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:

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

Ben: I’ve got a few for you. Is that alright? 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 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, 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 supercharge your marketing. Not that they won’t pay for R&D but they are more reserved about saying, this idea we don’t know whether it is going to work or not. Let’s throw a lot of money in to see if the idea is doable.

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.

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 three to five to seven years with that return on investment. We introduced Frontier Ventures which are venture capital, they have offices in Singapore and Russia. They looked at Expert 360 but they still did two or three months worth of work. They saw a really big gap in the market and banged on the 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, otherwise that’s what you’re investing for, but they believe 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. 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 two pages or three pages that states the terms of the deal before an investment. When we looked at 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 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 you have to meet, and if you don’t meet those hurdles, there are ways to protect themselves.

James: So they’ll dilute your shares.

Niv: Yes, they’ll dilute your shares, different conversions, different restrictions. They will ensure they are ranked above any of the other shareholders. Does that make sense? If there is an exit down the track, they will make sure if the business does go bankrupt or liquidated, 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 capitalists to come before for those reasons.

James: We had an interesting experience. We have the Samurai business and we were approached by US firm as 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 $2,000,000 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 $5,000,000 turnover range and looking to buy them at about one to two times their profit. The reason they wanted to do that is that they would then pump them up. Their impression in the market was if they got them to between $5,000,000 and $10,000,000, 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 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 $5,000,000 I might get three to four times profit. I said, how do you get ten? He said, 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.

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 revenues, their board was bad, they took a lot off the table. The other thing we didn’t like is when they’re listing and you’re giving them $10,000,000, the founders are already taking $6,000,000 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 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 low multiple or a high multiple. You’re right, 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.