Tech Startup Investment from My Venture Capital Days
The hype is real.
Technology companies have boomed in the last few years. Terms like AR/VR, AI, IoT, Blockchain, Machine Learning, etc, are frequently being discussed.
It is well known that the heart of tech lies in Silicon Valley – a map plotting quite a handful of the startups including well known and lesser known ones can be seen here.
There is also vibrant tech scene in Malaysia, but it is almost exclusive to the people who are involved in it. I was in and out tech conferences and company pitches when I was working in a venture capital. However, my exposure to these diminished significantly when I was out of the scene.
Trivia: Grab was a Malaysian company until it moved to our neighbour, Singapore.
On the other hand, there is no lack of investors looking into putting their bets on companies that are listed. In 2019, we saw a slew of IPO (Initial Public Offering) of famous tech companies – Zoom, Slack, Uber, Pinterest, etc. Here’s a short list, if you’re interested to know.
What is venture capital?
People should have at least heard of the term “venture capital” by now.
Venture Capital is an investment firm who specialises in investing in startups and early stage companies, who mainly focuses in technology companies.
The idea is to invest in a company in the early stage to reap the growth rewards. Imaging investing in Facebook in the early days with only $5 million valuation in year 2004. As of writing in Oct 2020, the shares are trading in the share market at $800 billion valuation. That’s 160,000 times return in 16 years!
The risk, as you may have guessed it, is that most of these startups fail along the way and all the money that’s invested is wiped out.
I had the privilege to get introduced to and also to evaluate various startups when I was in the VC scene. It is a bit of a pity that I had to leave the scene, but it was for the betterment of my overall wellbeing because of a toxic boss as detailed in my other post.
However, there is a thing or two about investing that I can takeaway during my time there.
Investing in Startups
When we invest in public listed companies in the market, we are dealing with established companies with track records and also scrutiny from various parties including the regulators.
However, when we are talking about venture capital investing into startups, it is multiple times more difficult to analyse and evaluate due to the lack of information. Venture capitalists must ensure the startups invested:
- Firstly, will survive
- Secondly, will grow at an exponential rate
This is all the more true nowadays when everyone and anyone can have a startup!
There is a famous style of venture capital investing adopted by some VCs called “Spray and Pray”. It is as the name suggests: Invest small amounts in multiple companies and pray that at least one grows to become a unicorn (billion dollar valuation). 500 startup is one of such venture capital.
A structured thought process for evaluation
When I was in the Venture Capital, there are 5 key areas that we segregate and deep dive when we evaluate every single startup. I believe that this is a structured way of dissecting a business and can be used even when we are evaluating established businesses.
Industry Overview
The first thing that we’d look at is by taking a helicopter view on the industry.
It is insufficient to base our analysis on just our own views and opinions. We will need to research into the industry to understand where the wind is blowing.
- What are the experts saying about the industry?
- What are the news that is floating around?
- How big is the market size that we are realistically covering?
- What are the catalysts in the industry?
- What are the trends in the market?
- Is it a crowded space and who are the competitors?
A simple question: In the face of the COVID pandemic, does it make sense to invest in the air travel industry when lockdowns are happening everywhere?
Before you answer no (or yes), think of how will you justify your answer to get a resounding no (or yes).
Products and Services
Let’s say it’s good to go for the industry.
In the broad umbrella of the industry that one serves, it is important then to drill down to what exactly is the products and/or services that the company is offering. This essentially captures the reason of existence of the company.
The products and/or services that is offered by the company has to provide a solution that is acceptable by the market. The focus here is to answer the question “would people want your solution?”.
Another thing that would always linger in the mind is the unique selling point of the products and/or services. This is especially important in an environment where there are other more established competitors. Again… answering the question “would the people choose you over your competitors?”
Marketing & Sales
The next thing to focus on is how will the company reach out to the market with its products and services.
I think we can agree here that a company that don’t know how to market and sell its products and services will be doomed to fail. What good is a world class product if it’s forever hidden in the shadows?
This covers the target market, partnerships, marketing tactics, etc. It is here that we assess how can a company reach its customers and, at most times, compete with the competitors for the customers’ attention.
One other thing that comes under this umbrella is the revenue model (that works). Netflix itself has changed its pricing / revenue model multiple times – from pay-per-use to DVD subscription model to online subscription to multiple subscription plans. The idea is not to have the right revenue model, but something that makes sense for the time to capture the market.
Human Resource
Now that we have analysed the industry and the business, it is time to see the gears that are working this company (i.e. the people behind it).
Arguably, a lot of people in the venture capital industry would say that the people are the most important asset when investing in a startup. This is actually very true for most businesses.
Give the right business to the wrong people and you would see it crumble, but give the wrong business to the right people and you would see an empire.
What are we looking here? The background of the founders, the reputation, the team profile. Are we having the right people playing the right role? We don’t want the technology engineer handling the marketing, now do we?
Finance
The last part of the equation is the numbers, aka the results.
We evaluate on two prongs: Historical & Future.
Historically we will tear up the financials of the business and what it has achieved so far. The main focus would be on the trends that it is showing. For startups that do not have revenue yet, then we will look into the subscriber / user numbers or whatever that they can show us.
For the future, we will evaluate the potential of the business. Mostly startups will prepare their forecast for us to evaluate, but we know that they will oversell in most cases. Hence, we have to take what we know about the industry, the historical numbers so far and the potential of where the business will go to review the forecast carefully.
History will tell us can they perform what they envision to do
Future projections will show us the potential of how big this deal can be.
Closing Thoughts
This is a thought process that has helped me truly understand a business whenever I needed to do a deep dive. In addition to that, it complements my investment principles whenever I evaluate companies in the share market.
It takes time to go through the entire process. There is no shortcut. In Venture Capital investment it is crucial to pick the one with the highest success rate.
How is this different from our own investment in the stock market? Or anywhere else for that matter…
I’d like to end this post with a saying that I heard and resonate well, “the degree of risk that we undertake when we invest is inversely correlated with the amount of information that we have on hand.”
