More and more these days, with technological disruption happening at an exponential rate, big companies in long-established industries are finding that they have to shake things up just to stay in the game.

Quite often now, this means investing in or even fully acquiring small tech firms, maybe even start-ups, from all over the world.

This is not only the quickest way for that large firm to acquire the innovative technologies being produced by the start-up, but it can also be more cost-effective. But as any venture capitalist would tell you, most start-ups — upwards of 70 per cent — fail.

Even those that might seem promising at the start could still end up becoming duds. For a large corporation looking to make an investment in an innovative start-up, this poses a conundrum.

The Singpost example

Nowhere was this Catch-22 situation more apparent than in the recent case of Singapore Post, which acquired a 96.3pc stake in US-based e-commerce provider TradeGlobal Holdings for $168.6 million in October 2015.

SingPost has embraced change. But the acquisition of TradeGlobal turned out to be something of a misstep.

In its fourth-quarter report in May this year, SingPost announced it had taken a $185m write-down on the loss-making TradeGlobal, causing it to report an overall net loss of $65.2m.

Even before that, shareholders had been questioning whether SingPost had overpaid for the stake.

That is, more than half the purchase sum was goodwill. These concerns were validated when law firm WongPartnership, hired by an independent committee to review the TradeGlobal deal, said in an update last month that it had made several troubling observations surrounding the deal.

From the outset, WongPartnership said, there was important information that was not raised to the board of directors, or raised with little detail or explanation, before it approved the deal. As a result, the board was unable to fully consider key risks relating to the acquisition.

For example, WongPartnership noted that TradeGlobal had been purchased by the seller at a significantly lower price which was not made known to the SingPost management until one week before completion. WongPartnership noted too that the earnings and revenue forecasts, upon which the TradeGlobal valuation was based, were aggressive and may have been over-optimistic.

Shielding shareholders

To be clear, acquiring start-ups that continue to be loss-making years later is neither unusual nor necessarily a cause for alarm over corporate governance.

Managers and directors have to be aware, as much as possible, of the risks they are taking on when making such purchases — and pay a fair price for those risks.

The fact is, as Pricewaterhouse Coopers (PwC) Singapore’s managing director of valuations Adam Sutton notes: “Assessing the value of start-ups is just hard, full stop.” He adds: “What can be surprising is the opportunistic nature of some of these investments.

“Although diligence is performed, it is not uncommon to find that relatively little strategic planning has gone into supporting the expected return or impact of making the investment, and also how to best incubate and support the business once it has been purchased.”

Mr John Kim, managing partner of Silicon Valley venture capital firm Amasia, says it can be especially hard for traditional business veterans to evaluate start-ups. Mr Akshay Mehra, co-founder of peer-to-peer lending platform Crowd-Genie, agrees.

“The usual metrics in a large organisation are all about repeatability at scale — so a business unit should be able to project its business for the next 12 to 24 months, and then the managers are expected to meet or beat these numbers.

“Now in a start-up where business models are in flux, any future projections are at best valid for six months. So when a start-up misses its projections... the traditional company managers will always struggle to assess such teams. This leads to frustrations from both sides — the acquired start-up and the acquirer.”

The (potential) solutions

In the face of such difficulties, the answer might simply lie in calling on expert help, experts say.

PwC Singapore’s strategy leader Richard Skinner says: “Hiring people with experience in early-stage technology business investment would help, but so could partnering with more experienced start-up investors.

“These investors may not bring the operational synergies a traditional business can offer, but they may have assessed hundreds of potential start-ups and can therefore make more informed judgments about key success factors, such as the founder and his team’s likely ability to succeed.”

Mr S. Sivanesan, a senior partner at law firm Dentons Rodyk, notes it would also help to have clear lines between the roles of the management and the board in such deals.

“The danger is when a board delegates that responsibility for an investment to management, and then fails to do its own proper due diligence on the management’s findings and recommendations or even understand the nature of the transaction.”

Mr Amit Saberwal, founder and chief executive of start-up RedDoorz, says a win-win solution for both parties would be for the big firm to start its own venture arm.

“The best way to do it is to have a completely new team to run this part of the business with enough exposure to tech investments and to also allocate enough capital at the beginning in a separate entity or vehicle, and then let it run its course,” he says. “Unless this happens, it would be really difficult for the big firm to create the right environment for success.”

The Straits Times/ANN

Published in Dawn, The Business and Finance Weekly, August 7th, 2017