There has been a slowdown in the start-up ecosystem and as a result, early-stage valuations have been curtailed. Having been involved with the early-stage space for almost a decade now, I’ve seen the ups and downs. In 2017/18, it was common to see early-stage valuations in the USD3-5m range in Southeast Asia. As more capital became available with more incubators, accelerators, and early-stage funds emerging, valuations crept up to USD5-8m. Then, when COVID hit and funds flocked up the risk curve and into the early-stage space, it was very common to see USD12-15m valuations for early-stage companies in Southeast Asia. We’ve now seen more of a correction back to the previous levels.

The Public-to-Private/US-to-SEA Lag

There is typically a three-to-six-month lag between what we see happening in the public markets filtering through into the private markets in North America. Then, there could be another six-month lag before we see those same attitudes being applied in Southeast Asia. This isn’t necessarily healthy for the ecosystem because the dislocations take longer to correct and during those periods of uncertainty, there is less funding available generally. Valuations have largely corrected in North America but remain slightly elevated due to other structural reasons in the ecosystem.

The USD375k MFN note offered by YC has elevated early-stage valuations generally. Don’t get me wrong here, because the structure of the investment is great for entrepreneurs that are operating in a large and growing digital market, but it can cause complications for founders operating in more fragmented regional markets. This also means that other entrepreneurs take it as a sign that seed-stage valuations should generally be high as well—“If they were able to attract that valuation and our product is superior, then we should be able to get a similar or better valuation.”

For the founders going through YC, they have already given away 7% with the first investment (maybe more if they raised other seed funding), and to assume that they only want to give away 20% in total in the pre-seed + seed rounds, then if they are raising USD2.0m, they would need to assume a minimum USD15m valuation. Considering USD375k of the following round is already guaranteed, then raising USD2m doesn’t seem like an unreasonable ask. Therefore, valuations in North America crept higher and to an extent, this flowed through to Southeast Asia as well.

Phases to Market Corrections

There are generally three phases to a market correction:

1. When sales growth fails to meet market expectations.
2. When earnings fail to materialize.
3. When directors want to be seen doing something because they were asleep at the wheel in the first two phases.

During a bull market, investors start to believe that all trees can grow to the sky. This results in valuations creeping higher and higher, justified by other valuations in the market (relative valuation methodologies are subject to distortion). At some point, revenue growth will drop or even decline as sales become harder and economic conditions tighten.

The flat-lining sales growth causes directors and investors to put a higher focus on earnings as they try to steady the ship. This causes a flow-on effect of lower sales to other companies in the ecosystem as unnecessary expenses are cut. There are a few iterations of this until a few companies, the ones with a necessary solution, will eventually see some positive sales growth return.

However, this isn’t when valuations start to turn up for companies because the directors want to be seen as doing something. This causes directors to push for higher margins and better free cash flow generation in the hopes of creating a buffer and preventing something similar from happening again in the future. This will continue for a while as profit growth starts to become the new norm again, and then directors will switch focus back to growth and the cycle starts again.

Conclusion

That said, in Southeast Asia, we’re probably somewhere between stages 2 and 3 with some companies having failed to make the necessary cuts to expenses to date. There are likely to be more cost cuts as we start to see the green shoots appearing. Early-stage companies in Southeast Asia appear to be getting funded between USD6-8m valuations at the moment, slightly above the 2018/19 levels but well below the COVID peaks.