The global recession is starting to bight hard.  But recessions present great opportunities for innovation.  Anecdotally and somewhat surprisingly (for us) the companies we’ve invested in have been experiencing an uptick in inquires over the last 6-months.  This appears to have been stimulated by a far greater willingness from businesses to consider change.  Anything that can help reduce costs or stimulate demand are now being more willingly considered.  So, that’s good.

However, capital markets are drying up and early stage investors need to consider long and hard the wisdom of investing in start-ups that have large on-going capital requirements – in this environment.  The view we’re taking at the moment is to “shy away” from opportunities that we see will need more than $5m in capital to commercialise them.  The reason being that the risks associated in raising this capital have increased significantly over the last 6-months.  We want to see businesses that could be realistically bought to market without requiring a big hit from a large US Venture Capital firm.

The path-to-break-even is also extremely important in this environment.  Cash is king and demonstrating a path to early cash flow generation will be a real plus in the eyes of any early stage investor.  To manage risk we are look long and hard at whether companies have options for generating enough early stage sales to become self-sufficient (maybe not hitting the high growth points we earlier would have hoped for) but providing the opportunity to ride out the storm and be positioned for growth when the world starts to right itself.  FYI, my current view is that we’re in this for atleast another three years….i hope i’m wrong and it’s shorter.

In summary three things to think about:

1. How does your business / opportunity provide value, to who, in a recession?
2. Be conservative on your overall cash requirements – don’t set a plan to raise the same amount of money as Facebook or Twitter?
3. Plot a potential path to break-even….ASAP

The inaugural angel association conference is scheduled for next week.  This conference is a great opportunity for angel investors to get together, network and share war stories.  I’ve been asked to run a session at this conference on the subject of “creating value in companies”, so i thought i’d take the opportunity to: a) get organised; and b) share some thoughts.

So here goes…”Building value in investee companies…an investors perspectives“.

Three key things to think about:

Focus early on the things you believe will create value,

Actively avoid the things that could destroy value, and

Actively manage your on-going funding needs

Things that add value

Building a business and managing your investment funding is about identifying and doing the things that create value in a business.  So, if we did an initial investment at say a valuation of $2m, we need to ask and answer the question “what do we need to do to grow the value to say $6m”.  From an investment point of view the valuation should be increasing significantly at each subsequent investment round.  So what’s the justification for value increase?  Well, it kinda depends on the idea and the industry that the business is operating in, but the things i look for are:

1. We’ve nailed the technology / product - note i use “we” because when Movac invests we become a team and its our job to help ensure these objectives get achieved…moving on…the first investment stage should ABSOLUTELY sort out the key technology or product risks and establish that the company can produce its widgets and ideally knows how to scale production up.  Generally i take this as a given – KIWI’s are bloody good at this.
2. We’ve protected our technology position - this is not relevant to all businesses, but patents can have significant value.  They provide a window of opportunity and protection for executing a new idea.  They also provide a basis for licensing deals. But you need to go beyond simply filing a PCT (i don’t rate PCTs without the backup) and do the real work…establish freedom to operate and commence the process of filing in your targeted market geography.  This means finding and spending the money on a good patent lawyer.
3. We’ve passed or progressed any major regulatory hurdles - again not relevant to all businesses but fundamentally important to BioTech businesses and any physical product that is likely to run into regulatory hurdles – domestically or internationally.  Be aware that the regulatory issues in Europe are somewhat of a mind field for young NZ businesses and this will be an area that you need help with.
4. We’ve assembled market proof - this is the stuff that, in my experience, KIWI companies are kinda crap at (gross generalisation, I know).  The strongest position that you can be in, in this regard, is that you are trading product; and/ or have signed distribution agreements; and/ or have an established pipeline of opportunities.  Leverage the support that NZTE and organisations like KEA can provide to this process.  You need to get offshore, meet people and do deals.  You need to figure out how to sell your widget globally.
5. We know how to scale up - we’ve addressed how to scale our business, particularly manufacturing and distribution, we’ve worked out the issues associated with manufacturing at scale, we understand the support issues, we’ve worked through any compliance related issues.
6. We’ve got a great team that’s positioned to execute - this one can not be under-rated and the worst assumption that we see made is when entrepreneurs believe they have all the skills and experience – in some cases they may have the skills but not the experience.  Having people that have been there before is absolutely invaluable and earns a BIG TICK from us.  An execution team, in our view will comprise:
   • A sales guy / gal - the person who can get out there and sell / market the sh*^te out of the product.
   • A product gal / guy - the person who knows how to make the product sing and dance.
   • A numbers guy / gal - the person who understands how the business operates in a spreadsheet.  Can articulate the implications of key decisions.
   • A strategic / management gal / guy - the person who can define and articulate long range strategy and who can recruit and build teams.
7. We’ve got good governance in place - ideally we’ve got a functioning board with some wise, experienced heads, one or two independents directors (who have no or minor shareholding stakes) and a robust Shareholder’s agreement.  Shareholder agreements are crucial to enable effective decision making around subsequent stages of investment.

Things that destroy value

Apart from failing to achieve the things outlined above, the things that can destroy value in a business are typically the big time wasters such as:

1. Unaligned shareholders + poor governance - a shareholder and / or director group that is not aligned around the goals for their investment (particularly timeframes for returns), confused about their roles or in openly hostile confrontation are sole destroying for a start-up.  From an investment point of view you can smell these issues a mile away.  The tend to create a corrosive culture around a business and result in lots of wasted time and distraction.  For this reason – treat you shareholders and investors well; communicate openly and regularly; work at maintaining alignment but don’t engage them in operational aspects of the business.
2. Entrepreneurs who do not listen - the transition from entrepreneur to manager of a global $10m plus business should not be underestimated.  Entrenched entrepreneurs who are not willing to adapt their role as the business develops can be and generally are major impediments to growth.  Working through these issues consumes a lot of time and is highly demotivating for all parties concerned.
3. Badly diluted founders - founders tend to be emotionally attached to their shareholding percentage and this can have a major impact on their on-going motivation in the business.  The tricky exercise here is managing the risk / reward equation throughout the on-going investment stages of the business.
4. Failing to manage the investment pathway - early stage companies always run out of money.  You need to stay on top of the businesses on-going requirements for capital and actively manage where you expect this to come from.  Avoid the assumption that the initial group of shareholders will keep investing for ever; regardless of how the company is doing you can not anticipate your investor groups wider drivers and limitation on funds.  See further comments below.

Managing the investment pathway

The investment pathway is something often ignored in the business proposals that we see.  Essentially this is actively planning the capital (investment) requirements for the business and putting a plan in place to:

1. Achieve the investment objectives (normally the same as the business objectives); and
2. Procure the funds at the target valuation

Many early stage investors and founding entrepreneurs often ignore the impact of potential dilution rounds on their projected returns – this can become a real stumbling block to obtaining agreement on subsequent rounds of investment.  So, the better prepared that everyone is for this the better.

The capital investment plan looks at:

1. The staging of capital - how much money is needed at each stage (each stage should provide for at least 18-months business development);
2. The objectives to be achieved for each stage - these are the things that, if achieved, will improve the value of the business; and
3. Where we expect the capital to come from - you  need to start your understanding and research on this early.  Most venture capital companies are upfront with their investment criteria, so you should be able to identify potential sources of capital.  The other things to explore are: what value can they add outside of money; how far through their funds they are; and their timing needs for exit – these factors will help identify the playing field for potential funding.

You need to start the dating game with potential investors very early in the process.  You should plan a “relationship development” campaign in exactly the same way you would with a potential large client.   Don’t leave it to the last minute to start this process.

If you’ve managed to do all these things, then your business is well positioned for growth and sucess – even in the current climate.

Good luck

QED (-;