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In part three of our series on the capital raising cultures in Australia and the US, San Francisco-based Steve Anderson explores the five things Australian and US venture capitalist must see before they will invest in an early-stage company.

Also in this series:
Part 1 – Funding in the US – Holy Grail or Holy Hell
Part 2 – The benefits of Australian VCs and US VCs

If the corporate vision is to grow a business beyond a ‘lifestyle’ size, and the founder is not independently wealthy, seeking capital from investors outside of family and friends is unavoidable.

In a downturn like this one, the amount of capital invested and the frequency at which it is invested is substantially reduced.

Despite the reduction in investments made by the venture capitalists in Australia, New Zealand and the US, recessions have been a popular time for startups.

More than half of the companies on the Fortune Magazine 500 list in 2009 and nearly half of the companies on the Inc. Magazine 2008 list were founded during a recession or a bear market.

That is not to say that starting a business in these times or any time is not risky. In the US, only 66 percent of startups survive at least two years, according to the US Small Business Administration. That survival rate drops down to 44 percent by the fourth year and is at 31 percent by the seventh year. This kind of data probably has universal application, much like the 80/20 rule. What is true in the US is generally true in Australia and New Zealand.

The notion that an entrepreneur’s idea can rise from nothing to a national or global success on the smell from an oily rag should be quickly discarded. Like it or not, venture capitalists usually need to be engaged as investors, but their cash infusion is only the fuel. The best bring serious support to success.

Venture capitalists in Australia and New Zealand come in a variety of sizes and strengths, from small, single investors to multiple-partner organisations. The venture capital industry in Australia is relatively young, starting in a recognised form in May 1984 with the initial government sponsorship called the Management and Investment Company Program.

In the United States, venture capitalism in its current form started in the 1950s. And in the US there is a distinction between what would be considered “angel” investors (individuals interested in placing their own money into startup ventures) and venture capitalists (investing other people’s money that has been committed to an investment fund into early-stage businesses).

The musts of engagement (getting the money) in both Australian, New Zealand and US camps have subtle differences that need to be understood.

The foundation of building a global business begins with recognising the financing steps and building them into the financial and business planning of companies starting in Australia or New Zealand, and migrating the business and its funding to the US where the market is bigger and investment pockets deeper.  

Five must-sees for Australian VCs

Just as an entrepreneur must understand the company’s customers, it makes sense for the entrepreneur to look at the product or service from the venture capitalists’ point of view. The VC’s point of view is always: “Will this business provide an appropriate return on our investment within three to five years?”

They make that judgement not by having their head spinning with the excitement of a “cool” technology, or its equivalent, but some fundamentals: market size, team competency, advantage, and capital requirements to reach the end game of a sale to a larger company or a public offering.

1. Market.
It must be large enough that the company can increase its revenue and profit to a level that, upon the sale of the company or an IPO, provides a satisfactory return on the investment. Domestic markets for both Australia and New Zealand, which is where most entrepreneurs begin their sales revenue climb and market penetration, are limited due to the size of the two countries. These home markets are excellent places to determine commercial viability of the product or service and the company, but they require expansion into other markets.

2. Personnel.
One critical measurable of the entrepreneur is how much “skin in the game” they have, or how much of their own assets will they lose if the company does not succeed. From the venture capitalist’s viewpoint, the entrepreneur must think like an owner of the business. The other characteristics looked for are:

• Enthusiasm about the business.
• Persistence (demonstrated ability to overcome obstacles).
• Communication skills to management, customers and investors.
• Ability to set realistic goals and achieve them.
• Ability to successfully accelerate the business.

3. How much capital will it take?
It is my personal experience that Australian and New Zealand entrepreneurs tend to underestimate the funds required. Being realistic about the fact that developing a business will usually take twice as long as originally estimated helps in determining how much capital it will take, including incoming revenue from sales.

4. Customer demand.
Why will customers buy this product/service rather than its competitors? And if this product/service is making a paradigm shift, do customers need it and why.

5. Experienced management.
One of the key resources in short supply in Australia is people with serious management experience. Most of those that have it are working somewhere else. It is one of the reasons that entrepreneurs start without the advantage of having a management team that has demonstrated its success before, and one of the reasons that venture capital investments are initially small and that business plans of Australian and New Zealand companies map a move to the US for a second, larger round of funding and adding experienced management.

US VCs – Positioning for Success

Venture capitalists in the United States have a strong preference for predictable results. The leading element of the predictability is a management team that can rapidly build a business that is large enough to produce a big payoff for them. Terms such as “outstanding management” and a “sense of urgency” are qualities that are only known about people who have done it before.

They would rather invest in a great, competent management team with deep experience in the market they are entering with a good plan than a great plan with a good team.

To overcome this, Australian entrepreneurs need to build their business’s revenue growth and momentum so that it is outstripping the competition, and use that experience to determine the abilities of their management before entering the US looking for a big B round of venture capital.

All the other four musts have to be there, too. But with full consideration for the multiples that the size of the US market and possible the EU market will impact on the business.

Steve Anderson started as a journalist, working first at The New York Times and the next 30 years interpreting business to investors. He is now Managing Partner, Marquis Advisory Group (San Francisco and Sydney).

Photo: PDR