Early stage venture capitalists are entrepreneurs, too! They’re switched on, chased up and brimming with ideas on how to breathe life into commercial opportunities. But first they have to be convinced that it is an opportunities. But first they have to be convinced that it is an opportunity. Paul D. Ryan persuaded five of Australian’s early stage VCs to share their wisdom, free of charge.
From the outside, VCs can appear aloof. This impression, largely perpetuated by spurned entrepreneurs, is greatly heightened by the fact that VCs, by their very job descriptions, have money to invest, while entrepreneurial companies, regardless of size, invariably crave capital for growth. Whenever there is a disproportionate power balance in a relationship, resentment is never far behind.
However, I was recently able to speak with five of this country’s leading seed and early stage VCs at the Australian Venture Capital Association Limited (AVCAL) 2005 Annual Conference, held in the last days of September. Surprisingly, our discussions suggested that most early-stage venture capitalists are more like the entrepreneurs they invest in than almost anyone – including the venture capitalists themselves – might think.
Sure they get pitched to all day and only invest in about one percent of opportunities that come across their desk, but they also need to be very much up to speed on a broad range of sectors, many of which are in the complicated science and technology fields. The earlier the investment stage, the more hands-on a venture capitalist must be.
In fact, there comes a point around the pre-seed/seed stage where the VC becomes the entrepreneur – identifying the opportunity, sourcing the product or service, building the management team and shaping every significant decision along the road to a distant exit.
We collated the best bits of these interviews to give you the low-down on what makes an early-stage venture capitalist tick – right from the source’s mouth
ALLEN AND BUCKERIDGE
With a background in finance and a successful entrepreneurial venture in China to his name, David Landers describes his role making pre-seed and seed investments for Allen & Buckeridge as a calling, woven deep into his DNA. He believes pre-seed investment is a different species from traditional later stage venture capital, requiring insight into the detail of often complicated technologies, without losing sight of the bigger picture opportunity.
In pre-seed, you are effectively creating the opportunity. You are ‘sourcing and screening’ and ‘structuring and negotiating’, here it gets interesting. The typical Series A venture capital deal is light years away from where I get involved. They (later stage VCs) need to see a management team, a developed or evolved technology, perhaps a first customer. We work backwards to the ‘big bang’
– somebody has to create the opportunity in the first instance. That’s where we come in.
We think that you have to create the best opportunities yourself.
We know, generically, what type of problems we are trying to solve. We like
technologies that address the issues of power in consumer devices. We like technologies that provide novel memory solutions, because we believe that memory is going to be more important than micro-processing in the future. We like technologies that enable incremental improvements to the efficiency of power and energy technologies.
We like to identify and own the problem.
Then we go out and look across public sector research (universities, CSIRO, etc.) and we look for technologies that we think can be used to solve those problems. Typically, what we find is that there is a capability or a technology that can be re-purposed to solve one of these problems.
Our better bets are the incremental technologies, the ones that improve the efficiency of existing technologies, rather than the ones that offer a completely radical new approach, where the world will have to change in order to adapt to it. For instance, we think that hydrogen-powered vehicles are still a long way away. Hybrids are already being adopted and we think that they will offer the winning solution in the interim. So we play the near-term opportunities, the incremental tweaks to existing technology.
I would describe us as being semi-literate with technology.
It’s like sailing, you know. You learn the language and people think you can sail until you get on a boat. Our experience at Allen & Buckeridge is that the technology has always done what the technology said it was going to do. If we got it wrong, it was because we got the market wrong, we got the management team wrong or we took model risk and it didn’t work out.
Around us we’ve built up a cadre of five start-up CEOs.
They are the first ones on the scene when we make an investment. These people are the rare resource. That’s where the bottle neck is. There’s no shortage of investment-worthy technologies out there. The money is not easy, but that’s a solvable problem. What’s lacking are the people who can jump in very early and create the opportunity. You are putting the people, the technology and the money together, and that’s what creates an opportunity. That’s how our deal flow comes together. You have to be so relentless, because you kiss so many frogs and turn over so many stones. We’ve looked at 600 deals and we’ve invested in six – 1 percent.
Since joining CHAMP Ventures in 2001, Stuart Wardman-Browne has been responsible for the investment activities of CHAMP Ventures, including the early stage technology fund, AMWIN Innovation. He currently serves on the board of directors of Australian Temporary Fencing, Maxamine and EnGeneIC. He was a director of Seek, until its IPO in April 2005, and a director of Gekko Systems, until AMWIN sold its shares in 2003.
I think the biggest mistake entrepreneurs make when pitching to us is not getting across the full story in a succinct and compelling way.
We want to know that this technology and this team is the way to take this opportunity forward. And we want to know that the result is going to be interesting enough for us to invest. The mistake is getting lost in the detail, of which technology is a favourite. The most common mistake of most entrepreneurs is not really getting across who cares.
It might be a neat piece of technology. But what changes will have to happen in its industry for it to be adopted, and who really cares enough to make those changes happen? Is it a solution that doesn’t really have a compelling problem? We need to hear who in the value chain really cares about this enough to drive it. And sometimes the answer is no one.
Another thing we hear consistently is that there are no competitors.
That’s just complete rubbish. There might not actually be any direct competitors. But there is a way of servicing that need currently, or the need doesn’t exist. There clearly is an alternative or competing solution. It’s possibly an even more common mistake than focusing too much on the technology. We are actively involved in all of our portfolios.
We always take a board seat and I would talk to the CEOs in my portfolio at least every week, and meet them every two weeks. We’ve backed management teams, so we want management to run the business. But we do get actively involved in any work leading up to significant decisions. We don’t often find a technology and then go off and find a team for it.
We find an area we like and then go and find what we think is the best company in that area – with management teams and technologies already together. We get hundreds of opportunities coming across our desks. We are pretty selective about the meetings we will take. At the end of the day, we wouldn’t back a one man band.
Ultimately, if it is a one man band, then we have to find a team. If the team is in place, then they need to turn up. I’m not expecting to see eight or ten people. I’m expecting to see two or three. Even in technology, the right people are half the battle as to whether you backed the right business. Therefore, it’s very important that the people involved come along.
My favourite deal that I didn’t do happened back in about 2001. I was really quite keen on the whole ‘intelligent agent’ area. I felt that with the web clearly growing in importance, useability and individual tailoring could be managed most efficiently through intelligent agents. We became aware of a company that used behavioural concepts to predict incoming computer viruses. I was really keen on that concept and we looked at it long and hard. But in the end there were two problems.
The inventors had hired a US CEO, and we weren’t quite convinced that he was the right candidate. More importantly, we had a term sheet drawn up but they never delivered the beta model in a satisfactory time period. In the end, they were picked up by one of the larger security players in the US.
GBS VENTURE PARTNERS
An experienced hand when it comes to the management of high-tech start-ups, Brigitte Smith joined Life Science VC firm GBS Venture Partners in 1998. She is a Fellow of The Australian Institute of Company Directors and is on the board of GBS portfolio companies Dynamic Hearing, Kinacia, Pharmaxis Pharmaceuticals and Smart Drug Systems.
We become very actively involved in the companies we invest in, compared to early stage US investors.
We often take quasi-operating roles in those companies, and we have very active boards that are involved in significant decisions. Because we are life science investors, we invest more in technologies than business concepts. The underlying asset is intellectual property. We don’t sit around and workshop and come up with intellectual property. Researchers in institutions and companies do that.
We might do quite a lot of work to take that intellectual property and make it into an investable proposition. But we don’t instigate the intellectual property. We build around internationally renowned scientists and their ideas.
Life science is unique in that usually, over the period of our investment, no revenues are generated. So we don’t need to do extensive due diligence on the revenue model, which is quite different from pretty much anything else. We are almost always looking at pre-revenue deals, both at the times we invest and at the time we exit. So it’s really about building the value of the asset, not building the revenues.
Things get pitched to us at a stage where they are not investable, and we often spend 12-18 months turning them into something that is investable.
Of course, we would love it if things were pitched to us investment ready. But it would have to be a fantastic new, novel technology targeting an unmet medical need. In my dreams it would be already in clinical development, with a fantastic management team. Technologies that are quite close to commercial realisation are particularly attractive. The lead-up time to commercial realisation is significantly reduced – it’s not seven years, it might be only three years.
The worst thing is when people come in and say, “We can meet this unmet medical need and here’s the result.”
But they don’t tell us what it is that they’ve invented that causes them to be able to meet that result. They get paranoid that it is subject to a patent or confidential, so they can’t tell us about it. It becomes this very difficult situation where they are just saying, “It’s a black box.” Specialist investors can’t invest in a black box. You have to actually open the kimono and explain it to us. We don’t want to hear someone read a patent to us. They need to be able to explain their technology, without giving away the confidential information, in such a way that highlights the gee-whiz factor. Crisping up that pitch and being able to do that in a life sciences context is a really important skill that a lot of people don’t have.
Brigitte Smith’s Pitching Tips
DR MICHAEL PANACCIO
Dr Michael Panaccio was Head of the Department of Molecular Biology at the
Victorian Institute of Animal Sciences prior to a successful stint at JAFCO Investment (Asia Pacific) Ltd. He is one of the founders of Starfish Ventures, which invests in innovative technology companies (the name is derived from assisting venture from “start to finish”.
I think you have to become actively involved, especially at the seed and early stage. One of the big issues in Australia is the lack of management depth. Therefore, if you don’t mentor and provide a helping hand, the companies are never going to get to the next level.
We rarely come up with the idea and then go and find a team and build the business. We talk about doing it, but the reality is, it’s one of those things where we have so much work on that it falls to the bottom of our list of priorities. Perhaps we get one opportunity a year that is managed that way. Most investment deals come through people pitching ideas. You assess those ideas and invest in a few.
We don’t pre-screen, as such. We try to meet as many people face-to-face as we can. One of the reasons for that is that an information memorandum (IM) doesn’t always communicate the opportunity very well. It might be a great opportunity with a great entrepreneur, but if you went on the IM, you probably wouldn’t have invested. Once you meet the individual, you might change your mind.
We invest in people, not businesses. We want to see the eyeballs of the people we are going to invest in. At the front end we are happy just to meet with the CEO and get him to share his vision for the business. If there is genuine interest, we’ll follow up with more extensive due diligence. Generally, the first visit they’ll come to see us. The second visit we go to see them in their offices and meet the whole team.
We notice two common pitching mistakes.
One is when capital seekers take up too much of their valuable presentation time trying to explain the technology and not explaining the business. The other problem is when they have a technology looking for a market; rather than saying, “Here’s the market opportunity and, by the way, we happen to have a technology that could address that market opportunity.”
Biotech is one of the areas that we are pretty keen to invest into.But we really haven’t seen much of what we are looking for. A lot of biotech is focused on curing disease or better diagnostics. What we are interested in is the aging process; specifically, whether people have or could produce real, active compounds that can address some of the signs of aging. Believe it or not, we just don’t see those types of opportunities. I think the reason being is that the medical community is extremely disease focused. The issues about aging probably don’t seem that important, therefore not much research gets done in that area.
We often suggest opportunities to the scientific community. Their response is that they don’t and can’t get funded to do that type of work, so if we want to pursue it, we need to fund it from the ground up. Normally, through the granting system, people go out and develop technologies and come to us when there is proof of concept or some sort of rational basis for an investment. It’s pretty rare that we will say,” Here’s the money. Go out and create XYZ.” There might be only one deal a year that you would do that way.
DIRECTOR, GENERAL PARTNER
TECHNOLOGY VENTURE PARTNERS
In 1997, John Murray co-founded TVP, which is today one of the largest specialist technology venture capital firms in Australia. He was also the founding executive of the Australian Technology Group (ATG) in 1993, responsible for IT& C-related venture capital investments. Murray holds international credentials in management, finance and private equity investment, and works actively with TVP portfolio companies, including Cap-XX and ManageSoft.
I think that if you get involved in early stage companies you do have to be pretty active in a number of different ways.
Hopefully, the entrepreneurs you end up backing see you as not just a provider of money, but as someone who can help them grow their business. We have the experience of working with multiple companies and seeing the sort of common issues that arise – particularly as they start to develop their business offshore. We are only really interested in companies that have global potential, and there are some pretty common mistakes made. We get involved typically in the area of strategy and the business model. We also get heavily involved in recruitment, which is generally a requirement when they go offshore. We obviously get involved in further fund raising by using our networks. Company building is really an important part of what your venture partner should be able to provide.
The last thing we want to do is to run the company.
I don’t have time to do that. The reason we get involved in a company is obviously the great market opportunity they are chasing. We hope that the people who are involved are a key part of that. If problems with the founding management team arise, we get involved. But that’s not our hypothesis going in.
There is a much more understood and developed process and relationship between the entrepreneurial community and the VC community in Silicon Valley compared with Australia.
There is also a greater realisation of the potential value the VC can bring. We are in the process of trying to bridge that gap and educate the market here. TVP has been heavily involved in a program called VC Connect, where Australian VCs try and reach out to the entrepreneurial community. We try and educate them on what’s involved in the process of venture funding and what comes with having aventure partner. Australia’s professional VC market is less than10 years old. It’s clearly a maturity issue, on both sides of the fence. We’re all learning a lot as we go.
A common mistake by entrepreneurs, who are often from a technology background, is to dive straight into a deep exposition of the strength and depth of their technology, rather than clearly articulating the market opportunity they are pursuing and the value proposition that their technology brings
That happens more often than not, but that is changing over time, as entrepreneurs become more educated about how to raise funding.
We obviously talk about ideas, but we are really interested in finding teams who are deeply involved in an industry segment, have built real expertise, understand there al market opportunity and have figured out a way to address it. It’s amazing how often you think you’ve found something unique only to discover after some digging that someone else is out there doing the same thing, or something very similar. I tend to discount anybody who comes in and says they have a ‘really unique’ idea.
Having competitors isn’t really a bad thing. It validates the market opportunity, which is something entrepreneurs don’t always succeed in doing when pitching to VCs.
In terms of opportunities, we are at a very interesting point in the ICT sector. It’s being driven by this convergence around wireless communication, broadband, pervasive low-cost, high computing power, new storage and display technologies and communication protocols. There is a huge opportunity to simplify the home entertainment experience– to make it truly plug and play, to remove all the wires and integrate all the different components. I’m sure we’re going to see a lot of opportunity there. In fact, if you talk to the VC community in the US, there is this increased interest in consumer technologies, because of convergence and there I sa new tech-savvy generation approaching adulthood. It’s very interested, indeed.
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