Convincing investors to back an idea is the key challenge for every start-up, and usually an idea is pretty much all they have.
Even a team that has runs on the board, with a product, customers and maybe even some revenue, faces the challenge of making investors understand the potential of their business. Banks won’t lend them money without collateral or some form of control, and jumping straight into a listing on the stock exchange isn’t an option.
Enter venture capital -- the guys with the funds who are good at sniffing out potential and have often been tech entrepreneurs themselves.
As Australia’s start-up community plants some solid roots, major VC firms are rising to the challenge and flexing their muscles. Business Spectator spoke with two Australian VC firms -- Square Peg Capital and Starfish Ventures -- to find out what makes them tick and what they are looking for.
Square Peg Capital
Established last year, Square Peg boasts an all-star list of partners, including Seek co-founder Paul Bassat, start-up veterans Gavin Appel and Dan Krasnostein, and former Macquarie Group banker Tony Holt.
With the VC industry mostly dominated by foreign players, Square Peg is hoping to pip them at the post on the next big thing.
“We invest in online and technology companies, with 50 per cent of our investments being in Australia. Our core focus is on businesses seeking Series A to B, right up to growth equity; that’s our sweet spot,” Appel says.
The start-up jargon can be confusing but Appel was kind enough to explain the stages that generally define the start-up process.
“The first gate is attaining that minimum viable product; they’ll need capital of maybe $100,000 and they’ll tend to get that from Angel investors, a high-net-worth individual or a successful entrepreneur.”
At this point the business has identified a market and refined its product.
“The next logical step is to raise a seed round. This will take their product to market and get validation for the market fit.”
Appel explains that this process is a general guide and that there are no defined dollar amounts for each stage.
“The seed stage might raise $500,000 to $2 million. It’s about attracting customers, getting a product-market fit and getting positioning right.”
The next step is Series A to B funding and Appel says this is where execution and acceleration become important.
“Providing capital at this stage allows us to leverage our capital to help businesses execute on their plans; but we also want our portfolio companies to be able to leverage our networks, both locally and globally,” Appel says.
Global expansion is a focus for most businesses and while many choose to seek funding and growth offshore, Appel and Square Peg are doing their best to build local opportunities.
“I would say that Australia’s ecosystem is going to be Australia’s own ecosystem. It’s not going to be Silicon Valley or Israel. Australia is running at a million miles an hour, it’s developing its own framework to operate and we want to help shape that.”
Risk aversion is an all too familiar theme in Australia but that’s starting to change, with the success of 99Designs, Atlassian and public companies like Seek. The trick now is to keep building on these successes, says Appel.
“In the last three years it’s a whole different world in terms of activity and capital, and in terms of media exposure. More successes will lead to more forms of capital opening up, I think,” he says.
Starfish Ventures is Australia's largest private investment fund manager and prides itself as a provider of substantial funding to needy start-ups.
Investment director Tony Glenning told Business Spectator that while VC firms are in the business of picking winners, it’s not just about giving start-ups money.
Glenning says Starfish looks for a long-term investment to which they can also add their own experience.
“We look for companies who’ve had angel and seed funding. Got a bit of traction, got some proof points around their business model. We focus on Series A funding with a general aim of sinking $5m to $10m into a project over the life of the investment.”
When asked about some of his firm’s best prospects, Glenning is diplomatic.
“These companies are like children -- that’s a hard question to answer. It’s a bit unfair to say which one is your favourite,” he says.
“Perhaps I’ll answer it in a different way: a couple of the companies in our portfolio are having some great success and crossing the chasm to being genuinely successful businesses. Nitro software is doing really well, as is DesignCrowd; I can speak to those because I look after them.”
While celebrating the success stories is important, it’s important to remember that most start-ups usually sink into obscurity. With such high failure rates, how does Starfish choose its targets? Glenning says it boils down to the team -- that the dynamic between the individuals in the team is vital, especially for earlier-stage businesses.
“As much as anything, you’re backing the people -- they don’t have as much proof point around anything else.”
And of course, personality goes a long way.
“At the end of the day, as investors we’re going to have a working relationship with these people for many years, and hopefully a productive working relationship. There are going to be ups and downs and so you definitely need to have a meeting of the minds about personalities and whether you can work together.”
While youth and inventiveness are important, there is also value in the lessons of trial and error.
“The fact that they’ve done it before, successfully or unsuccessfully, is definitely going to add to their experience," Glenning says.
"In terms of entrepreneurs that have had some failures, the real question is what have they learned from that? You’ve got to have that ability to pick yourself up off the floor. An entrepreneur with a failure in their past shows they haven’t been put off by that. They’re willing to give it another go. As long as the lessons are good I think that’s an asset to their ability.”
Follow John Treadgold @johnnytreadgold