According to the Australian Bureau of Statistics, just one-tenth of one percent of business pitches secure venture capital investment. Yet despite the odds, many entrepreneurs remain fixated on this Holy Grail. In Anthill’s July 2004 cover story, Paul Ryan explored the divergent expectations that colour the entrepreneur/VC relationship in Australia. Three years on, he returns ringside to find out how far this vital but flawed symbiotic alliance has evolved. Is it a meeting of minds or clash of heads? Well, that all depends on who you ask.
It has always been a curiosity that the private investment network in Australia, a country of just 20 million citizens, is constantly compared with the pulsing ecosystem of California’s Silicon Valley, where the elite techies, business advisors and investors of the world form an unparalleled density of IQ, ideas, experience and commercial opportunity.
Of course such a comparison will be unfavourable to Australian entrepreneurs and investors. In terms of a physical contest, it would be similar to pitting Mike Tyson (the vintage, ear-biting, white pointer, 1980s model) against the boy from Skippy (also the ’80s model), in a bare-knuckle street stoush.
So, let’s kick off by spending a few peaceful moments ignoring Silicon Valley and the tyranny it wields across a vast ocean. This is a story about Australian inventors and entrepreneurs trying to build globally-competitive companies, and about their relationships with the venture capital community that aims to assist them.
DING, DING, DING
In these pages three years ago, I questioned whether the relationship between entrepreneurs and venture capitalists was a meeting of minds or clash of heads. The consensus back then was that it was a clash of heads (a points decision), at least from the entrepreneurs’ perspective. They did not believe that VCs had any great empathy for the inventor’s plight. Nor did they think them sufficiently cavalier when it came to seizing early-stage opportunities that were but a $2 million capital injection away from global conquest.
Conversely, the VC attitude could best be described as sober. VCs are hard-nosed investors with a singular focus on maximising their return on investment. They invest in investable companies based on clear criteria. The capital they invest is (for the most part) not theirs. If they are ever seduced by a potential investee’s vision or attitude, it is imperative that they divorce all emotion from any assessment of the attending market opportunity. Business is business.
The Australian Venture Capital industry is now more than a decade old – still a delicate age, but old enough to have opened and exited several closed-end funds, developed viable networks of investors and managerial talent and, in general, learnt a thing or two.
Of course, a decade is also a reasonable amount of time for Australian entrepreneurs to develop an understanding of what venture capitalists do, what they don’t do, and why. So have they been doing their homework?
Nick Peace is an investment director at Starfish Ventures, focusing on early-stage life and materials science investments. At a recent seminar held in Melbourne to educate Australian Technology Showcase member companies about the venture capital process, I asked him to identify the most enduring misconception entrepreneurs hold about venture capitalists and the venture capital process.
“Too many entrepreneurs think: ‘I have the best technology, therefore I will be successful, therefore you must fund me.’ But, of course, it’s never that simple. You need to be targeting a clearly identifiable market need, have a distribution strategy in place and, preferably, strategic partners to help you achieve market penetration.”
This was the exact same point a number of VCs made to me three years ago, and many times since. In fact, it’s been such a mainstay complaint from VCs for the past decade that it is tempting to mark it down to irreconcilable differences. An entrepreneur’s product is his baby, and how many parents are unbiased, cool and rational when it comes to their progeny?
Peace also pointed out that this same exuberance still leads far too many entrepreneurs to seek venture capital investment when it is clearly not the most appropriate option, or to approach the wrong type of VC with their investment opportunity.
“It’s important to ensure that your business – the investment opportunity you present – fits into the VC fund structure. There’s no point taking an ICT investment opportunity to a life science VC firm, or pitching for seed investment from VCs who specialise in later-stage expansion capital investments.
“Most importantly, we have to see a clear exit opportunity. You might have the most extraordinary technology, but if you can’t demonstrate a clear path to a profitable exit, we won’t risk our capital with you. Venture capital investments are not philanthropy.”
GET IN THE RING?
Martin Wells, CEO of Sydney-based web start-up Tangler, is under no illusions about the highly specific role venture capital plays in the development arc of Australian start-up companies.
“Contrary to popular opinion, most VCs don’t like to take big risks. They like to make smart bets that the product is now ready to take advantage of an opportunity for a lack of cash.”
Wells grew his first significant company, Dot Communications, organically, and has taken angel investment for Tangler. He is very active in educating other entrepreneurs about the commercialisation process and says many of them believe the role of the VC is in actual fact what angel investors do, which is to validate a product concept into an executable model.
If you are after a mentor and a safety net, forget venture capital. You’d better start cozying up to a wealthy angel investor (though, truth be told, if you are not on favourable terms with an angel already, one is unlikely to swoop down from the sky and lend you its wings).
Wells’ advice to entrepreneurs trying to raise VC? Don’t.
“Honestly, you’ll spend an enormous amount of time and probably corrupt your product. You’ll probably end up not developing something that is useful and fundable because you’ve spent so much time worrying about what you thought VCs wanted. If you have a product that is not yet making money, don’t waste your time figuring out what VCs will fund, because what they want to fund is something that already works and makes money. Stop even thinking about funding and concentrate 100 percent on developing a product that you can deliver now, that can make money now.”
Wells is about to move to Silicon Valley for the next four years, as he believes that it is the most suitable location for him to develop Tangler.
Choosing to pursue foreign venture capital comes with no guarantee that the result and experience will be any richer than here in Australia.
Trepidation about the immaturity of Australian VC led Mike Nash to seek and secure $2 million from Swiss VC firm HPI for his mobile phone software company Entellect Solutions at the height of the tech boom. According to Nash, the relationship soured, partly due to the tech-wreck, but also because the (now defunct) VC firm was not particularly effective and had a tendency to interfere.
Nash ended up losing his company, but came away with a firm belief that the role of VCs (beyond providing capital) involves suggesting ideas and opening doors, but doesn’t extend to operational meddling.
“Many entrepreneurs mistakenly bring in external management in the belief they aren’t up to the task of running a VC-invested company,” says Nash, from bitter experience. “There’s a time for this, of course, and it depends on individual circumstances – but don’t feel you have to, just because you’ve taken investment.”
Nash now runs Sydney-based IT consultancy Tall Emu, for which he has not yet sought VC funding. However, he is adamant that if he does, it will be from a tier-one Australian VC firm.
Not all inside observers of the entrepreneur/VC relationship believe that a lack of cohesion between both parties is the primary fault of either.
“The attitude of the institutions towards investment in venture capital in Australia is disgusting – literally disgusting,” says Geoff Mullins, founder of VentureAxess and Chairman of VentureAxess Capital. “That’s something that I only see changing with the advent of more foreign direct investment.”
Mullins is the instigator of the Pacific Technology Corridor being established in North Sydney. It is modelled on successful global technology commercialisation hubs, such as Silicon Valley and the Atlantic Technology Corridor in Ireland.
“I’ve said to the government, as a hypothetical, if everybody who entered into a new superannuation policy had at the bottom of their application form a question that said: I would like up to two percent of my superannuation to be invested in emerging Australian businesses – tick yes or no – our problems would be over,” says Mullins.
The purpose of the Pacific Technology Corridor is to create an environment where public R&D, government initiatives, entrepreneurial talent and private capital can knit together organically to mitigate investment risk and maximise commercial opportunities. Part of this is getting universities involved in a hands-on way, through programs such as the Macquarie Technology Business Incubator, involving VentureAxess and Macquarie University.
The ultimate goal is to create a community of skilled, connected, educated and confident entrepreneurs and venture capitalist, which Mullins says will attract foreign investment and technology transfer. From that base, multinational investment fund of funds can take up residency and allocate capital locally.
It’s a point Jeffrey Castellas, CEO of Clean Technology Australasia, is eager to expand on. For the past two years he has been working with entrepreneurs and investors in the clean tech space (in Australia and internationally) to build a sustainable industry, both environmentally and economically.
Castellas knows that VC interest in various sectors is driven directly by superannuation fund interest. Until quite recently, Australian clean tech entrepreneurs have been tearing their hair out with frustration at the lack of Australian VC interest in their technologies.
“Venture capitalists get about half of their money from institutional investors. Our super funds need to start putting money into a dedicated clean tech fund of funds that has the mandate to invest in venture capital companies with clean tech portfolios.”
Already, Australian VC firms, such as Cleantech Ventures, One Ventures, CVC Sustainable Investments and Starfish Ventures, are developing dedicated clean tech portfolios – a trend that is only likely to gather momentum.
Castellas has in mind something like the clean tech fund of funds established from the Californian Pension Fund (US$200 million that when partnered with other money has swollen to a fully allocated US$2 billion). But he also believes that the onus is not on Australia’s institutional investors to do this alone. Again, it is something that could be formed from a partnership with international funds to provide more capital and opportunities for Australian entrepreneurs with marketable products.
Geoff Mullins says he is also close to announcing the creation of a second board – an Australian version of the NASDAQ – something he believes Australia desperately needs. Details of the initiative are under wraps until it is formalised, but Mullins hinted that it will likely involve The Newcastle Stock Exchange and as well as an offshore exchange.
HANGING UP THE GLOVES
So where does the relationship between entrepreneurs and venture capitalists stand? Well, it could be worse (it has been worse), but it could be better.
It is certainly true that as the Australian VC industry has matured, many of its leading representatives have placed greater emphasis on educating the entrepreneurial community about the realities of venture capital investing. Programs such as VC Connect, run by Slattery IT, have helped elevate VC/entrepreneur discourse to an altogether higher plain.
And entrepreneurs are not quite so bullish in their resolve that VCs owe them something. There now exists a far more profound understanding that venture capital is just one of many options available to company owners building rapid-growth businesses.
No one is expecting to go to bed tonight and wake up tomorrow morning in an Australian Silicon Valley, where ideas and money grow wild and cross pollinate right there on the vine. That kind of fertility takes generations to ripen, and requires from all involved the ability to swallow pride, learn from mistakes and engage one another.
The Top 10 Lies of Entrepreneurs
- “Our projections are conservative.” Entrepreneurs like to assure potential investors that they’ll be doing “$50 million in three years.” VCs will multiply that by 0.1 and add three more years.
- “A market research company says our market will be 50 billion by 2010.” Don’t choose a particular set of data simply because it paints a pretty picture.
- “Yahoo!7 will sign our contract next week.” Under-promise, over-deliver. Only talk about deals you’ve signed.
- “Key employees will join as soon as we get funded.” VCs will check this out, so you better be sure.
- “We have first-mover advantage.” Even if you do, and you probably don’t, it’s a tenuous advantage at best, good for maybe five weeks of lead time.
- “Several VCs are already interested.” VCs only have two states: a term sheet has been offered or they’re not interested. And they will talk to each other.
- “News Corp is too slow to be a threat.” There’s a reason why Rupert Murdoch has a private jet and we fly economy. Even if you’re right, no one will believe you.
- “We intend to launch in China.” Just like charity, success starts at home. Where you see opportunity, your investor sees liability.
- “Our patents make our business defensible.” Competitors will work around any patents of real value. The key is implementation, so hire engineers and practitioners, not just lawyers.
- “All we have to do is get one percent of the market.” a) That isn’t as easy as it sounds, and b) VCs want entrepreneurs who chase 99 percent, not one percent, of the market.
(Adapted from Guy Kawasaki, www.garage.com/resources)
Top 10 lies of VCs
- “I liked your company, but my partners didn’t.” In other words, “no.” The sponsor wasn’t a true believer. A true believer would get it done.
- “If you get a lead, we will follow.” The venture capitalist is saying, “We don’t really believe, but if you can get Sequoia to lead, we’ll jump on the pile.”
- “Show us some traction, and we’ll invest.” In other words, “no.” This lie translates to: “I don’t believe your story, but if you can prove it by achieving significant revenue, then you might convince me. However, I don’t want to tell you ‘no’ because I might be wrong.”
- “We love to co-invest with other venture capitalists.” If this is a good deal, I want it all. Entrepreneurs should want to hear, “We want the whole round. We don’t want any other investors.”
- “We’re investing in your team.” While it’s true that they are investing in the team, entrepreneurs are hearing, “We won’t fire you.” That’s not what the VCs are saying at all. What they are saying is, “We’re investing in your team as long as things are going well, but if they go bad we will fire your ass because no one is indispensable.”
- “I have lots of bandwidth to dedicate to your company.” Maybe the venture capitalist is talking about the T3 line into his office, but he’s not talking about his personal calendar because he’s already on ten boards.
- “This is a vanilla term sheet.” There is no such thing as a vanilla term sheet. Do you think corporate finance attorneys are paid $400/hour to push out vanilla term sheets? If entrepreneurs insist on using a flavour of ice cream to describe term sheets, the only flavour that works is Rocky Road. This is why they need their own $400/hour attorney too–as opposed to Uncle Joe the divorce lawyer.
- “We can open up doors for you at our client companies.” Even if the VC can open the door, entrepreneurs shouldn’t expect the client company to commit.
- “We like early-stage investing.” Venture capitalists fantasise about putting $1 million into a $2 million pre-money company and end up owning 33 percent of the next Google. That’s early-stage investing. Do you know why we all know about Google’s amazing return on investment? The same reason we all know about Michael Jordan: Googles and Michael Jordans hardly ever happen.
- “We share your vision.” This is not strictly a lie, but becomes one fast if you don’t live up to the VC’s expectation.
(Adapted from Guy Kawasaki, www.garage.com/resources)