Navigating the perils and pitfalls of the Southeast Asian startup ecosystem

Introduction: With investors and founders at odds with each other, and geopolitical complexities looming across different jurisdictions in Southeast Asia, Rajah & Tann offers suggestions on diffusing tensions and resolving conflicts 

The past year has seen a sharp rise in founder-investor tensions, a few spectacular flameouts in the Southeast Asian startup space, and ongoing boardroom friction. A panel of legal experts and investors from across Southeast Asia weighed in on the impact of these developments on dealmaking in the region in a discussion moderated by Hoon Chi Tern, Deputy Head, Mergers & Acquisitions, Rajah & Tann Singapore LLP.

Participants in the panel discussion included Jacyn Phuah, Partner, Christopher & Lee Ong from Malaysia; Angelica Ayu Maharani, Partner, Assegaf Hamzah & Partners from Indonesia; Susli Lie, Partner, Monk’s Hill Ventures, from Singapore; Vu Thi Que, Chairwoman, Rajah & Tann LCT Lawyers from Vietnam, and Nattarat Boonyatap, Partner, Rajah & Tann Thailand.

Excerpts from the discussion, edited for brevity and clarity:

There have been some high-profile governance issues, to put it lightly, in Indonesia. How have investors reacted, and have there been any changes in processes and due diligence?

Angelica Ayu Maharani: The most important thing within governance is to set clear terms in the shareholder agreement or any other assessment document. It is good to have a well-defined division between the founder’s rights and authorities, as well as the investors’ rights. The reaction towards the unfortunate cases has been investors making more requests for access to information as well as step-in rights.

How do you negotiate the line between founder rights and investors protecting their investments?

Susli Lie: For most companies in the early stage, the governance structure is very nascent, or in some cases, non-existent. Monk’s Hill Ventures is a generalist fund, investing in Southeast Asia, typically leading Series A. We usually get a seat on the board and are the first institutional board members.

In the venture space, it is about taking a bet not just on the conviction and capabilities of the founding team but also their commitment. There needs to be an element of trust: for instance, that we as a significant minority investor, will not be eased out.

Many first-time founders in this region may have never been on or managed a board. Even at late- stage series, founders are still a majority either with outright ownership or by influence. As investors, we must find a way to collaborate.

The typical tensions revolve around divergence and strategic direction. There may be issues around capabilities or competencies, and whether a founder is still the right person to lead a company. Where it usually gets hairy is not just founder-investor tensions but tensions among investors as they pursue different objectives. My fiduciary duty as a board member could come into conflict with my fiduciary duty as a shareholder.

We typically prefer that the board composition remains odd-numbered. In instances of direct conflict between shareholders and board members, we either recuse ourselves or appoint another person from our team to vote in a different capacity. It is important to identify this early on.

In some instances, the company may include an independent board member to provide perspective or help break a tie. But it is quite unusual to have independent board members until you reach a certain stage. I see the benefits, but at an early stage, I do not want to dilute the founder’s ability and autonomy to make decisions.

In Malaysia, GICs such as Khazana have launched new funds. What are the considerations when dealing with these investors and capital providers?

Jacyn Phuah: Common features that they look for are observers and model reporting obligations to ensure the implementation of all the objectives of an initiative. A piece of advice is that whenever you are engaging with investors, always uncover the objectives and norms, so that you can adjust accordingly.

While Malaysia and Singapore are quite far down the road in terms of governance, in Vietnam, the structures have traditionally been family controlled and founder-led. But now there is a push towards better board composition and gender diversity. What impact will such a move have?

Vu Thi Que: Vietnam is unique since we reformed from a socialist economy and are now trying to open the market and welcome FDI. We have moved from state-owned enterprises to private sector firms owned by families, who wish to maintain the prevailing governance structure.

But recent reforms from the government are moving towards international standards for governance. We have laws on credit institutions that require mandatory independent members on the board of directors. Other regulations on investment and enterprise law preserve the independence of the board of directors.

However, even the legal framework cannot change the mindset of a company’s owners. We provide them with case studies about firms that improved their governance that went on to successfully grow capital, hit the IPO milestone, or secure further investment. It is also about respecting the founders and their families. They have board seats which do not necessarily guarantee voting rights. We are working to improve dual management and board control.

How different is the market in Thailand—reputed to be one of the toughest in the region to invest in?

Nattarat Boonyatap: The Foreign Business Act lists the sectors that are restricted when it comes to foreign investment. For example, in the service sector, foreigners are generally prohibited from direct operation. In the past, the typical structure was to create a 51:49 ownership split, where Thai nationals would hold 51% and foreigners 49%.

After the recent major earthquake in Bangkok, one of the affected buildings was found to have a foreign investment using the 51:49 structure and nominee arrangements. As a result, the authorities have set up a special division to monitor and inspect shareholding structures, especially those using this split. Recently, clients have come to us wanting to restructure their companies to eliminate nominee arrangements.

One solution is to set up another holding company with two Thai directors and have the Thai shareholder with a 51% stake. We then limit their operational involvement and the dividends they receive. This holding company replaces the Thai nominee shareholders in the operating company. The approach exploits a loophole in the Foreign Business Act, which focuses on the proportion of shares held by foreigners (the 51:49 split) but does not consider who manages the company.

Another option required by certain laws is that a Thai individual must directly hold 51% of the shares in the operating company, especially in the travel and tourism sector. In this case, you need a Thai shareholder to directly hold the 51% stake, but you can use different share classes or structures. Here, you may need a third-party Thai shareholder for the operating company. The most important thing is to include restrictions on share transfers at both the board and shareholder levels to ensure you maintain control of the company.

Shifting to exits, how do you resolve tensions between founders and investors in an exit scenario?

Susli Lie: A company that scales will raise money from different investors. Eventually, companies bring in strategic investors who, in some instances, put more money to gain control and visibility, and perhaps make an acquisition down the road. It opens a path for exit but could also mean that even from day one of accepting such money, there are certain considerations put in place for financial investors like us. We typically hold a position for quite a long time and stay on the board until the very end.

If there is still an opportunity for the company to continue growing but we are not the right investors, we begin to consider a secondary exit for ourselves. That does not necessarily hinge on a primary transaction happening with the company.

If we feel it is the right time for an IPO, that decision is taken collectively. If anyone has misgivings, the pre-IPO round allows for reconstruction of the cap table.

Taking note of nuances across jurisdictions, in Vietnam, how difficult is it to change directors?

Vu Thi Que: In Vietnam, the company is mostly managed and governed by the board of directors: the member council for a limited liability company, and the management board for a joint stock company. When we talk about buyers coming in and how we can control the company management, there are two layers: changing the board members, and the legal representatives.

Based on the law, the legal rep change should take about three to five days. But Vietnam is currently undergoing significant reforms in administration provinces. As a result, the licensing authority is overloaded with work, and it takes exceptionally long to change a legal rep.

For changing the board of directors, the timeline by law is to allow a board meeting of an LLC from 15 days for the first and second time to 10 days for the third time. For a general meeting of shareholders of joint stock companies, it is 30 days for the first and second meetings, down to 20 days for the third meeting. It could take up to 50 days to convene three board meetings — quite long when compared to other jurisdictions like Singapore.

There are also questions about the validity of the appointment of a new legal representative: whether the valid date is the one updated on the investment and registration certificate of an enterprise, or the date of appointment. Our view is that it comes into effect immediately.

Key takeaways from a case study

The discussion was followed by a case study on a demanding situation in a hypothetical Southeast Asian startup, with founders seeking geographic expansion, and investors looking for an exit with no agreement on whether it should be via an IPO or trade sale. Based on suggestions from the audience at the roundtable, Rajah & Tann’s Hoon Chi Tern recommended the following steps to forestall such conflicts:

Documentation can never provide a complete solution: Hoon Chi Tern advised against bringing out documentation at the peak of the conflict. Instead, he said, “You should have key elements from the document which could resemble a road map from day one. With people aligned on the end goal, there is no need to bring up documentation.”

There is no substitute for trust among partners: Hoon Chi Tern recommended having an understanding with investment partners — be they founders or fellow investors. This would help all parties build a common horizon and outcome.