “bad year” are always “exceptionally good”, especially as we are starting to see a stabilisation of interest rates and inflation.

“There’s a lot of investors across VCs and or private equity that have a lot of dry powder through new funds being raised, and they’re really looking for that next generation of investments while having the need to exit some of their longer dated investments,” Bates said.

“I am quite bullish on the opportunities for the VC community in terms of the ability to exit, given most have concentrated their efforts into creating value in their portfolio companies, and working hard to turn them into profitable companies as early as possible,” he said.

Data from Enterprise Singapore supports Bates’ statement. According to the agency, early-stage deals accounted for about 95% of the deal volume and 53% of the deal value in Singapore in 9M23.

In 2024, Bates is seeing investment opportunities for VCs in Series B rounds across the ASEAN region. Many have corporate headquarters in Singapore with operations across the region. Singapore continues to support innovation across many sectors, which will create new opportunities for VCs.

“The investor community has become far more professionalised in the approach to investing in Series B and beyond,” Bates said. Startups building towards their Series B must ensure that they have audited financial, robust forecasts, as well as good corporate governance to attract VCs and investors alike.

He added that startups in the Series B level of funding must ensure that capital they are raising will be sufficient enough not just for two years, but for at least three.

“That's really to give financial stability to the company and ensure that they have a pathway to profitability through that period,” he said.

Top priorities

Looking at sectors, Bose said the tech sector, particularly Generative AI, are likely to attract investments in 2024 as they have in 2023.

Cybersecurity will also be popular, said the GlobalData expert.

Bates had a similar expectation for emerging deals in Gen AI, SAAS technologies, cybersecurity and KYC, which will be key themes for investors and startups in 2024. In Singapore, he said food agriculture will also be a robust area.

Financial services, on the other hand, won’t be as attractive as before, said Bates, adding that there’s already a number of good fintechs in Singapore.