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Calls grow for more rational valuation as VCs eye start-ups

Venture capitalists are looking to fund more early-stage start-ups' transformation into billion-dollar firms in Indonesia, but experts around the world are calling for more rational valuation of technology-based companies

Adrian Wail Akhlas and Riza Roidila Mufti (The Jakarta Post)
Jakarta
Wed, October 16, 2019

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Calls grow for more rational valuation as VCs eye start-ups

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enture capitalists are looking to fund more early-stage start-ups' transformation into billion-dollar firms in Indonesia, but experts around the world are calling for more rational valuation of technology-based companies.

With gross merchandise value (GMV) increasingly becoming the metric to value online retail businesses in their initial stages, venture capitalists and economists are now warning of the sustainability of such valuations. Billion-dollar unicorns should be measured by real revenue, profit and loss at that stage, they warn.

GMV measures total sales volume transactions through digital platforms, which most of the time act as mediators for transactions rather than the direct seller. Meanwhile, revenue comes from the income of doing business as the mediator, through fees or advertising.

“I don’t really believe in GMV, because if someday there is a global recession, that source of finance will decline. So if the business model continues to burn money, of course the model will have a limit,” renowned Indonesian economist Chatib Basri said, warning of the sustainability of tech businesses.

“If they rely only on raising funds, someday when there is a sudden shock in which funding is stuck, they will no longer be able to burn money and the impact will be systemic,” said Chatib, a former finance minister with academic experiences at Harvard University and the Australian National University, in a discussion organized by Indonesian unicorn online marketplace Tokopedia.

Many small and medium enterprises and individuals trade goods on digital platforms, hence the need to protect online marketplaces from a systemic crash by ensuring sustainable valuation and investment, he added, citing Tokopedia’s 2018 GMV of Rp 73 trillion (US$5.15 billion). Transaction value on the Tokopedia platform has been estimated at Rp 222 trillion in 2019, equivalent to 1.5 percent of Indonesia’s gross domestic product.

Five Indonesian start-ups have turned into unicorns, namely Tokopedia, ride-hailing app Gojek, e-commerce platform Bukalapak, travel and leisure marketplace Traveloka and e-money platform OVO, according to the Communications and Information Ministry.

Global venture capitalists have set their sights on more investment in Indonesian start-ups despite rising fears that the trade war-driven global headwinds will lead the world’s most powerful economies into recession, and result in an economic slowdown in Indonesia.

Funding for start-ups in Indonesia, the second most funded country in Southeast Asia after Singapore, is on track to match the 2018 funding record of $3.8 billion this year, with fewer deals but larger investment value, according to the 2019 e-Conomy Southeast Asia study by Google, Temasek and Bain & Company.


“I don’t really believe in GMV, because if someday there is a global recession, that source of finance will decline. So if the business model continues to burn money, of course the model will have a limit.”

 

In a recent blog titled “The Great Public Market Reckoning”, United States-based venture capitalist Fred Wilson argued that the narrative that had driven the start-up hype and valuations for the last decade was now falling apart.

Wilson said public markets were a lot different than the private market as financial transactions in private markets were controlled by the issuers and could occur whenever the issuers wanted. Meanwhile, public market investors can buy and sell stocks every day based on what is attractive to them and what is not.

“Valuations in the private markets, particularly the late-stage private markets, can sometimes be irrational. Public market valuations, after a stock has traded for a material amount of time and lockups have come off, are much more rational,” wrote Wilson, whose venture capital firm has invested in companies such as Twitter, Tumblr and Foursquare.

He referred to several tech companies that had gone public in the US, such as computer software company Zoom, website security company Cloudfare and ride-hailing app Uber. 

“Many of the stocks that have performed the best [in public markets] are software companies with software margin […] at the same list, many of the stocks that have struggled are companies that have low gross margins,” said Wilson.

He was referring to the 81 percent gross margin booked by software company Zoom, while ride-hailing app Uber recorded 46 percent gross margin.

“If the product is software and thus can produce software gross margins of 75 percent or greater, then it should be valued as a software company. If the product is something else and cannot produce software gross margins then it needs to be valued like other similar businesses,” Wilson added.

During the first three quarters of the year, venture capital firms around the globe invested $96.7 billion in 7,862 funding deals, according to a report by venture capital database PitchBook Data Inc. and National Venture Capital Association. In 2018, the funding value booked a record $137.6 billion. 

As many late-stage start-up companies in the US have not performed well in the public market, some venture capitalists are investing in early-stage start-ups in developing countries, such as Indonesia, aiming to nurture them to eventually become huge start-ups.

American venture capital firm Sequoia Capital managing director for India Rajan Anandan said the company had set aside $36 million for early-stage start-ups in India and Southeast Asia in the first round of a start-up accelerator program called Surge. The second stage would see $45 million in funding.

“The purpose of Surge is to speed up early development of start-ups,” said Rajan, adding that “we are opening up access to finance, human resources, networks and many years of Sequoia’s experience in developing companies”.

Of the 37 start-ups in the two-round Surge program, five are based in Indonesia, with mentors including unicorns ride-hailing app Gojek and Tokopedia.

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