The winter of Vietnamese startups: spin-off can be an answer to attract investors

2024 is destined to be a turbulent year for the world economy. Analysts said it was the weakest period since the 2007-2008 financial crisis. As investment institutions warn in 2023, this year will be more difficult when investment funds tighten their investments and place higher demands on startups. In this case, a spin-off could be an answer to financial difficulties and may be more attractive to venture capital firms.

2023 also witnessed the decline of Vietnamese startups, and the number of new unicorns is at its lowest level in nearly four years. According to statistics from Do Ventures, the "Vietnam Open Innovation Ecosystem Report 2023" released by BambuUP shows that venture capital investment in Vietnam will slow down for the second consecutive year in 2023. In the first nine months of 2023, total venture capital investment in Vietnam fell by 13% to US$427 million. There were only 56 investment cases, a 40% drop and the lowest since 2018. In small and medium-sized investments, investment in startups has dropped significantly. The number of investment cases below $500,000 fell by 50%.

In this case, a spin-off of a company that is in financial difficulties may be more attractive to venture capitalists. It is very difficult for venture capital investors to judge whether a startup company will succeed. For this reason, many venture capital firms, especially those that mainly make early investments, adopt a wasteful comprehensive coverage strategy. Some firms may invest in more than 1,000 companies and hope that at least 10 startups will be successful in making up for the losses of other projects. Therefore, for venture capital investors, the risk faced by investing in spin-off subsidiaries of Series A companies is relatively small, because investors have a clear understanding of the founders, teams, parent company finances, etc.

For founders, when the current business faces difficulties in profitability and monetization, using existing funds to do related and more popular businesses will be more attractive. For example, fashion e-commerce startups can completely extend their business to the trading of second-hand fashion items like Piktina. And the idea of such a spinoff is nothing new. For example, when VinGroup engages in business innovation, it often establishes separate subsidiaries. For example, the relationship between Xanh SM and VinFast is that Xanh SM clearly uses VinFast electric vehicles, but it still operates independently as a subsidiary, rather than becoming an electric taxi division of VinFast. This is not only a judgment based on business logic and financial logic, but for a spin-off and serving as independent departments of a company, the success rate of the spin-off is often higher.

How do spin-offs attract venture capital?

A spin-off is a new company formed from an existing company. This phenomenon is common among businesses, for example, in the United States, an average of 50 subsidiaries are opened each year, and subsidiaries usually do better than other types of companies. The establishment of spin-offs is usually popular in academia. When universities want to commercialize research inventions, they will establish spin-offs. According to data, such companies are 108 times more likely to have an IPO than other companies.

However, spin-offs are uncommon among Vietnamese startups. lt is not surprising, since startups are often told by investors that they need to focus on one idea. However, when faced with financing difficulties for existing businesses and the company faces a life-or-death decision, spin-off often becomes an acceptable option for existing investors. From an investor's perspective, several factors make them accept the spin-off model.

Factor 1: Huge market opportunity. spin-offs rely on the existing company's expertise in related businesses to identify other huge opportunities in the market. So the spin-off's team should know whether the new business model will work before starting operations. Here we use SitePoint, an American company, as an example. SitePoint was established in 1999 as a community website for website developers that generates content such as online teaching and paper books. While running the site, founders Matt Mickiewicz and Mark Harbottle noticed an increasing demand for forum posts about buying and selling sites. So they started charging to sell and buy listings, which encouraged a new business model, and eventually, they decided to spin it off into a separate product. In this way, Flippa was born, and now it has become a major online website buying and selling website.

Later, another popular SitePoint forum post was spun off by the founder into 99designs, which has raised more than $45 million in funding so far and rapidly developed globally. Mickiewicz's work with designers and developers led to DeveloperAuction, now a job site called Hired. Hired received US$70 million in financing and acquired three startups to accelerate its development. Information about market opportunities provided by SitePoint's parent company is very important when establishing a spin-off with a new business model.

Factor 2: Investors want a product that the market can accept. Investors can easily trust spin-offs due to the existence of the parent company. New products are generally used as derivatives of original products and follow market logic that has been repeatedly proven and successful. The existing company can also use the resources to support new product development until the product is proven in the market. For example, AdWerx is a spin-off of ReverbNation, which was once a rapidly growing software company in the music industry and was founded in 2006. AdWerx, an advertising tool for real estate agencies, may seem irrelevant, but before AdWerx went to market as a spin-off, its product was created, tested, and refined using ReverbNation's resources.

Factor 3: Investors can trust the existing team. Venture capital, especially early-stage investment, is investing in the founding team. Investors will understand the reliability and efficiency of a company's founding team before actually investing. For example, American investor Mark Suster once said: "I’m personally 70% management, 30% product. But for any investor, it takes a miracle to get investment dollars out of them if they’re not impressed with the team.” Finding the right CEO, as well as expertise in the field and a well-functioning team within can make a startup idea a reality. Quiet Logistics is a third-party logistics service provider that has transported more than $1 billion worth of goods for brands such as Bonobos, Ministry of Supply, and M. Gemi. The Quiet Logistics team created a new warehouse robotics company, Locus Robotics, which raised $6 million in funding from investors who backed Quiet Logistics because they had confidence in their management team.

For founders, spin-offs are a small and beautiful way to survive the winter

Spin-offs are not only good for investors but also founders. The more attractive a startup is to investors, the better the company can negotiate on its terms. Due to the founder's previous achievements, he can directly negotiate with previous investors and add his financing terms. In addition, spin-offs do not need to approach investors until the final stages due to support from the existing company's internal resources.

As with the Vingroup example mentioned at the beginning of the article, the success of the spin-off approach has been adopted by large companies frequently. For example, AOL once tried to integrate the culture of its spin-off into Alpha's product team. The product team created a series of experimental products, experimented with many small ideas, and spent several months converting each idea into the smallest possible product. A feasible product is then put into the market to see if users buy it.

As the entire venture capital business in Vietnam has entered a cold winter, venture capital investors are looking for small but beautiful investment projects. Spinning off businesses has historically been proven to be a more beneficial way for founders to survive the winter.