The major boom in series A financing deals over the first quarter of Y2K is truly unprecedented. From Seoul to Singapore, the Asian venture capital market for internet start-ups is white hot and unlikely to cool anytime soon.
In just one week, Asia Online has raised $100 million for future acquisitions and InnoMedia has attracted $115.5 million in capital - staggering sums for early stage companies with very limited track records.
Meanwhile, top-tier private equity players such as Draper Fisher Jurvetson, 3i and Carlyle Group have all launched major technology funds focused exclusively on Asian opportunities. As we have already witnessed in the burgeoning US market, competition for Asian deals will intensify significantly with this major inflow of new money, further ratcheting up pre-money valuations for the next generation of Asian start-ups.
In this new market paradigm, incubators are viewed as an increasingly attractive business model for sourcing attractive deal flow and nurturing future e-business success stories. In the more developed US market, over 600 incubators are presently nurturing thousands of start-ups and have already hatched many of today's leading dot com players.
In Asia, about 30 incubators exist today with many more being launched each week, by international venture capitalists, local property developers and family conglomerates alike. While each hopes to cash in on the tech frenzy sweeping the region, triple digit returns will be elusive for most. The winners will those with a truly meaningful value proposition for Asian start-ups and a laser-sharp focus on a few critical success factors.
Value proposition for start-ups
So how do incubators create companies from scratch? It starts with a business idea, either brought to the incubator by budding entrepreneurs or hatched by the incubator's own management team. The path from idea generation to operating business is a difficult one for most young companies (see fig. 1).
Incubators systematically walk these new entities through each stage in the process, helping them formulate a business plan, providing office space and recruiting a top-notch management team. The experience of an incubator's management team and its breadth of industry contacts are often invaluable for fledgling companies. The network effect of co-location with other aspiring technopreneurs is another major benefit.
In return for this nurturing, incubators are typically compensated with 10%-50% sweat equity, which they sell off to new investors in later financing rounds. Pure incubation fills a need historically serviced by traditional venture capital firms. However, in today's booming private equity markets, average deal sizes are increasing with most VC's looking at minimum early stage investments of at least $5 million to $10 million and up. Asian incubators will serve an important role as a seed stage investor creating future deal flow for venture capitalists and exit options for themselves.
A new business model offered by a small number of incubators is business acceleration. The number one priority for post-series A internet companies is fast time-to-market growth. Three to six months can easily mean the difference between market leadership and bankruptcy. Turbo-charged growth requires carefully negotiated alliances and/or acquisitions, access to top-tier vendors and suppliers and best-in-class operational capabilities - all areas that experienced and well connected incubators can assist with.
For these services, the incubator is paid either with cash fees, 1% to 10% sweat equity or a mix of both. The value created is then captured in a higher market multiple in the next financing round. The incubation and acceleration value propositions are summarised below (see diagram).
Four key success factors
Delivering on the value proposition is no easy task and many incubators will achieve less than stellar returns on their sweat investments. The leading Asian incubators will all share a common set of key success factors:
1. Disciplined investment strategy and screening
For the best performing US and European incubators, 300+ business plans are reviewed for every 3-5 term sheets they draft, of which 1-2 will actually be signed. Attracting aspiring entrepreneurs is the easy part - turning most away and nurturing only the most promising is an absolute requirement for success.
2. Differentiated capabilities/expertise
Leading incubators assemble deep and balanced teams with extensive prior management experience in technology, finance, marketing, strategic planning and operations. Access to this expertise is a critical advantage for incubated portfolio companies vs. their competitors.
3. Network synergy
The incubator must provide a valuable network of external suppliers and advisors including executive search firms, technology vendors, consultants, bankers, accounts and attorneys. Of equal importance is the internal network synergy created between portfolio companies via information sharing, alliances and even mergers.
4. Established brand and track record
The track record of successful incubators such as Internet Capital Group and CMGI creates significant value for its portfolio companies. They attracts higher quality deal flow, best-in-class management teams and board members, alliance partners for portfolio companies and ultimately command higher exit valuations than their less well regarded counterparts.
In the next 12 months, over 50 new incubators will sprout up all across Asia. These incubators will no doubt play a critical role in seeding, growing and accelerating the next generation of Asian internet start-ups. This new wave of incubators will inevitably discover that six bag returns are far more difficult to achieve than they anticipate.
The core value proposition must be clearly understood and seamlessly delivered to portfolio companies. And this requires more than just free office space and a secretarial pool. The leaders in this field will demonstrate investment discipline, develop differentiated capabilities and networks and bring a credible market track record. The few that can deliver will emerge at the forefront of the next wave of Asian I-builders.
Edmund Lin is a specialist in e-commerce and private equityáwith Bain & Company, Singapore.