How To Think Like Tech Startup Venture Capitalists

Whether you are learning how to invest, or have a software company you hope to find backers for, there’s a lot you need to know about funding and investing. Risk is the name of the game. The earlier in the game someone invests, the higher their risk. But what other factors mean the most in watching for positive investment signs? Whether you need the capital or are looking to make the right deal, there are things you need to understand. Watch this video to discover some of the most important determining factors in a solid tech investment poised for a huge return.

Video Transcript:  

Thinking like a venture capitalist – question time

I want to open up to questions and keep it really open.

Ben (Alliance Software, CEO & Founder):  I was thinking about the people in the room while you were talking. The profile for a lot of people in the room would be they’ve speculated their own money; typically paid something out of a mortgage, they’ve got some friends and family to put some money behind them.

I’ve generally had the view, that when tech startup venture capitalists get involved, they only want to invest to facilitate your growth. They’re generally looking for firms that have proven the concept. Really, what they want to do, is be the shot in the arm to say, ok, you’ve proven it can work here. You don’t have the marketing muscle and the funding, we want our money to really be the supercharge for your marketing. Not that they won’t pay for R&D, but they are more reserved about saying –  this idea we don’t know if it is going to work or not, let’s throw a lot of money in to see if the idea is doable.

Question: That has been my perception. Do you think that is fair or do you think that is unfair?

Niv: It’s a good question. When you do speak to some of the venture capital firms, they are looking on the one hand for bang for their buck. They are looking for some sort of cutting edge technology that is a disrupter, with good management and a good board that is potentially under funded that they can add value to.

Adding value is very important to them, but they also need to understand that they’re going to take a business, and it’s going to take their investment at least 3 – 7 years with that return on investment.

When we introduced Frontier Ventures, which are a venture capital firm with offices in Singapore and Russia, they looked at Expert 360 but they still did two or three months worth of work. What they saw was a really big gap in the market and bang for their buck. They liked the management, they liked the board and they wanted to take that and distribute the content, or effectively that platform, into Europe.

Not only are they looking to get a return on investment, that’s what you’re investing for, but they believe that they can add some sort of expertise on the board or they can help with the composition of their relationships or introductions into different platforms and open doors. So there are different reasons for the venture capital guys to get on board.

When Peak and Rampersand and Frontier Ventures worked on the term sheet (and the term sheet is really a 2 or 3 page document that states the terms of the deal before an investment) for Expert 360, there was a lot of back and forth for the last month. If they don’t hit specific gross profit targets or dart targets or revenue targets; you as investors, and the capital venture guys (because I came in the same term sheet) you get more shares or a lower share price or a different conversion.

I’m not saying they’ll say, yes I’ll invest and take money out of the table. That isn’t what I was saying, I was just saying there are different restrictions and hurdles that you have to meet, and if you don’t meet those hurdles, there are ways to protect themselves.

Ben: So can dilute your shares?.

Niv: Yes, they’ll dilute your shares, different conversions, different restrictions. They will ensure that they are ranked above any of the other shareholders. Does that make sense? If there is an exit down the track they will ensure, if the business does go bankrupt or is liquidated, that they will get their money out. That is grave. You can come under the venture capital, but we don’t necessarily like the tech startup venture capitals to come before for those reasons.

Ben: We had an interesting experience. We have the Samurai business and we were approached by a US firm for a buyer. We didn’t get to a point of sale because we couldn’t agree on a price.

At the end of it, I got speaking to a guy who probably has a similar job to yourself. He made some comments to me. I think at the time the Samurai business was making a $2 million turnover. When we had done all this work, and it was very clear that the deal wasn’t going to go ahead, he said basically they were what is called bottom feeders.

They were looking for people in the sub $5 million turnover range and looking to buy them at about one to two times their profit. The reason they wanted to do that is because they would then pump them up and their impression in the market was that if they got them to between $5 million and $10 million, that’s the point at which others would pay a much higher multiple. The multiple went up as the revenue base went up.

We were too small and we were annoying. They were willing to buy us and try to clean us up, but they weren’t willing to pay a premium price. I said to him ok, I can get one to two on a bottom feeding sale. If I can get to $5 million I might get three to four times profit. I said, how do you get ten? He said, you list or you find someone that you really annoy. People pay ten times profit when you threaten them, when you threaten Adobe. I’d love to threaten Adobe with our product.

Question: Has that been your experience that people have fundamentally good businesses but your advice to them would be get your revenue up to the next level and then people will start to take you seriously?

Niv: It happens all the time. There’s been a lot of talk about selling your property yourself rather than through an agent. Purplebricks is doing a lot of TV advertising. There is a company called Buy My Place which is listed, called BMP. We caught up with them about a year ago, before they listed. They’re up about 50% to 100% since IPO. Their business was terrible. They didn’t have much revenue, their board was bad, they took a lot off the table. The other thing we didn’t like is the fact that when they’re listing and you’re giving them $10 million, the founders are already taking $6 million in their pockets. We don’t like that. You want people investing in the business.

I’ll give you an example. Sea Foam, which is a company that was listed, it was up $250,000. Not only did the managing director get a lot of shares, but he bought an extra $250,000 or $270,000 on market yesterday. That is a good signaling effect. We like management having more skin in the game.

You do see a lot of different opportunities, whether it is at a lower multiple or a high multiple. You’re right in the fact that if there is someone who is really annoying out there, whether it is Buy My Place or real estate.com.au, they’ll buy you and they’ll pay more.

You can understand that on either side of the coin, whether you are a startup looking to show your value, or a backer looking for all of the right market signals, you have to know what to look for. Now that you have learned the value of being the unexpected underdog that’s annoying the bigger developers, you can apply this to your own vision and drive for your tech company. As an invester, you know the right kinds of startup to keep watch for, but even more you know to look for the company’s own position. Are they proving their dedication by backing their own project financially? Watching for the signs means being better prepared for the right investment decision.

If you’re looking to grow your startup or to back the right tech company on the rise, we’re here to point you in the right direction. Get in touch with us today.