Cover story: A venture worth the risk

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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 15, 2017 – May 21, 2017.

As a venture capitalist, Teh Kim Seng is used to taking calculated risks in order to achieve his objectives. He also adopts this approach in his personal investing portfolio, which is made up of 50% venture capital investments, 30% in property and the remainder in equities and cash. While this allocation may seem like a risky one, it is all part of a carefully designed strategy.

“I have allocated enough cash to cover the daily needs of the family for the short and medium term. I also hold some blue-chip stocks that I can cash in whenever I need cash. This is the part that is in the ‘safe’ investment category that I can’t afford to lose in any situation.

“For the extra cash I have, I allocated some in real estate [investments] as they are for longer-term holdings and are less liquid. The rest of it, I will happily invest in Netrove,” he adds.

Teh is the founder and chairman of Netrove Ventures Group, a regional venture capital and corporate finance advisory firm. Founded in 1999, the company started with two offices in Malaysia and Hong Kong before expanding to mainland China, Vietnam and Thailand. The company focuses on risk capital investment and fundraising, corporate finance advisory, initial public offering (IPO) as well as mergers and acquisitions in the region.

His personal involvement in the venture capital industry is what led him to allocate half of the investments from it in his portfolio.

“I am very passionate about this industry, and am in a unique situation of being both a general partner (GP) and main limited partner (LP) in Netrove, a venture capital company which I founded and actively manage. Naturally, a lot of my net worth is still parked in this segment.”

In comparison, he says many other venture capital managers who are the GPs would be different because they are working for the LPs, hence they only earn a fee and a carry from their success. This is why their allocation in venture capital would likely be at a significantly lower percentage.

Teh’s 50% allocation in venture capital was not intentional, growing from 30% he allocated five years ago. But over the years, his assets in Netrove have grown at a much faster rate compared with other assets.

“I will of course review the allocation from time to time, perhaps when I am close to retirement or when I am no longer running Netrove actively. Currently, what I have in property, stocks and cash is more than enough for my family’s needs, so leaving the rest in a venture capital firm that is managed by my team is not a bad thing,” he adds.

Teh says most of his real estate investments are from the extra cash that he has. He wanted to make his cash work harder by earning both rental and capital gain with the help of some mortgage leverage and chose to buy properties in several countries for personal reasons and investment purposes.

“I have properties in Malaysia, China and Hong Kong and I am about to buy another in London. I see blue chip listed equity almost as cash because they are very liquid.

“Hong Kong has been my home for the last two decades and I know the market dynamics really well. I also own property in Kuala Lumpur because it is my second home. As for China, I see the potential growth in real estate in the two decades to come. I am looking to buy a property in London because my children are studying in the UK,” he says.

Over the past 15 years, Netrove has logged an astounding triple-digit internal rate of return (IRR). Each investment has raked in returns of between 10 and 30 times. It is quite an achievement — Teh points out that even some of the top venture capital firms in the US were only logging an IRR of 40% or so.

He attributes the firm’s returns to its family-office-like fund structure and intense hand-holding strategy with portfolio companies. He believes these two factors are main contributors to the firm’s outperformance.

Netrove’s current portfolio of 15 companies have a total value of US$100 million and it still has about US$15 million in the pool waiting to be invested. According to the firm’s website, some of the portfolio companies include CrowdPlus Asia, an equity crowdfunding platform in Malaysia; EAT Holding Corp, an investment fund with a focus in education and healthcare; Fifth Media, a mobile games, contents and aggregation site in Vietnam; Fruiti King, a premium gelato and popsicle maker in Malaysia; and Galasys Technologies, an e-ticketing and theme park management system in Asia.

Other portfolio companies are Garant-Mobel Holding International, a high-end furniture retailer and soft franchiser in Europe and Asia; Gravity4, an advertising technology company in the US; Green Energy Technology Holding, a solar power plant builder and operator in Thailand; Leroy International, a healthcare direct sales company in China; Touristly, a travel platform in Malaysia and Visual Math Interactive, a mobile gamified education platform in Malaysia.

From law to venture capital

The cornerstone of Netrove was set when the World Wide Web (WWW) hit Asia in the 1990s. A job offer from Clarion Capital, a regional investment firm, brought Teh back to Hong Kong from the UK where he was practising as a corporate finance lawyer at Simmons & Simmons, an international law firm with offices across Asia, Europe and the Middle East. He was a senior associate at the law firm, after serving there for eight years.

His transition from the law profession into the financial world was a natural one. This can be traced back to his secondary school years, when he was a pure science and double mathematics student. The Malaysian native, who was born in Klang, Selangor, had humble beginnings.

“I was born into a family of 12 kids — nine daughters in a row followed by three sons. I am the youngest child. We lived and grew up in a stilt house. I really understand what poverty is all about [as I grew up in it] during my childhood. My father was unskilled and illiterate and I lost my mother at the age of nine. I experimented with a lot of things in life on my own without parental guidance,” he recalls.

Teh never thought of reading law until his father’s humble business went bankrupt during the 1980s.

“I love numbers. My ambition then was to be a computer programmer. But when my father’s little construction company went bust, we were forced to deal with lawyers. I was only a teenager then; I did not comprehend whatever the lawyers said. But I thought if I could be a lawyer one day, I would be able to help my father and other people like him — I would communicate legal issues better to clients.”

After graduating with a bachelor’s degree in law from the University of Leeds and earning a master’s degree in law from Queens College, University of Cambridge, Teh chose to practise corporate finance law because it allowed him to deal with a lot of numbers. He worked very closely with investment bankers, and eventually became one himself.

“When the internet was introduced in Hong Kong in the mid-Nineties, I was already working there as an investment banker. Many new companies and great innovations were created because of it. It was amazing to see how creative people can get with the help of the internet,” Teh says.

“I was knee-deep in the whole dotcom boom, reading many success stories of those new American companies leveraging the WWW to create new businesses and services, to make things work. People in Asia were slowly catching up and trying to duplicate those models and success stories.”

It was during this time that he spent a lot of his after-work hours (which means after 9pm in Hong Kong) to go to pitching sessions by young entrepreneurs trying to start something new. Teh says those were casual meetings at a hotel or a bar to hear out great ideas and decide which to invest in.

“There were about 20 of us who were there frequently to meet those young entrepreneurs. We were part of the first group of angel investors in Hong Kong. Other than us, nobody really understood what the internet was all about back then. The pitching sessions usually finished in the wee hours of the morning. I would go home, take a shower, rest for a few hours and then show up to my day job at 8am,” he says.

This crazy schedule went on for four years, from 1996 to 1999. Eventually, it became too exhausting and Teh finally decided to quit his investment banker career to focus on investing in start-ups. He was already the partner, director and chief operating officer at the investment firm, but he knew venture capital was his passion and he wanted to dedicate more time to it.

“When we made our investments in those start-ups, it was just some casual arrangement with minimal paperwork. We gave them our money and let them report back after a period of time. I wanted to institutionalise this whole concept and work. I told some of the members in the group of angel investors that we should formalise things,” he recalls.

From there, Netrove Partners Sdn Bhd and Netrove Ventures Corp (Hong Kong office) were founded. A partner oversaw the Malaysia office while Teh managed the Hong Kong office.

“The reason we set up two offices from the very beginning was that most of my connections have been in North Asia ever since I returned from the UK. Moreover, I had a Malaysian partner that could help me run the office in Malaysia,” Teh says.

What differentiates Netrove from any venture capital firm, he notes, is that it does not follow the typical fund set-up. “A typical fund set-up would be a venture capital management company raising up a few funds, giving them anything from 5 to 10 years of lifecycle, invest and divest the funds within the set time frame, calculate the returns and give the money back to the investors with profits shared if there’s any,” Teh explains.

“Netrove is different. We are more like a family office, where the management team and I manage the funds in the company. We effectively invest through a corporate structure rather than a fund set-up. Because of this, we don’t have an expiry date. We can continue to invest in as many companies and for as long as we want. After we exit, the money will be channelled back into Netrove and we will use it to invest in other new companies or make a distribution to shareholders.”

He points out that the problem with a typical venture capital fund structure is that the set time frame may limit the manager’s ability to maximise returns for investors. It may not be beneficial for the portfolio companies too.

“For example, if a venture capital fund’s lifecycle is seven years and if the fund manager invests in a new company in the fifth year, he only has three years to exit. He would be forced to exit once the fund is almost expired, even if he thinks that the company still has potential to grow. It may also hurt the company’s business or disrupt its management team because they may still need the fund manager’s guidance but he has to exit according to his timetable.”

These are not problems for Netrove, Teh says, owing to the family office structure. “We prefer to hold a portfolio company and exit it within five years. Most of the time, we stick to this rule. But if we don’t want to exit it, we don’t have to because of any artificially imposed expiry date. We can hold an investment for 15 years if we want to!”

Why does the firm choose to hold a company for more than five years? Teh says it is because they still believe in the story of the company.

“After a period of growth, the portfolio company may change its form. If, however, we think that the high growth could be sustained, we will choose to stay with the company. It is like watching a good movie. Why would I leave when the movie is still playing? The excitement is still there so I will keep watching,” he laughs.

Teh says venture capital suits his nature as he loves taking calculated and smart risks.

“No other investment or asset class has this risk-reward profile like this industry. I am also a natural entrepreneur. I am interested in idea and product creation, branding, marketing, sales and finance. To a certain extent, being a venture capitalist allows me to venture into all these aspects of a business.”

Portfolio of companies

Teh says Netrove started off investing in companies that were in the early start-up stage. Over the years, as capital grew, the firm also invested in companies in the Series-A, which already have proven products, models or even make a small profit.

“Our investment amounts range from a few hundred thousand to a few million US dollars. We occasionally also follow to invest in companies in Series-B, but we wouldn’t lead the round. These companies are usually looking to raise US$5 million to US$20 million for market expansion. The management team would be quite mature and capable and we may have limited value-add to the company,” he explains.

“For a firm like ours, we are more focused on seed or the Series-A stage as that is our expertise and we can add tremendous value to their growth. We don’t invest in many Series-B but that doesn’t mean we don’t stay in these companies when they raise their round to Series-B or beyond. We just don’t invest new money into them.”

Throughout its 18 years in the industry, Teh says, Netrove has had a particular strong interest in internet companies. However, it is also keen to explore mobile software, applications and games.

“Most of our current portfolio companies would fall into these two categories, but there would also be some odd ones that do not belong to either. This is because they have a compelling business thesis and we made exceptions for them,” he notes.

Teh’s deep interest in internet and mobile applications comes from his early years in Hong Kong. But he also sees the extreme excitement in these two sectors as they are transforming the world.

“The mobile apps sector is exciting because it is the one tech segment that Asia is leading the West in many ways. Mobile apps and software continue to grow at very high rates and this created the convergence platforms of mobile and PC internet, which also converged hardware devices and changed the landscape completely over the last two decades,” he points out.

“Look at how the world connects now. Look at how our behaviours have changed and how much time we spend on our devices. Look at how convenient finding information is now. The enablers are the internet and mobile apps! Why shouldn’t we focus on these segments when we have the experience and expertise in them?”

Teh says the company has two core investment philosophies. “Firstly, we must be able to understand the business and share the passion of the business and entrepreneurs. Secondly, we need to be able to add value to the company. If we can provide nothing else other than just money, we will not invest in the company.”

This ties back to the operation of Netrove. It is really intense as its team members would go in as part of the executive team of its portfolio companies — that is how the firm adds value.

“We put our people into the companies to work with the management team. Because of this, we cannot have too many portfolio companies. We have 15 in our portfolio now, and I think the optimal situation should never exceed 20 companies. The current ratio is almost one company to 1.5 of our team in the region,” Teh explains.

There is also the “spray and pray” strategy practised by many venture capital funds. They may allocate US$500,000 or US$1 million each into 20 companies and have only a few employees taking care of these companies. They would be happy if one or two of those companies turn out to be successful. Teh does not follow this trend because there are few “spray and pray” firms he knows of that survive.

This is why Netrove employs such an intense strategy, and also why it can only invest in companies operating out of countries it has offices in.

“The idea is to explore and bring in new deals. If a company looks interesting, we will send people out to do due diligence, structure a deal, talk to lawyers and so on. After sealing the deal, we need to keep a close eye on the company and grow it with the management team. We wouldn’t be able to do all these without an office on the ground,” he explains.

Just like location is the key in buying property, Teh believes people are the most important element in spotting a company with high potential. He trusts that quality people will be able to navigate through any weather.

For instance, in the two Malaysian companies the firm invested in, the entrepreneurs were what piqued his interest. Both founders had compelling stories that Teh saw potential in, and how Netrove could add value to these companies.

“When Fruiti King’s founder Gideon Leong came to see me about a year ago, he told me he had a small factory making ice cream, and he wanted to grow it further. He needed funding. Ice cream is not our forte, but it is not too hard to understand. So I tried to explore it,” Teh says.

Being a food lover, he tasted the ice cream sample that Leong brought and was amazed by how good it was. The next day, Teh sent his team out to try all available ice cream in the market to see if they could find something equivalent or as good as Fruiti King’s. The team came back and reported that they could not seem to find any that could beat those Leong brought.

The next question Teh asked himself was, how would he add value to an ice-cream company? He does not have any experience in manufacturing so he called up a friend who owns Papparich, a restaurant chain in Malaysia.

“I asked him to try the ice cream samples and let me know whether he would want to carry these in his restaurants. He called back shortly to say that he wanted to sell the ice cream and invest in the business because they were really good!”

Teh sealed the deal with Leong as he saw how Netrove could add value to Fruiti King. “I also asked my friends in China to sample the ice cream and they said they wanted to bring the products to China too. We could help to develop the business and introduce more distribution channels to it.”

Visual Math Interactive is another Malaysian company where Teh sees a lot of growth potential. The founder is a former teacher who developed Zap Zap Math — a game-based mathematics learning platform for kids.

“When the founder John Ng came to me, he had already spent seven years to create a website that provides solutions for kids who have problems learning mathematics. He did all this, without any help, from his own bedroom. I saw his passion and I thought the company had a lot of potential. I told him, ‘You are either stupid or crazy, and I am going to join you’,” Teh recalls.

The team helped Ng by building a team of experts in product design and management. Ng is an academician and programmer, so a gaming, user interface (UI) and user experience (UX) designer came on board to join him. Later, the company hired a new CEO to manage the daily operations. Teh says the company has seen phenomenal growth in recent years.

While people always come first, Teh says other factors of the business are equally important when it comes to picking the right portfolio company.

“Other factors include what is the space that the business is in, how innovative the technology or the product is, how big is the total available market, who are the competitors, how they compare, what is the growth rate and so on,” he says, adding that he is still learning too as it is very difficult to develop a winning strategy.

Teh says the firm has not taken any external funds for 15 years now. “We did that in our first few years. When our investments started to pay off, we reinvested the money and we no longer need external funding.”

Although Netrove doesn’t take in investors’ money, the team would be happy to talk to investors who are interested in the venture capital industry. Teh says investors need to have at least half a million to spare if they were to invest in venture capital.

“Investors may be able to make as good returns as ours if they join us earlier in an investment round. But they need to be mindful that they are taking concentrated risks as they are only investing in a single company, whereas Netrove has more diversified risks as we have a portfolio of companies,” he says.

Although the firm has been making admirable returns, Teh is the first to admit that a pretty track record doesn’t mean the firm will not suffer a loss in the future. Despite having half his own portfolio in venture capital, he warns that people need to remember that high returns always come with high risks.

“There is no conducive climate for investors to invest in venture capital. In this industry, every day we are dealing with high risks and high returns. People need to be conscious of their overall portfolio and how diversified they are. If all of their needs are well taken care of, and they want to put some money in the high risk investment, I think at most they should allocate 20% of their portfolio in venture capital. For someone who is still struggling to make ends meet, he should steer clear of this investment class,” he explains.

SUCCESS STORIES

Having been in the industry for 18 years, Netrove Ventures Group has made more than 15 exits and raked in multiple times of returns.

Founder and chairman Teh Kim Seng talks about some of the memorable exits that Netrove had made. These success stories brought enormous financial returns to the firm and its people.

Quamnet, a financial portal in Hong Kong, was among the first few companies the firm invested in. Netrove stayed with the company for 14 years, Teh says, the longest holding period in the firm’s history.

“We invested in it in the late 1990s when the dotcom bubble was about to burst. The company suffered quite badly during the first few years but eventually got bought out by a Hong Kong-listed company at a good valuation. When dotcom two came back around 2003, it went through a growth curve and the big return was when we got bought out by another listed company in 2011,” he recalls.

Netrove was given listed shares of the company, which it held until 2014. Teh says a private bank in China bought into the company then, sending the share prices higher, so the firm thought it was the right time to sell those shares and completely cash out at a really good price.

He also recalls the exit of Pixel Digital Media Company (now known as Pixels Ltd), an advertising technology company. It gave the firm access to the shares of a Silicon Valley-based company, Gravity4, which is in a similar business as Pixels.

“The company was based out of Hong Kong and Malaysia. We invested in it in 2007 and got it listed on the Alternative Investment Market (the secondary board of London Stock Exchange). The company was growing until the Asian financial crisis hit in 2008. The business was badly affected and needed to be recalibrated so we had to privatise it to grow it again,” he says.

“Two years ago, Gravity4 came and bought the company. So we exited partially with cash and partially with shares of the Silicon Valley company after eight years with Pixel. Isn’t that exciting? The parent company is still growing nicely today, so we are not looking to exit those shares yet and look forward to bigger returns in days to come.”

Teh also remembers 49you.com, a mobile digital content and gaming company in China. The firm invested in it for five years and then cashed out. It sounds pretty normal except for one thing: the firm would have made better returns if it had not exited then.

“It was one of the top five largest mobile developers and distributors in Guangdong province. The company continued to grow as it raised a lot of money in series-A and series-B. When it got to series-C, one of the investors wanted more shares, but the company wasn’t ready to dilute further.

“We thought it was a good time to exit, so we offered our shares and made more than 20 times returns from it. The company is four times bigger than it was today. If we were to sell our shares now, we would have made 80 times returns. But it is okay as I am always happy to have cash,” he laughs.

VENTURE CAPITAL IN ASIA

Although other major regions such as America and Europe have seen a decline in venture capital activity, Asia’s total venture capital invested remained steady between 2015 and 2016, at just over US$39 billion each year. According to the fourth quarter 2016 edition of Venture Pulse report, numerous mega deals early in the year buoyed total funding overall, then trailed off during the second half of the year, to just a single US$500 million funding round in the fourth quarter of last year.

“Similar to venture capital investors in other regions around the world, investors in Asia have taken a more cautious approach to their investments this year. While investments are still being made, the due diligence and deal approval process is taking longer than it has historically.”

The Jan 12 report, published by KPMG Enterprise, also says artificial intelligence and cognitive learning are expected to be very hot topics for the venture capital investment industry. Outsourcing, healthcare and education technologies are also seen as top priorities for this industry.

Netrove Ventures Group founder and chairman Teh Kim Seng says venture capital in Asia has seen tremendous growth in the last five years, especially in China, which saw hundreds of billions of venture capital money flowing in. Countries like Indonesia and India are also seeing a big pick-up as some of the economic issues are being resolved.

“Venture capital in Malaysia has grown a lot and the landscape has changed a lot over the last decade. The set up of venture capital firms in the country is gaining pace. This is particularly owing to government-linked corporations such as Malaysia Venture Capital Management Bhd (Mavcap) and Ekuiti Nasional Bhd (Ekuinas) giving birth to outsourced programmes. They are setting up numerous funds to invest in the venture capital industry.”

However, Teh points out that the litmus test for venture capital firms is 10 years. This means that although some of the funds, using the “spray and pray” strategy may see a few of their investments in portfolio companies pay off, it will take 10 years to see if these firms can last until the end.

He says venture capital firms typically like high-growth industries, which are almost synonymous with the technology, media and telecommunications (TMT) sectors. There are also a few non-TMT areas these firms are interested in, such as healthcare and food and beverages. He personally thinks TMT is still the one that rakes in the highest return if investors know how to pick the right company and time to exit.

He observes that raising new venture capital money in the current market situation is difficult, whether for new venture capital funds or for entrepreneurs looking for additional investments.

“I think venture capital is a cyclical industry. Every three to five years, we will see a new investment or divestment cycle. In the last two years, there have been less exits and IPOs compared to the past three years, so investors are holding their cheques and being more cautious. They will get back in to invest when they see more positive market conditions,” he adds.

Source: http://www.theedgemarkets.com/article/cover-story-venture-worth-risk, 24 May 2017