Side Stepping Venture Capital02/11/16
Peter Park covers a brief introduction into the world of Venture Capital in this week’s edition of The Take.
What is Venture Capital?
Venture Capital (VC) is not something you come across every day, but the principles of VC are invaluable in the world of finance. VC is a way of financing smaller firms with very high risk, but the potential to grow enormous. VC firms will invest in these companies, which provides the company money to grow and expand, and in exchange the VC firm will generally achieve returns as if they were a shareholder. It is a dynamic and innovative industry, and unlike other forms of investing, VC will usually have greater control over the actions of the companies they invest in.
What I do:
Venture Capital is somewhat similar to fields like investment banking and private equity. You source a deal, evaluate whether the deal is worth investing in through due diligence and business analysis, negotiate back and forth, and execute on the deal. What makes the job really cool is that you get to go to a lot of interesting startup related events because you are part of your local startup community.
Raise money to quickly grow or die.
Seed funding is when a startup is pre-revenue or pre-MVP (minimal viable product). The Australian VC market is still primarily focused on seed funding, typically under $1m, though the trend is moving towards Series A+ funding, which is around $2-10m+. Most companies seeking VC funding have proven their product market fit through customer validation, and will be ready to market and sell their product. This is where most startups, fail and where investors demand the most protection. The company needs to be able to get their product into the market and selling as fast as possible. If you want to get into VC, pay attention from now!
Finance 101: High risk, high return. I need protection!
In order to protect themselves from the inherently high risk of venture capital, VC investors strategically use a range of protection clauses in funding documents. This is where the higher degree of control will typically come from in VC compared to other forms of investment and capital raising. Here are some you might want to know:
1. Appointing a Director: VC firms will generally appoint a director or have the ability to do so for companies they invest in.
2. Required/special resolution: The VC firm will ensure the board of their invested company goes through formal procedures, so the company doesn’t just spend $100k without telling investors, or change the business model without review.
3. Anti-dilution: Basically, you paid for 10% equity but isn’t it unfair if future investors pay the same price and get 10% and your holding is decreased?
4. Founder vesting: So you are one of three founders and want to leave and take all of your equity? Nope. You can only take 25% of what you are entitled because you’ve only stayed for one year. Stay on for 4 years to get your full share. Remember you are a core part of the company. We won’t let you go that easily. By doing this, VC firms are keeping the founders working on improving the company.
5. Liquidation preference: If the startup is wound up, I have a priority claim on the money I invested by a factor of X. If the startup is worth $100k on winding up, I get $100k first before anyone on 1x preference. This is an ultimate protection for investors really. One thing I don’t like in Australia is that seed investors demand liquidation preference, which is kind of worrying because startups in a seed stage are more likely to fail than those in Series A stage where liquidation preference is more common.
Can I get into VC?
Getting into VC is doable but difficult, particularly in Brisbane. The Australian VC market is still very small, especially compared to other global tech hubs. Australia is definitely on the rise with more startups and investors entering the market. Generally, VC firms in Australia seem to hire from those working at investment banks or in management consulting with around 2-3 years’ experience. The background in investment banking or management consulting would help you greatly, as you understand the strategic use of legal documents in corporate transactions and how important stakeholder relationship and communication is during the deal lifecycle. Good command of Excel and PowerPoint is helpful, although not so necessary in early stage investing because there is often little or no revenue to analyse through a spreadsheet. It is definitely more relevant once companies reach a serious growth stage, and valuation and company capitalisation becomes more important, ie. Who holds how much share of the company? Look out for Twitter or LinkedIn recruitment posts or referrals in your network for recruitment news. If you know any High Net Worth investors, they might have a family office. This could be very niche but possible.
What can I do to get into VC?
Read a lot. Subscribe to websites such as Mattermark Daily and the Fortune Term Sheet newsletters for daily doses of VC deal news. Read Elaine Stead’s Medium blog, she’s Head of VC at BlueSky VC based in Brisbane. CB Insights is pretty cool with their helpful infographics providing an insight into venture capital. Try Tomasz Tunguz’s (VC in the US) newsletter for nitty-gritties of startup growth and operation. Hit up startup events wherever possible. Perhaps most importantly, network!