Cover Story: Planting the seeds of growth with incentives

This article first appeared in Digital Edge, The Edge Malaysia Weekly, on March 13, 2023 - March 19, 2023.
Cover Story: Planting the seeds of growth with incentives
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The state of the Malaysian start-up ecosystem is a point of contention. Some argue that start-ups are undergoing a consolidation phase, where they have either ceased operations or are being acquired by large corporations. Others believe the ecosystem is still in a nascent stage, lacking in variety and innovation.

Despite the numerous government initiatives that accelerate growth, nurture partnerships and provide commercialisation support to vitalise the landscape, the ecosystem is still lagging behind its regional peers. This is where private sector participation is key.

The Malaysian start-up ecosystem is about to get a boost with more private sector involvement, thanks to the rollout of a corporate tax deduction of up to RM20 million, which was introduced in Budget 2018 and gazetted by the Securities Commission Malaysia (SC) last year.  However, it is only recently that corporations have started taking advantage of it.  

Corporate involvement can identify problems in the ecosystem that are impeding the progress of start-ups and allow them to scale, and investment from the private sector translates into a self-sustaining ecosystem, say industry players.

Conglomerates can offer start-ups industry expertise and resources that they do not usually receive from purely financial investors, says Victor Chua, managing director of venture capital firm Vynn Capital. 

“The challenging economic environment is a good backdrop for corporate involvement in the start-up ecosystem. There are two ways to survive any economic downturn. Either you stop investing, cut costs and reduce expenditure, which might help with survival but not long-term growth, or you take a different turn and start investing in long-term solutions that will help with business breakthroughs,” says Chua.

The incentive is to encourage venture capital activities by individuals or companies with a business income. 

Essentially, the incentive — or the “Deduction for Investment in a Venture Company (VC) or Venture Capital Company (VCC)” — gives individuals with a business source income and Malaysian incorporated and resident companies a tax deduction of up to RM20 million on the value of investment made in a start-up through a VCC that is registered under the SC. The investments are in the form of seed capital and early-stage financing.

The incentive — which is valid for investment in a VCC made between Oct 27, 2017, and Dec 31, 2026 — can be claimed after the investment has been held for three years.

The start-ups have to be Malaysian companies incorporated under the Companies Act 2016. The start-ups must use the seed capital financing or early-stage financing for activities or products listed in the Promotion of Investment Act 1986; or for technology-based business activities as specified in the guideline issued by SC in relation to venture capital tax incentives; be involved in products or activities that have been developed under the research and development scheme approved by the Ministry of Science, Technology and Innovation (MOSTI); or products, services or activities under the research, development and commercialisation grant scheme approved by the Malaysia Digital Economy Corporation (MDEC).

The only other tax benefits for direct investment in early-stage start-ups are angel tax incentives, which were introduced in 2013. Angel investors are accorded tax exemptions of up to RM500,000 a year in the second year of assessment.

“The set of activities that the start-up must be involved in is essentially technology-based business activities. This incentive is for technology-based companies, and not for brick-and-mortar type businesses,” says Peter Wee, honorary secretary of the Malaysian Business Angel Network. MBAN, which has been pivotal in advocating increased private sector involvement in early-stage companies, is the official trade association and governing body for angel investors and angel clubs in Malaysia.

If 300 corporate companies were to invest RM10 million each over five years, the impact on the economy would be RM3 billion, adds Wee. “MBAN aspires to get 300 corporate members to dedicate just a RM10 million investment over five years. And this is excluding our ongoing angel investments. With both these parties (corporations and angels), we hope to make an impact on at least 1,000 start-ups.”

MBAN is now working on getting corporations to invest in start-ups by spreading awareness and education. “There is a limitation in the investment amount made by angel investors compared to corporations that inevitably have deeper pockets,” says Wee. “If a start-up works with a big company, it will give them credibility. Corporations can play a pivotal role to help start-ups develop themselves. There is a corporate tax incentive now to turbo-boost investment into start-ups.”

Karen Puah, a council member of MBAN, says: “What MBAN does is, at the end of every month, we will curate five or six start-ups and then place them in front of our investors — individuals and corporations. Start-ups will naturally do one thing that they’re good at, that corporations need.

“Corporations are so big they cannot pinpoint what they want to do, or what they’re good at because they’re good at so many things. That’s where the functions of the start-ups in this particular sense work very well.”

MBAN’s corporate members include Hong Leong Bank Bhd, Malaysian Research Accelerator for Technology and Innovation (MRANTI), Sunway Bhd and Gamuda Bhd. MBAN has 25 corporate members.

Cultivating collaborations

Corporations can also benefit from the start-ups they have invested in, by way of expanding their portfolio. Fundamentally, corporations can reduce their tax burden, gain financial returns and have access to portfolio companies.

Although RM20 million is not a significant amount to corporations, as some funds may require investments of up to RM80 million, it is big enough for a start, says Jamaludin Bujang, managing partner of Pan-Asian venture capital firm Gobi Partners.

The tax incentive for corporations may make it more palatable for them to invest in start-ups as it lowers the barriers of entry with its deductions. However, these companies are not necessarily looking into incentives because most do not need them, notes John Lim, executive director of digital and innovation at Gamuda.

“Most corporations have the money to spend. The question that needs to be answered is what do start-ups bring to the table? Why buy the cow instead of just the milk?” he asks. “If start-ups can clearly articulate the answer to that question, incentives from the government are just the cherry on the cake.”

Corporations tend to invest in start-ups to grow their business through external innovation, or from fear of being obsolete and unable to compete, says Vynn Capital’s Chua. “Corporations can be incentivised if they see a strategic value in investing as well as the opportunity to learn and grow their knowledge capital. Of course, tax incentives would help provide even more reasons for corporations to invest.”

MBAN’s Wee adds: “For this incentive, I think the challenges would be awareness, education and confidence. With everything new, you have to get some small wins first. Somebody needs to do it and see the benefits, and you will get a flow of people. The early adopters are very important. That’s why we’re having a lot of awareness and education. At our events, we always talk about the corporate tax incentive.”

Currently, Malaysia is ranked as one of the top 100 emerging ecosystems in the world, and Kuala Lumpur is ranked among the top 21 to 30, according to Start-up Genome’s “Global Startup Ecosystem Report 2022”.

The report states that the local ecosystem is valued at US$72 billion versus the global average of US$28.6 billion. Total early-stage funding available is only US$198 million, however, compared with the global average of US$687 million.

This is an impetus for corporations to be more involved in boosting the start-up ecosystem.

Corporations shy away from working with start-ups because of the perceived hassle and worry about non-performance, says Gamuda’s Lim. As start-ups are often lean, inexperienced and lack full-fledged products ready to go on day one, they will need time to understand the complexities of the industry.

The fledgling companies are also inexperienced when it comes to contracts and legal negotiations, he adds. Moving into production is another hurdle. Handling multiple projects with a lean team often means deliverables cannot be met on time. Start-ups also find it hard to recruit the right talent in software development and engineering.

“Malaysian corporates adopt a wait-and-see approach, although some are already setting up their internal academy to groom their internal talents to set up new start-ups within their organisation as part of their talent retention programme,” says Quek Wee Siong, CEO of MHub, a property tech start-up founded in 2017.

“Many start-up founders have great vision and a great business model but lack the knowhow on corporatising their start-up as they scale. They tend to use the same methodology when the company is growing from a five- to 10-person team to 50 to 100 people,” he notes.

Connecting the dots

Corporate involvement also provides start-ups with an avenue to test their ideas via conveniences such as sandboxes. Furthermore, mentorship opportunities from corporations could help start-up founders develop leadership and people management skills, and execute financial planning and business plans.

“Corporations can allow start-ups to try products in [corporate] environments to see whether they work. Corporations must also co-create and collaborate with [start-ups] to help them understand how they can improve,” says Gamuda’s Lim.

Moreover, these businesses have massive buying power and are experienced in the problems that arise in the ecosystem and know how to solve them.

“By working with corporations, start-ups can get industry expertise and resources that they can’t get from pure financial investors. Essentially, start-ups can save a lot of time and pivot less if they work with corporations,” says Vynn Capital’s Chua.

In some countries, corporate involvement makes up the building blocks of the start-up ecosystem. Singapore’s Economic Development Board, for example, evaluates and provides funding to start-ups to work with governmental boards such as the Land Transport Authority, which then require partner companies to adopt technologies introduced by the start-ups.

In Japan, the start-up ecosystem is deeply influenced by the country’s large firms, states the Carnegie Endowment for International Peace, a US-based international affairs think tank.

Additionally, the Japanese government announced an open innovation tax incentive that allows companies to deduct 25% of share purchase amounts in start-ups to be deducted from their taxable income, according to Deloitte Japan.

This strengthens Japan’s competitiveness by using companies’ technologies, ideas, resources and other assets to develop new products and business models and sows the seeds of innovative technologies, says Deloitte.

“Corporations look for companies that can add strategic value to the mothership. The biggest incentive for the corporation is how the start-up can diversify its income stream without straying too much from the core business,” says Thinesh Kumar, founder and CEO of Lapasar, which has benefited from such collaborations.

“The more strategic the start-up is, the more incentivised the corporation is to invest.”

Lapasar, which KPMG and HSBC have identified as an “emerging giant”, is a business-to-business procurement start-up that has raised funds from venture capital firms such as NEXEA and Singapore’s SeedPlus.

Corporations look for start-ups they can collaborate with. For instance, conglomerates such as the Sunway Group, which is heavily involved in sectors such as construction and healthcare, will be able to mentor and provide market access to many types of start-ups, besides providing funding.

It is beneficial to invest through VCCs, which have wide networks, making them a great connector for corporations to step into the start-up ecosystem. VCCs also add value to investments by doing due diligence and providing a proper valuation for the start-ups they are invested in.

“We have already reviewed 630 companies for our Superseed II fund. If each company wanted to raise RM1 million, we would need at least RM600 million. Companies are raising more than RM1 million in most cases. Do we have RM600 million? We don’t,” says Gobi Partners’ Jamaludin.

There are now more start-ups and VC firms, but there is still insufficient local funding that can fund these demands, concurs Vynn Capital’s Chua. “Growth needs to be fuelled with money, and that’s why a lot of start-ups are looking to Singapore and other markets for funding.”

To overcome this challenge, there needs to be more funding, and corporations are one of the sources. There has been an increase in corporation participation in VCC funds, though.

“Ten or even 15 years ago, there were hardly any corporations [that wanted to invest in start-ups]; they probably wanted to do it themselves. But, now, I am seeing more and more companies getting involved and participating in VCC funds as well as making [direct] investments in start-ups,” says Jamaludin. “Companies are looking at VCC funds to access new things they can invest in or get into.”