Time to be bold: How the government can reshape our startup ecosystem
By Aaron Sarma and Dr. Sivapalan Vivekarajah April 24, 2020
Increase funding for venture debt under MDV with aggressive 1:1 matching ratio
- Not the time to take foot off the gas, rather, need to put pedal to the metal
[Part 2 will be published Sunday.]
The economic impact of the COVID-19 pandemic is being felt by all quarters of the market and arguably the worst is yet to come. Startups are especially hit. The Malaysian Global Innovation and Creative Centre (MaGIC) estimates that 40% of local tech startups won’t survive this crisis.
There’s been much consternation about the government coming in to save startups. While the PRIHATIN SME stimulus package announced by Malaysian Prime Minister Muhyiddin Yassin on 6th April 2020 focused on SMEs and particularly micro SMEs, many in the startup ecosystem in Malaysia have expressed concern that there hasn’t been a dedicated stimulus for the local tech industry.
It is understandable that the government may have challenges diagnosing how it can help the startup ecosystem. While it is true that startups are a type of SME, there are fundamental differences between a startup and most SMEs.
Market risk vs Execution risk
At its core startups have an element of market risk. Most startups launch on an assumption of what they believe their opportunity is and their entire mission is to prove this hypothesis. No one knew they would want to use an app to call a ride until Uber and Grab came along. Who would have imagined buying books online until Amazon did.
Not so long ago we used to frequent DVD shops to buy our favourite movies and now all of us are streaming on Netflix or some other streaming platform. It’s only when a startup establishes that there is demand for their product that they can even begin to think about the next kind of risk.
Most SMEs have execution risk. That is risk related to the ability of the business owner to execute their business plan. This applies to restaurants, hair salons, car dealerships and the like. We all know what a good restaurant is, what makes a good barbershop and why some fashion boutiques do well and others don’t. Most SMEs have a playbook that is familiar or known.
Startups on the other hand are developing their playbooks on the fly through trial and error. For this reason, we should not assume that the same approach can be applied for startups and most SMEs.
Throughout this discussion we have seen some advocate that it is pointless to save startups. To a degree, we understand the rationale. Firstly, startups fail all the time. As such, it’s okay to let them shutter and for a new crop to emerge later on. Secondly, most startups don’t make a dent in the economy with minimal impact to tax revenues and job creation - at least in the early stage. And thirdly, there is the argument that we don’t know how this crisis will end and thus, why support a lost cause.
If you’ve made it this far, guess what?
Spoiler alert: Startups absolutely need to be saved!
Startups are drivers of innovation in the new economy. They represent the world as it could be, perhaps as it should be. Our startups not only contribute from a technological perspective but also in job creation and talent development. Arguably, for every 100 failures there is at least 1 company which has the ability to change an industry, employ hundreds and generate millions in revenue. At one point even the likes of AirAsia, Sunway Group and MyEG were startups too. Today, they employ thousands and generate billions of Ringgit in revenue.
By allowing startups to simply perish, we risk sacrificing the good companies alongside the bad ones. We will also lose precious talent to other countries and worst of all, we would have set our local ecosystem back years. All the efforts made to groom our ecosystem over the last two decades would be in jeopardy.
Apply pedal to the metal
This is not the time to take the foot off the gas. We need to put the pedal to the metal.
If we believe that startups are companies that are building the future of the economy it is imperative that we support them in the present. The solution for this of course should be shouldered by all participants in the economy. To butcher an old adage - it takes an ecosystem to raise a startup.
Startups of course should ensure that their businesses are built to last. Indeed, through this crisis, we are seeing founders pivoting and making hard decisions in order to survive. Their courage and valour is commendable. The corporate sector should adopt more solutions by startups through collaborations and partnerships. These partnerships could in fact be beneficial for both entities as we navigate this difficult period. In any case, this is a discussion for another article.
The government however, holds a unique place in this equation with access to more than just capital to bolster innovation and support agile founders. There are some things that only the government can do.
It must also be noted that while there may be close to a million SMEs the number of tech startups are only a fraction of this, probably numbering below 10,000. Hence the cost of the stimulus we are recommending is far lower than the PRIHATIN package.
To help drive a discussion, we wish to recommend 10 stimulus ideas that can provide immediate relief for the startup ecosystem. These proposals are divided into two sections:
Firstly for immediate financial support to ensure companies can make it through this current difficult period - to survive, and secondly to provide funding for the future for the companies to take advantage of the economic recovery to grow their business - to thrive.
Section 1: Survive
1. Expand the wage subsidy program in PRIHATIN SME to include knowledge workers
The biggest expense for startups is talent. As much as 70%-80% of costs are staff costs. A key difference between startups and conventional companies is that the salary structure is inverted. When starting out most founders pay themselves a minimal amount and instead invest in developers and individuals with domain expertise. Most of their staff earn above the RM4,000 a month threshold in the PRIHATIN SME stimulus. As such, the early stage startup founders will find themselves to be probably the only employees in the company to benefit from the current stimulus while continuing to be pressured to retain and compensate their key talent.
a. Increase the subsidy to 50% of salaries for staff earning below RM8,000 per month for 6 months. It looks increasingly likely that the recession will last at least a year, hence 3 months subsidy will not be sufficient. Total staff subsidy capped at 50 staff per company.
b. Have a 20% subsidy for salaries for knowledge workers who earn more than RM10,000 a month for 12 months. This is to allow our startups and technology companies to hire top talent to drive their innovations. It will also make Malaysia more competitive compared to our neighbouring countries and the government will still earn via taxation so this incentive ultimately is budget neutral. The long term effects here however will be substantial. In addition to this the government will also develop visibility on the digital skills being adopted by Malaysian companies which is in line with the development of the Digital Skills Registry being spearheaded by Malaysia Digital Economy Corporation (MDEC).
2. Expansion of the rental subsidy program in PRIHATIN SME
The next highest fixed cost is rental. Most startups use their office space as a way to build culture and while the new normal of remote working has been widely adopted, most startups will return to their offices as the MCO is lifted. Helping startups manage this cost would go a long way in helping them focus on building their business and growing revenues.
Provide a 6 months 50% rental subsidy for startups. Capped at RM10,000 per company per month. In PRIHATIN SME, government owned buildings will provide the subsidy and privately owned buildings were encouraged to follow suit. We would suggest as an extension to also utilise and channel this subsidy through MSC Cybercenters and MSC Digital Hubs which are administered by MDEC.
3. Increase Debt funding
We will address venture capital in our next segment but we think venture debt is a great avenue for startups to get capital to tide them over. Currently Malaysian Debt Ventures (MDV) is the only agency providing venture debt. MDV also provides a matching fund for companies that receive VC funding wherein MDV matches by providing 25% matching. In effect this is a loan.
a. Access to Venture Debt via MDV
Our recommendation is to increase funding for venture debt under MDV and to have a more aggressive matching ratio. Our proposal is for debt to be matched at 1:1. That is for every RM committed by a venture capitalist, startups will be able to get the equivalent in debt funding. This way, we can stretch the startup’s runway with additional cash. As the economy recovers they will be able to repay these loans.
Our initial thoughts are to increase the fund amount to RM200 million and cap the distribution amount to RM2 million per company. This will benefit 100 companies but as it’s debt, principal repayments can be rolled forward to continue funding more companies.
Interest rate from the Govt to be 0% but MDV can charge up to 3% to cover their costs with a waiver on interest for the first 6 months as being offered by most banks during this period.
b. Venture Debt via Angel Investors
An extension of this would be to also allow venture debt to also be provided as matching for Angel and Accelerator investments at the same ratio but capped at RM1 million for Accredited Angels, Angel Clubs and Accelerators.
4. Access to project financing / factoring
There are some startups that have received purchase orders or would like to proceed with tenders but have held back because of concerns of being unable to finance their operations to carry out these projects. Project financing or factoring could be a solution to allow startups to make payroll, buy inventory and reinvest in the business as needed. In addition, this allows startups to participate in deals that might otherwise be out of reach due to long payment cycles or high capital requirements.
The government should designate licensed factoring companies, peer to peer and online factoring companies to advance between 80 percent-90 percent of the invoice value based on proof of invoicing or of completion of work. This enables the startup to have access to cash or working capital for their business. We recommend a stimulus package of RM200 million capped at RM2 million per company and this will benefit more than 100 companies.
Part 2 will be on 6 more recommendations on how the government can help startups thrive in a post-COVID-10 world
Aaron Sarma & Dr V. Sivapalan are leaders among the Malaysian tech startup ecosystem.
Aaron Sarma & Dr V. Sivapalan are leaders among the Malaysian tech startup ecosystem.