Transcript of the Money Men on 11 Aug 09
- John Quirk (Howard & Partners) and Dennis Rowe (Endeavour Capital)
Overview of the current money market
JQ: In reviewing material for tonight we looked at the NZTE sponsored Escalator Course and came to the conclusion that you couldn’t do much better preparation for securing investment than attending this course. It is a free, four hour session that will give you everything you need to know and we can’t recommend it enough.
DR: Internationally we are now post-Armageddon following the second worst depression the world has seen. Investment dropped off the cliff at the end of ’08 but tracking investment for the first quarter of ’09 shows a pretty healthy level of investment in the major markets. The IPO market for VC backed companies has, however, all but disappeared and a result of this, company valuations have dropped by as much as 40-50%. There is some concern that VCs are only going to support companies they are already invested in but with no IPO’s there is a reasonable level of new investments being seen.
JQ: It is tough at the moment and company valuations are low. You can get funds but will be determined by the valuation. Recommend raising funds in the following order:
Write more invoices
Friends, family, fools
Strategic alliance
Banks
Angels
VCs
Q: What is the first thing you look at in a company?
JQ: First the passion and the people.Second — is it globally scaleable? If a company is taking on the world then that is interesting. DR: First thing is; does it have global ambitions? It needs to have a good business plan, a good idea and one or two people in the management team that have either done it before or can execute a global plan. People: Plan: Ability to execute.
Q: Due diligence — how do you go about it?
DR:It is a stepped process:
Companies need to demonstrate that they understand the competition that exists for them world-wide. They need to be in market and get a handle on what the competition is. Get a feel for how they will transfer a big part of the company into the global market.
JQ: It is a bit like selling your house. Due diligence is the preparation you do before a sale; the painting, cleaning, tidying, to get your house in order. Someone buys it as it is all done.I encourage all companies to keep their houses in order. Make sure all contracts are sorted — legal, supplier and employment. Not difficult to do it on an on-going basis but a big effort to do it if you have to pull it together quickly. Due Diligence itself is a formal process. It covers all your books and contracts. It is about making the figures ‘real’ for a potential investor and being able to back up the assumptions that have been made. You should always be “sale ready” so that anyone can review your company at any time in a full and open process. As a software company you can expect some level of technical analysis to be done but basically good software sells and other aspects of your business tend to be more important.
Q: How long does due diligence take?
JQ: Depends on the stage and size of the company and size of the investment to be made. Can be a couple of days but generally around a week.
DR: Due diligence will only be undertaken if there is a deal on the table and both parties are pretty committed to this going ahead. As an investor you want to make sure that what the company is saying is true.
Q: How do you start the valuation process?
DR: Generally there is some early discussion on valuation prior to the Term Sheet being prepared - this outlines the terms of the deal and key financial points. For software companies you look for a rapidly growing market and ability to deliver rapid growth. You need an investment that grows the pie rapidly for the investor. If you take a look at www.corumgroup.com it gives the stats for all software sectors and the multipliers to use for valuation. At present the across the board valuation multiplier for software companies is 1.2 x previous 12 months revenue as a maximum for the valuation. The multiplier has dropped by 40-50% to what it was a couple of years ago.
JQ: It is more of an art than a science and generally a large number of factors are taken into account before coming up with the final figure.
Q: If the product is proven in NZ how do you go about estimate your first year US sales?
DR: You need to plan ‘robustness’ into your figures. I would call on those we know in the market and get them to help with assessing the potential.
Q: Why are investor’s looking for 10x return on their money?
JQ: If you take a hypothetical $50 million investment portfolio — from this you might realistically make 10 investments over five years. Over a ten year investment cycle the likely results from this might be:
The rest are quite likely to fail. On this basis you would get a return of 15% on your investments over five years — so for a VC having one investment returning 10x is pretty much essential. It is a reality driven by necessity.
DR: VCs actually need their own exit strategic. The current hold period for equity is 8.6 years — so that is not a long period of time to get in and out in a ten year closed fund cycle. This is a key difference between VCs and Angels. VCs have a closed fund structure that requires them to invest their money and get out in 10 years. Angels can have longer wait periods and often serve earlier stage companies better — with smaller levels of investment and being more flexible. Everyone is in it to make money but Angels are not so tied to time frames and are typically not going to exit without the original investment requiring a second round of funding.
Q:What happens when the owner wants to stay and keep running the business and the VC wants to exit?
DR: In general, VCs don’t get involved in family businesses. In any business, the founder’s goals need to be made clear at the time of investment. If you are able to take the company public and the founder remains as CEO then there is no need to exit. However a very, very small percentage of companies are able to do this. Key thing generally is around the loss of control and when the founder wants to exit. These are discussions that are had before the Term Sheet is drawn up. Going forward we are going to see bigger IPO’s of a higher quality. Trade sales are a more likely exit scenario especially for the type of companies we find in NZ.
Q: How does a company get noticed by VCs and other investors?
DR: Good execution and good press. JQ: In New Zealand, for a small company, a good media profile can be really helpful. Talking to other VCs and going to NZSA meetings is another way we pick up on good companies. It is a small country and it is not hard to identify who the good companies are.
DR: A VC isn’t going to make you rich and famous. They can share knowledge and provide capital — but it comes back to the people in the company who are able to take an idea forward...the VC can only proffer advice and assist.
Q: What tactics should I employ in approaching the money market?
JQ: Always have a Plan B.Never go looking for money if you don’t have 6-9 months of capital in hand as you don’t want to be running out of money in the process of going looking.Have your house in order.
Q: What comes up in due diligence that can be identified as “typical” of New Zealand companies?
DR: Generally they are not good at understanding global competition. They often haven’t measured it up on the streets of World and understand competitive nature of what they are going into. JQ: Thinking it will be quicker/easier than it was...in general it is “3-2-1”:
JQ: Going through the problems is very disruptive and put a strain on existing revenues. Raising capital can be difficult when you are trying to deliver business-as-usual. VCs typically don’t take a controlling position and not involved in the day-to-day business. They will have a minority position and may want some controls such as OK’ing the Business Plan and say in the hiring and firing of key executives.
Q: What is the difference between an Angel and VC?
DR: In general Angel investors don’t necessarily take a portfolio approach — but they all have the same aim - to make money
Q: How do you vet an investor - particularly if you are looking to get advice and/or assistance as part of the deal?
JQ: Do the Escalator Course.Apply for funding and through that process use money to vet a variety of investors.
DR: Do research — look at their past investments and existing portfolio. If they have not invested in a software company before then you probably shouldn’t look to them for assistance. Also look where they are at in the cycle of investment. I would start a year before you are going to need to go to money to do the due diligence on VCs. http://www.fundit.com/ is a site that gives feedback on VCs.
Q: What is the biggest problem in managing investment?
DR: Really early stage companies with technical founders can be an issue. Particularly if they still want to be the CEO and don’t have that skill base.At the end of the day most of the problems are generally people related.
Q: How do you intervene when milestones are not being met?
DR: You deal with the issues and have plain, frank discussions.Not letting it go on too long if there is a problem — a competent Board will identify potential issues early on to ensure that these matters are dealt with in a timely manner.
SUMMARY ADVICE FROM BOTH
