It is a question we’re asked a lot: As so-called ‘Angel investors’, what are the key indicators we look for in early stage startups or growth companies that we consider vital to the probability of success for the company (and investor)?
It’s certainly something that has been debated at great length and we’re not claiming to have all the answers. What we do want to do is outline what we’re looking for in a potential investment partner. This view is primarily based on previous operational experience in the Fintech sector but we have no doubt they apply to any technology startup with an eye on exit or IPO.
In the Fintech sector an appreciation of the various ‘killing fields’ for emerging companies is key. As a rule of thumb, for every ten Fintech startups that make it to $1m revenue, only one will ever surpass $5m revenue for two consecutive years; only one of the ten that make it to $5m will ever see a $20m turnover year, and so it continues. When a new niche develops, 10-15 new tech companies seem to appear from nowhere and generally only one of those companies will see a big exit, a second might achieve a modest exit with the rest likely to slowly dwindle into obscurity at best. Wall Street is littered with former ‘Presidents’ and CEO’s of tech startups that simple never made it past those key ‘killing fields’.
The key to fame and fortune is to pick one of the winners; as is so often the case these are few and far between.
There can be no doubt that any investor with enough savvy to back one of the big winners will see astronomical returns – the strategic investor at Wombat saw $3m turn into $50m in slightly over two years. However, the reality is that whatever stage an investor gets involved there is an 80% to 90% chance the business will never make it to the ‘next level’ and the investment will be lost. Of course the same goes for founders and management teams, who need to bet their careers (and savings) on businesses with the highest probability of success.
Having been around the sector for a while, both with Lough Shore Investments and some independent Angel Investing (some good, some less good) I’m increasingly of the opinion that striking a ‘balance’ between a number of key cornerstones in the business is a common trait across all the big winners. And they’re not necessarily what you might expect!
– Sales and marketing
– Technology and development capability (esp. agility)
– Management (commercially street wise, cost control & ability to build a team)
Sales and marketing
For me, sales and marketing comes first. Early stage technology companies should not operate in a vacuum so the first task is to identify and close a handful of alpha customers to partner with during development. The most fundamental question to ask of any early stage technology company is have they managed to close some deals.
In practice, these first deals generally follow from relationships the principals in the business built in their previous lives, so while they get them into the game, don’t necessarily demonstrate the ability to scale a sales and marketing engine. However, without early deals the company will most likely never get off the ground.
Looking again at those crucial ‘killing fields’, the ability to sell and market your offering becomes even more critical in scaling from $1m to $5m revenues and beyond. My own personal rule of thumb is that a company (or business unit) doesn’t become a technology ‘business’ proper until it is consistently closing out five or more deals a quarter from an install base of ten or more customers. The quality of these customers is also key; they need to be the leaders in their sector and not the second tier.
There is no doubt the various social media platforms has levelled the marketing playing field. A well thought out website and marketing campaign can make a 5 person company look like a 100 person firm from the outside, on a meagre budget of £10,000 or so. High quality marketing with a huge potential reach and impact is accessible to just about any business these days.
It is important to note that sales and marketing does not come later or when the company secures funding, if it is a 5 person company then it has a 5 person sales and marketing team. Everyone should be able to sell themselves, the company and the product, everyone should be able to tell the story. Technical brilliance can only come to bear when the team can achieve this.
Technology and development capability
Technology is evidently at the core of any technology business, however, I would urge caution. If Fintech is anything to go by even the current incumbents have tech that is fit for purpose with nearly all the emerging companies producing super high quality technology. Reality bites when customers are disillusioned by poor service and support, glacial delivery cycles, response times, etc. In other words, a firm needs great core technology or more specifically the ability to build it but that alone isn’t the differentiator.
For me the core differentiator is not splitting the atom in the first place, eventually everyone can do that. Rather, it is the ability to build a world class development engine, find the right people, and build an infrastructure that allows a stream of world class products (or features) to be delivered into the customer with speed, agility and the support and service to match. That infrastructure also means ensuring you have great technologists that can support your pre- and post-sales efforts.
Interestingly in Fintech some of the emerging companies in the $20m to $50m turnover bracket with the most robust defenses have core compentence deeply engrained in teamwork, skills and business process. Ability to deliver is the key differentiator, rather than patents or source code.
Again, this isn’t only true of Fintech. Facebook wasn’t the first social networking site, but there is no questioning their ability to deliver a platform that simply steamrollered the competition into oblivion.
Management
The final pillar and the most important in the long term is management. Scaling a company is difficult, many founding CEOs are oblivious to the nuances of scaling cost behind revenue, building a balance sheet, budgeting, recruitment, and building and retaining high quality teams. Simple guiding principles such as remaining ‘quarterly cash positive’ or holding costs 10% to 20% below those of competitors can transform the ability of a business to grow and compete.
Legendary growth investor Philip Fisher reminds us of a more fundamental reason why quality commercial management is key. There is no free lunch!
He points out that the moment a hot shot emerging company appears on the scene the incumbents will engage in all out warfare to ‘snuff’ out the danger. Very often this sets world class professional executives with years of ‘ring craft’ against naive techie entrepreneurs; and the outcome is almost always the same, just when the tech company thinks it has got its big break it gets blind-sided by a flurry of crushing blows from one or more of the incumbents and gets wiped out.
The key point is that in order for a company to emerge (or even to get acquired by one of the incumbents) the management team will have to endure 3-5 years of commercial shenanigans and get themselves so deeply embedded in the fabric of the sector that they become an essential acquisition target or post-IPO buy. In short, they must out-manoeuvre and out-general the incumbents (with their armies of world class executives).
My suggestion, the early stage CEO not only needs to keep a copy of ‘The Art of War’ on their bedside table, and know how to apply it; they also need to understand the topography and dynamics of their sector, not to mention the principles of tight cost control, growing a balance sheet and building motivated high quality teams.
There is no such thing as a free lunch and crossing those key ‘killing fields’ is difficult. World class executive management is key if a hot technology company is going to make it and achieve that big exit.
If you can demostrate your business is striking this balance then you should get in touch and tell us your story.