13/04/2016 - 06:01

Startups need investors’ ‘bread’

13/04/2016 - 06:01

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Legend has it the wife of King Louis XVI of France, Marie Antoinette, said, ‘let them eat cake’ on hearing the starving peasants were in revolt against bread shortages.

Startups need investors’ ‘bread’
Cliff Obrecht (left), Melanie Perkins and Cameron Adams raised $20.8 million from VC and Hollywood stars last October. Photo: Attila Csaszar

Legend has it the wife of King Louis XVI of France, Marie Antoinette, said, ‘let them eat cake’ on hearing the starving peasants were in revolt against bread shortages.

We’re talking the late 18th century, around the time of the French Revolution; and, as we know, to the victors go the spoils, particularly when it comes to the (re)writing of history.

The saying actually predates Marie Antoinette’s birth by about a century, and was probably first uttered by another French noble, Marie-Therese, the wife of Louis XIV.

But the attribution persists, and has been used to reinforce the notion of a ruling class out of touch with the needs of the populace.

The words ‘let them eat cake’ rung in my head this week as I indulged in a discussion I’d had many times before, relating to Perth’s burgeoning startup sector.

While most involved in the discussion agreed there is a lack of early-stage funding deals, a distinct divergence of views was offered when the reasons for this were sought.

I’d like to explode a few myths, if I can.

Myth 1: If they were good deals, they’d get funded

I hear this one a lot. If they were good deals, the argument goes, then eventually (or even swiftly) they would get funded, as an investor would see the opportunity was too good to miss. Some may pass, but eventually a good startup business would attract money.

In Perth, this argument rests on the market for startup funding acting perfectly, which only exists where there are a large number of buyers and sellers, such that no single buyer or seller can influence price. Perfect markets also rely on a perfect spread of information, freely available to all, and homogeneous products.

Perth’s startup sector is no perfect market. While there are numerous startups to choose from, the number of private investors willing to back them is very limited. There is one venture capital fund (and that’s already fully invested, two-thirds in biotech) and one angel group, which meets four times a year and maybe does five or six deals annually. Meanwhile, there are plenty of potential investors dripping with money (business, mining or property) but not involved in the startup sector.

Neither is there a perfect spread of information, with only a privileged few getting in front of the investors. And as they are all very different, each startup investment opportunity needs to be considered individually – a bit like buying an investment property. It’s time consuming, uneven, and sporadic at best.

I’m no expert on what makes a good startup investment, but I believe there are many more out there worth a $25,000 or $50,000 investment than are currently being funded. I am seeing too many move away from Perth for funding (and securing funds) and too few getting funded here.

Yet Perth has far more high-net-worth individuals per capita than anywhere in Australia, and is one of the top places in the world for multi-millionaires.

There is a distinct disconnect between those who might have spare money to invest and those who could do with a decent little early-stage investment that could provide several months of development time, get them to market, and the revenues to see if there is something viable there.

Myth 2: They shouldn’t be raising money anyway

This argument goes that startups should forget about raising money and should start pitching to customers instead. Get to minimum viable product (MVP), get early clients on board, earn revenues, and maybe they’ll find that they won’t even need investors at all; or if they do, they’d secure a better price, be able to raise more money and give away less equity in the bargain.

I agree 100 per cent.

However most startups are either doing exactly that (out of necessity) or cannot get any further without something else investing upfront. They’ve piled in their own cash, savings, taken on credit card debt, used money from family and friends, and spent months on the idea – with no payback. They have got somewhere and are now looking for some extra help.

Some ideas just need money to get off the ground. You have to spend something to build it, you have to get out there to see if it works, and this may take $50,000 or more beyond the funds available to the founders.

Most successful startups have had early-stage money. Very few are profitable or cash flow positive from day one (or after the family and friends’ money has gone). Often there are dead ends, false starts, and wasted attempts – all the cost of learning. If you’re doing something very new, disruptive and game changing (surely what the investors want to see?) then it simply takes some funds upfront. Like buying the investment property.

It also takes time. The successful ones will tell you it took five or more years to make money. It certainly took my startup this length of time, and others like realestate.com.au, carsales.com.au and others took seven or eight years before profits appeared.

Melanie Perkins and Cliff Obrecht from Canva understood this. They’ve raised millions and millions but are they profitable, or cash flow positive yet? They were helped off with a cool $3 million a few years ago, which took them away from Perth to Sydney, and have since raised many millions more.

Nick van den Berg and Al Bentley from Simply Wall St could not raise money in Perth, but have successfully raised $750,000 from angel investors, also in Sydney (why not in Perth?). Their lead angel told me at a lunch function a few months ago that, in the case of Simply Wall St, the idea was so disruptive, “you just had to give it a go to see if it worked”.

Exactly.

Myth 3: The entrepreneurs are unrealistic 

Sure, owners of anything are unrealistic about their valuation. I think my property is worth more than it is, and also my car. The price is determined only when someone is willing to pay for it what I am willing to sell it for.

However given a limited number of genuine local startup investors, the power is weighted heavily on the buy side; in some cases the negotiation is more like staged bullying (running down the efforts of the downtrodden entrepreneur, and finding all sorts of reasons not to invest). Meanwhile, the poor startup trudges back to their lean canvas to see if they can eke out another month or two.

Perth investors have grown fat on the ability to exit their investment through an ASX-listed entity. We have seen 60 backdoor listings announced during the past two years as the mining downturn takes hold and empty shell companies seek to evolve into tech operations. This is a highly expensive and dangerous way for a genuine startup to raise funds.

While potentially fine for a commercialised organisation with revenues and a clear growth path, it is clearly not suitable for the early-stage venture.

Sure, entrepreneurs are unrealistic, but so are investors. You can’t have it both ways; you can’t have your cake and eat it. It’s a punt. You will probably not see that money again. Yes, it’s probably illiquid, for years. But if you win, you win big, so it’s best to make a few bets, to cover yourself. The more you make, the more you spread your risk. You may say ‘no’ to 20 before saying ‘yes’ to your first. But you might do two or three a year.

Myth 4: It’s good they get money elsewhere and leave

The argument goes that we should not worry about our best and brightest startup ideas leaving our shores to get funded elsewhere. Sometimes they just need to spread their wings, and once they make their money they will return and help our ecosystem back here.

Well, maybe. But why can perfectly good Perth ideas get funded in Sydney, Singapore or San Francisco and not here? Why should they have to leave to get funded when we have so much money in the hands of private individuals in our city (and come July a nice little tax deduction too)?

Why should they have to leave our great lifestyle, family and friends … unless they really want to?

To me, this argument is lazy. While it’s perfectly fine for businesses to go wherever they want, it is not fine to have so few early-stage funding deals here, with the subsequent loss of jobs and income that could have been created.

We are competing in a global marketplace, the gloves are off, it’s either get nimble and innovative, disrupt your own market or someone else will do it for you. Where is the post-mining diversification we so badly crave? Even during the boom people were worried about us becoming a one-trick pony. That pony has now well and truly run its race, but where are the up-and-coming industries? They need to be backed. We have no idea what great businesses might flourish and grow unless we give them a helping hand.

Opportunity

Startup investment is not for the faint hearted. It’s not a slam dunk, it’s not for your nest egg, it’s play money. Many thousands of high net worth individuals in Perth could make two or three $25,000 to $50,000 investments a year and not even notice it. Conservatively, that’s $250 million to $500 million of available funds a year. That would make a tiny fraction of a dent in the portfolios of many, but would revolutionise our local economy.

Perth could become a regional tech startup sector, offering a great lifestyle, climate and investment funds to plucky entrepreneurs who want to cash in on a place that just happens to sit in the same time zone as 60 per cent of the world’s population.

It would be negligible if we don’t do this.

Why a tech startup? Because the best ones have highly scalable business models. Those guys and gals down at Spacecubed hammering away at their idea on a laptop could have $100 million businesses in a few years (just as Canva does today after a relatively short four-year journey). This type of growth is hard to do with traditional bricks-and-mortar businesses.

It’s the most speculative investment these investors will make, but for many it’s the best fun they can have. They can add some value to the startup (sharing hard-won advice on commercialisation, open some doors) and it can give them plenty of dinner party conversation.

If we can throw enough darts at the dartboard here in Perth, we will hit a bullseye or two. It’s a numbers game. It’s a funders’ game.

So, let them eat bread. Cake will come later. Perhaps.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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