This article first appeared in Digital Edge, The Edge Malaysia Weekly on September 11, 2023 - September 17, 2023

Most start-ups have to raise funds at some, sometimes multiple, points in their lives to fund growth plans, increase revenues, hire staff and expand abroad. Often, the life cycle of funding follows a linear progression from the founders funding their business together with their family and friends, followed by angel investors, who are individual investors that are not family or friends, who may provide larger amounts of funding, sometimes up to RM1 million, though mostly in the tens or hundreds of thousands, mostly for commercialisation of the products or services. Some start-ups may also obtain government grants for both prototype development and commercialisation if they have unique or innovative businesses.

If the business grows successfully, the next round of funding is usually either through an equity crowdfunding (ECF) platform, peer-to-peer (P2P) lending or venture capital investors. Bank funding is mostly closed to start-ups as they rarely have profits at the early stages and are thus considered too risky for banks. Both ECF and P2P are very successful in Malaysia. According to the Securities Commission Annual Report 2022, just in 2022 alone, start-ups raised RM100 million via ECF while P2P loans disbursed came up to RM1.6 billion. It must be noted that both ECF and P2P are not just for start-ups but also for small and medium enterprises.

As the companies continue to grow and show promise of scale in terms of revenue and market growth, venture capital is the next option, especially if the funding requirement exceeds RM1 million. However, for every 100 companies that pitch to venture capitalists (VCs), only one or two receive funding, so this funding source can be rather challenging and is only an option for the best companies with the best potential for high growth. VCs can provide large amounts of funding and many successful start-ups have raised tens or hundreds of millions over a few years. Recent examples include Aerodyne, which has raised US$60 million; Carsome, US$607 million; and Soft Space, US$37.5 million (data from Crunchbase).

The organisations that invested in the above three companies also include pension funds like Kumpulan Wang Persaraan (KWAP), which invested in Aerodyne; sovereign wealth funds like Qatar Investment Authority in Carsome; and corporations like Sumitomo which invested in Soft Space.

Soft Space is an interesting story because, unlike the other two start-ups and unlike most start-ups generally, Soft Space’s initial investors were all corporate institutions and not VCs. In fact, the only VC that invested in Soft Space, RHL Ventures, came in much later than the corporations.

To understand Soft Space, I invited its chief strategy officer Chris Leong to share this rather unconventional funding story with 24 CEOs from the 100 Soonicorns programme run by Proficeo and ScaleUp Malaysia in partnership with Penjana Kapital and Malaysia Digital Economy Corporation (MDEC). 100 Soonicorns is a programme for some of the top venture capital-funded companies in Malaysia. What he shared was fascinating and provides an alternative funding plan for start-ups.

Although Soft Space started in Malaysia and its founders were Malaysian, its first customer was actually a Thai bank that adopted its unique payment software. Only after showing success in Thailand did it sell to its first Malaysian bank and today, 11 years after commencing operations, it is a global company.

When it raised funds, however, it initially didn’t get much traction with VCs but with Japanese corporations — the first being transcosmos, a business process outsourcing, call centre and digital marketing company. It took Soft Space a year of due diligence and discussions before making the investment. This was a successful investment and it was followed by Sumitomo-Mitsui and JCB, the Japanese-based credit card company.

The reason Soft Space sought these investors was more strategic than purely for funding as they were all involved in the credit card and payments space, just as Soft Space was. This strategic partnership via an investment helped Soft Space penetrate the Japanese market, one of the most conservative in the world. Almost no foreign companies, especially from Southeast Asia, have managed to penetrate this highly valuable and lucrative market.

This is the first important lesson from Soft Space. You don’t have to always consider venture capital funding as the only source of funding. A strategic corporate investor can be doubly valuable as it doesn’t just provide funds but can also provide access to markets, especially markets that would have been impossible for the company to penetrate.

The second reason was that with these large corporate investors, they were not in a hurry to exit their investments; hence, this gave Soft Space the space and time to build the business without the pressure of an exit. Venture capital funds are normally set up with a certain timeframe, usually between seven and 10 years. As they approach the later years, they need to exit their investments either through a trade sale (merger or acquisition) or an initial public offering (IPO) on a stock market. For an investee company, this puts pressure on the founders to grow the business as fast as possible so that VCs can get an exit, usually about five to seven years after the investment. Does this put undue pressure on start-up founders? Oftentimes it does but that is the trade-off when you take on VC funding. You know they will need an exit, so you need to grow as fast as possible.

With Soft Space’s corporate investors, they were willing to play the long game. Since a quick exit is not needed, the founders can build the business more purposefully, focus on building great products and build a proper path to profitability without the added pressure of an exit. And this is the second lesson from Soft Space: With patient investors, you can build a business that will last a lifetime and you don’t have to sacrifice your long-term strategy to achieve an exit.

Investors with global brands also gave Soft Space a strong endorsement as a trusted brand, which helps with its branding globally. That’s the third benefit of a branded corporate investor.

Additionally, having investors from the same industry can also give good insights into trends, technologies and market needs — especially when they are global players as well. JCB and Sumitomo-Mitsui were both global companies and this provided Soft Space with great insights into any market it wanted to enter.

Soft Space did something unconventional and it worked out well for them. This does show start-ups that there are alternatives to the conventional fundraising routes, but you need to be careful as well.

Many local corporate investors don’t yet understand the start-up space and, when investing, tend to take majority stakes even in the early stages. This is not good for start-ups as it will end up being a subsidiary and before you know it, it will have to follow the processes and rules of the parent company or group, and 90% of the time, it will end up killing the innovation spirit of the start-up and result in frustrated founders who end up being “employees” of the company instead of founders. In the case of Soft Space, the corporate investors were true investors who took minority stakes and allowed the founders to continue building the business, which continued to innovate and grow.

Also, just because a corporation is in a similar industry doesn’t mean it is automatically a good investor. It may end up imposing its ideas on the start-up and forcing it to take a different direction, which will again kill the innovation drive of the start-up.

So, while there are many great benefits to having strategic investors as demonstrated in the case of Soft Space, one still has to be cautious and check out the investors well before accepting their investment. Just like the Japanese took a year to invest in Soft Space, one should also take one’s time building a relationship with the corporate investor before taking it on board as an investor. It is a marriage and, like a marriage, the courtship is also important.

The lessons Leong shared from Soft Space are invaluable for start-ups as they consider raising money for their businesses. Venture capital funding can bring huge benefits and should always be part of one’s consideration when fundraising as there are many great VC fund managers and firms that can help on one’s journey. But like them, there are also strategic investors who can do likewise. It can be a winning solution, so choose well.

Dr Sivapalan Vivekarajah, who has a PhD in venture capital from the University of Edinburgh, Scotland, is co-founder and senior partner of Scaleup Malaysia Accelerator (www.scaleup.my) and adjunct professor at the School of Science and Technology, Sunway University. He is the author of the book Supercharge Your Startup Valuation.

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