How the Asian startup ecosystem is faring in 2023

Welcome to the first edition of Hedwig—a fortnightly newsletter that gives you a bird’s eye view of the Asian startup and investor community. In our inaugural newsletter, we look at the macroeconomic cues and what they mean for the VC ecosystem, particularly in Asia. And the themes in the region's venture capital industry that may define 2023.

Hedwig | VC edition—Part 1

After a year of doom or gloom, 2023 began on a somber note—entrepreneurs and investors, all bracing for another rough year, marked by the ongoing Rusia-Ukraine war, persistent inflation, looming recession, volatile markets, and the continued funding winter for growth and late-stage startups.?

By and large, everyone factored in the impact of these events into their expectations from this year. The only hope was that things wouldn't get more depressing than they already were.

And indeed, the winds of change have begun to blow, with China’s great reopening on January 8, 2023, after almost three years.?

During the World Economic Forum’s annual summit in Davos, Switzerland in mid-January, international economists pinned their hopes on the resurrecting consumption demand in China to revive global growth. The global supply chain is also getting back on track with China opening up its borders.?

Then there are other forces at play.?

In the US, inflation is cooling even as the labor market remains strong, raising hopes that the American central bank won't increase interest rates as steeply as last year and may eventually begin bringing them down.

As per Economist, the chances of a soft landing—in which price growth comes under control without a recession—have gone up. More importantly, the American economy is still growing.

Meanwhile, in Eurozone, gas prices are falling due to an unusually warm winter in the region, and that has abated the fear of an energy crisis. There is now less than a 30% chance of a recession in Europe, down from the estimated 90% last summer, Anna Titareva , an economist at UBS, told Financial Times.

She isn’t the only one subscribing to this view. In a survey with fund managers, Bank of America found that fears about a global recession have fallen to a six-month low, thanks to the cheer brought by the revival of the Chinese economy.

The only caveat is that the pent-up commodities demand in China and overheated labor markets shouldn’t pull up inflation in the Western markets. Otherwise, central banks would be forced to continue raising interest rates and that would push their economies deeper into a slowdown.?

Nonetheless, there is a sharp about-turn in global economic sentiment this month. IMF has, of course, taken note and revised its global growth forecasts in an update to its World Economic Outlook, which is less gloomy than before.?

Global growth, it says, will slow down from 3.4% in 2022 to 2.9% in 2023 and then rebound to 3.1% next year. The silver lining here is the expected global GDP this year is 0.2 percentage points higher than its previous forecast. Moreover, IMF predicts global inflation to fall to 6.6% in 2023 from 8.8% in 2022.?

India remains a bright spot, and together with China—which is expected to rebound this year—will account for half of the global growth this year, versus just a tenth for the US and Eurozone combined, believes IMF’s director of research Pierre-Olivier Gourinchas.

All in all, Asia has a big role to play in stabilizing the world economy. When macroeconomic conditions improve, it reflects in the stock markets across the world, which eventually gets mirrored in private markets.?

Well, that’s what everyone is hoping to happen, at least in the second half of the year.?

So let’s see what investors in Asia have been expecting this year, all things considered, and how that's turning out to be.

Here are the top five themes in the Asian VC space:

Early-stage deals to remain investors’ favorite

It is neither new, nor it is surprising. Yet, this trend is a significant one.?

Historically, great companies have emerged from periods of distress. General Electric. Disney. Microsoft. Mailchimp. Apple. Netflix. Slack. WhatsApp. Instagram. Venmo. Alibaba. The list can go on and on.?

When resources are scarce, entrepreneurs lean more on their creativity and ingenuity to innovate solutions. And they target problems and areas for which customers would be willing to shell out money despite the downturn. Those who invested in such companies early made some of the biggest returns in the venture industry. No wonder, VCs rush to find early-stage deals in a downturn.?

There is another reason for this preferential treatment. Investors believe early-stage startups are not as impacted by macroeconomic conditions as growth-to-late stage companies. This resonates even more when you look at Asia, which, barring China, has fared relatively better in 2022.?

That investors are writing more and more small checks is evident in numbers.

While total funding in Southeast Asia dropped 32% to US$15.8 billion compared to last year, there were nearly 10% more deals. A report by Global Data indicates that startup investments in China nosedived 46.4% to US$57.4 billion with a notable fall in average funding size. In India—where VCs poured in US$24 billion last year, 33% less than that of 2021—early-stage startup funding rose 12% to US$2.8 billion over 2021, notes PwC. This trend seems to be continuing well into 2023.?

What's also interesting is that even though the early-stage deals’ valuations have come down 30-50%?from the FOMO-driven high of 2021, the best early deals still command high revenue multiples. And given that they are being funded in a corrected market, they may just be the kind of companies that investors dream of backing.?

Resilient, profitability-oriented founders

It’s no secret that funding winter of 2022 has put founders back on the right track, after the hyped-up 2021.?

Entrepreneurs are focused on getting the fundamentals of the company right and reaching profitability. Growth at all costs is no longer popular with investors. Not the right time, not the right sentiment. Aim for positive unit economics, while trimming extra costs is the mantra now.?

Besides, when the startup industry goes through sharp corrections amid a slowdown, founders start thinking about building resilient and sustainable ventures that can withstand the ups and downs in the economy.??

And as mentioned above, many founders are looking to solve pain points and real problems for their customers—building solutions that don’t fall under discretionary spending.?

“The downturn will push startup founders to build painkillers, not vitamins,” believes Mar Hershenson , Managing Partner, Pear VC . This rings true for startups across the globe.?

Moreover, some investors expect 2023 to make founders more resilient. Sophia Bendz , General Partner, Cherry Ventures , aptly puts it, “ The year will be rooted in the still-tough market and macro environment of 2022, and that will produce a generation of founders that are more robust, more strategic, more determined, and far more resilient than those we’ve witnessed in the past decade.”

Climate tech funding to climb higher

It’s evident. Global climate investments are climbing up at a higher pace than ever before.?

According to market research firm HolonIQ , venture capitalists, globally, invested US$70.1 billion in climate tech in 2022, a whopping 89% more than in 2021, defying gravity in a broader market that fell significantly.

At US$28.6 billion, the US invested more in climate tech in 2022 than it did in the entire 2006-2011 cleantech 1.0 boom. Asian economies have caught up beautifully with the climate funding wave that began rising in 2020 in America.?

In India, climate tech funding zoomed to US$3.7 billion in 2022 from US$400 million in 2021, when money was abundant in the ecosystem.?

Researchers at HolonIQ believe the Indian VC market is refocusing from consumer to climate tech, which has become a preferred investment segment. And that Indian policymakers, corporates, and investors alike see the potential for India to take a leadership role in climate tech.

Climate investments in China grew to US$10.7 billion in 2022 from US$6.3 billion in 2021, even as the overall startup funding dried up severely in the country.??

As for Southeast Asia, climate companies raised US$1.11 billion in the first 11 months of 2022, compared with US$607 million in 2021, according to DealStreetAsia. This is the first time the region has received over a billion dollars in climate tech financing.?

Apparently, more and more investors are seeing climate tech deals as safer bets since the broader tech industry is in the doldrums. HolonIQ expects climate tech financing to moderate in 2023 amid a challenging economic backdrop, but the sector is likely to enjoy preferential allocation and may witness a focused investor base competing for quality deals.

Accessible tech talent pool expands amid layoffs

In 2022, the tech industry globally axed nearly 160,000 jobs, as per the data collated by layoffs.fyi. This figure has almost reached 78,000 in 2023. Already.?The layoffs are now spilling over to other industries as well.

In January, Dutch health technology company Philips scraped 6,000 jobs to drive profitability. Industrial giant 3M slashed 2,500 manufacturing jobs. Chemicals giant Dow is firing 2,000 people. Toymaker Hasbro, the company behind the game Monopoly, is letting go of 1,000 people. You get the point.?

And layoffs don’t seem to be stopping any time soon. Asia hasn’t been that insulated from this trend. Companies want to cut costs, at all costs.?

According to Tech in Asia, the funding shortage has led to more than 152,000 pink slips from Asian tech startups since last year. This includes 3262 employees in India and 93 people in Southeast Asia who were fired in January.?

All these layoffs can partially be tied up to 2021’s massive startup funding that led firms to hire haphazardly in the anticipation of growth.?

On the flip side, for the startups that are well-funded or that have succeeded in raising money during the funding winter, these layoffs are an opportunity to access a new pool of brilliant people. Moreover, industry veterans believe other industries like automobiles are likely to take this chance to grab tech talent available in the market.?

As per The Information, despite the talent wars cooling off last year, many companies are still struggling to attract and retain top talent as they look to do more with less.?

Autonomous tech, robotics, and AI to grab the spotlight

2023 is said to be the year when most of the big tech giants would look for the next big thing, one that will ensure that they remain relevant in the next 10 or 20 years.?

And as things stand now, the key theme this year is turning out to be autonomous tech and robotics as well as AI—specifically generative AI—thanks to none other than OpenAI’s ChatGPT, the AI chatbot with an uncanny ability to generate content like humans that took the world by storm over the last two months.?

The war of giants to lead the AI race has already begun. Microsoft, already a backer of OpenAI, is investing US$10 billion in the company with the aim to integrate ChatGPT into Microsoft’s offerings.?

In turn, Google’s AI subsidiary DeepMind is gearing up to unveil AI bot Sparrow, which will counter the rising influence of ChatGPT.?

Chinese search giant Baidu, which is also known as China’s Google, has also jumped into the fray and is set to launch a ChatGPT-style service and embed it in its search engine.?

In a way, autonomous tech, robotics, and AI would be a means to an end—which will help the tech giants zero down on the next big thing or the next big trend in the industry.?

That’s all for the VC edition–part 1 of Hedwig. In the second part, we will dive into individual Asian economies to see how local startup ecosystems are faring this year. To get an overview of different segments of the Asian startup ecosystem, subscribe to Hedwig and receive it in your inbox every second Wednesday.?

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