Let them eat cake

Asking for startup money

Legend has it the wife of King Louis XVI of France, Marie Antionette, uttered the words “let them eat cake” on hearing the starving peasants were in revolt against bread shortages. We’re talking late 18th century, and although the Queen would have probably said the words in French (something like ‘Qu’ils mangent de la brioche‘) there’s no evidence that she actually said this at all. The saying actually predates her birth.

But the attribution persists, and has been used to show how out of touch the nobility were at the time, resulting in the French Revolution, and King Louis losing his head.

The words rung in my head this week as I indulged in a discussion I’d had many times before, relating to Perth’s burgeoning startup sector. The weight of opinion agreed that there’s not enough early stage funding deals going on. As to why, there was a distinct divergence of views.

I’d like to explode a few myths if I can …

Myth 1 – If they were good deals, they’d get funded

I hear this one a lot. If they were good deals, the argument goes, then eventually (or even swiftly) they would get funded, as an investor would see the opportunity was too good to miss. Some may pass, but eventually a good startup business would attract money.

However, this argument rests on the Perth market for startup funding acting perfectly, which (let an old economist like me remind you) only exists where there are a large number of buyers and sellers, such that no one buyer or seller can influence price. Perfect markets also rely on a perfect spread of information, freely available to all, and homogeneous (exactly the same) products.

Perth’s startup sector is no perfect market. While there are a good number of startups to choose from (300 at last count?), there are a very limited number of private investors willing to back them. There is one VC fund (and that’s already fully invested, 2/3rds in biotech) and one angel group which meets 4 times a year and maybe does 5 or 6 deals annually. Meanwhile, there are plenty of potential investors dripping with (business, mining or property) money removed from startupland.

Neither is there a perfect spread of information, with only a privileged few getting in front of the investors, and as they are all very different, each startup investment opportunity needs to be considered individually, one by one, a bit like buying an investment property. It’s time consuming, uneven and sporadic, at best.

I have no idea what makes a good startup investment (well, I have some idea, but I am not arrogant enough to say I know which one will be a unicorn and which will fade to nothing), but I believe there are many more out there worth a $25,000 or $50,000 investment that are currently being funded. I am seeing too many move away from Perth for funding (and securing funds) and too little getting funded here; and yet, Perth has far more high net worth individuals per capita than anywhere in Australia, and is one of the top places in the world for multi-millionaires.

There is a distinct disconnect between those that might have spare money to invest and those that could do with a decent little early stage investment that could give them 6 to 9 months of road, get them to market and revenues to see if there is something viable there.

Myth 2 – They shouldn’t be raising money anyway

This argument goes that startups should forget about raising money anyway (far too many think the capital raise IS the end game, clearly it is not) and should start pitching to customers instead. Get to minimum viable product (MVP), get early clients on board, earn revenues, and maybe they’ll find that they won’t even need investors at all, or if they do, they’d secure a better price, be able to raise more money and give away less equity in the bargain.

Bingo – I agree 100%.

However, most startups are either doing exactly that (out of necessity) or cannot get any further without something else investing upfront. They’ve piled in their own cash, savings, credit card debt, taken money from family and friends, spent months on the idea, with no pay back, giving it their all. They have got somewhere, and now are looking for some extra help.

Some ideas just need money to get off the ground. You have to spend something to build it, you have to get out there to see if it works, and this may take $50k or more beyond the funds available to the founders.

Most successful startups have had early stage money. Very few are profitable or cash flow positive from day one (or after the family and friends money has gone). Often there are dead ends, false starts, wasted attempts, and this is all the cost of learning. If you’re doing something very new, disruptive and game changing (surely what the investors want to see?) then it simply takes some funds upfront. Like buying the investment property.

It also takes time. The successful ones will tell you it took 5 or more years to make money. It certainly took my startup this length of time, and others like realestate.com.au, carsales.com.au and others took 7 or 8 before profits appeared.

Mel and Cliff from Canva understood this. There they are today, smiling out at us from the front page of the local weekend paper. They’ve raised millions and millions of funds  – are they profitable, or cash flow positive yet? They were helped off with a cool $3 million raise a few years ago, which took them away from Perth to Sydney, and have since raised many millions more. Nick and Al from Simply Wall Street could not raise money in Perth, but have successfully raised $750k from angel investors, also in Sydney (why not in Perth?). Talking to their lead angel at a lunch function a few months ago, he told me that in their case, they had an idea so disruptive, “you just had to give it a go to see if it worked.”

Exactly.

Not all startups deserve money, some may not be at the right stage, but somewhere along the line, many do, and the vast majority of these simply aren’t getting the funds they need, despite there being ample in our city. Water water everywhere, nor any drop to drink.

Myth 3 – The entrepreneurs are unrealistic 

Sure, owners of anything are unrealistic about their valuation. I think my property is worth more than it is, and also my car. The price is determined only when someone is willing to pay for it what I am willing to sell it for.

But with a limited number of genuine local startup investors the power is weighted heavily on the buy side, such that in some cases the negotiation is more like staged bullying (running down the efforts of the down trodden entrepreneur, and finding all sorts of reasons not to invest). Meanwhile, the poor startup trudges back to their lean canvas to see if they can eke out another month or two.

Perth investors have grown fat on the ability to exit their investment through an ASX-listed entity. We have seen 60 ‘back door’ listings announced over the last 2 years, as the mining downturn takes hold and now empty shell companies look to evolve into a tech company. This is a highly expensive and dangerous way for a genuine startup to raise funds. While potentially fine for a commercialised organisation with revenues and a clear growth path, it is clearly not suitable for the early stage venture (or only in very rare cases – FMG was in fact a back door listing, but I wouldn’t classify that as a tech startup.)

Sure entrepreneurs are unrealistic, but so are investors. You can’t have it both ways, you can’t have your cake (or bread) and eat it. It’s a punt. It’s a riverboat gamble. It’s like betting on the horses. You will probably not see that money again. Yes, it’s probably illiquid, for years. But if you win, you win big, so it’s best to make a few bets, to cover yourself. The more you make, the more you spread your risk. You may say ‘no’ to 20 before saying ‘yes’ to your first. But you might do 2 or 3 a year.

Myth 4 – It’s good they get money elsewhere & leave

The argument goes that we should not worry about our best and brightest startup ideas leaving our shores to get funded elsewhere. Sometimes they just need to spread their wings, bless them, and once they make their money they will return and help our ecosystem back here.

OK, maybe. But why can perfectly good Perth ideas get funded in Sydney, Singapore or San Francisco and not here? Why should they have to leave to get funded when we have so much money in the hands of private individuals in our fair city (and come July a nice little tax deduction too)? Why should they have to leave our great lifestyle, family and friends… unless they really want to?

To me, this argument is lazy. While it’s perfectly fine for businesses to go wherever they want (fly my darlings fly), it is not fine to have so few early stage funding deals that jobs and income that could have been created here (and stayed here) are exported to other cities or countries. We are competing in a global marketplace, the gloves are off, it’s either get nimble and innovative, disrupt your own market or someone else will do it for you. Where is the post mining diversification we so badly crave? Even during the boom, people were worried about us becoming a one trick pony. Now that pony has well and truly run its race, where are the up and coming industries? They need to be backed. We have no idea what great businesses might flourish and grow unless we give them a helping hand.

~~

Startup investment is not for the faint hearted. It’s not a slam dunk. It’s not for your nest egg, it’s play money. Many thousands of high net worths in Perth could make two or three $25k to $50k investments a year, and not even notice it. Conservatively, that’s $250 to $500 million of available funds a year, that would make a tiny fraction of a dent in the portfolios of many, yet revolutionise our local economy.

Perth could become a regional tech startup sector, offering a great lifestyle, climate and investment funds to plucky entrepreneurs who want to cash in on a place that just happens to sit in the same time zone as 60% of the world’s population.

It would be almost criminal (and certainly negligible) if we don’t do this.

Why a tech startup? Because the best ones have highly scalable business models. Those guys and gals down at Spacecubed hammering away at their idea on a laptop could have $100 million businesses in a few years (just as Canva does today after a relatively short 4 year journey). This type of growth is hard to do with traditional bricks and mortar businesses.

It’s the most speculative investment these investors will make, but for many of them, it’s the best fun they can have. They can add some value to the startup (sharing hard won advice on commercialisation, open some doors) and it can give them plenty of dinner party conversation.

If we can throw enough darts at the dart board here in Perth, we will hit some bulls eyes. It’s a numbers game. It’s a funders’ game.

So, let them eat bread. Cake will come later. Perhaps.

Photo Credit: Flickr.com, Heather Katsoulis

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13 thoughts on “Let them eat cake

  1. Great post Charlie (as usual). Three points I would add:

    1. Ben Horowitz from A16Z venture capital says one of the main things they look for in founders is courage. I think he can say that because he (and A16Z in general) are also very courageous. Of course, its probably quite a bit easier to be courageous if one has a very high net worth.

    As a result, I think we need to find courageous very-high-net-worth individuals in Perth.

    2. I don’t believe $30-$50K on its own can be much more than a micro-seed investment, to help with incorporation and some legal fees and a few low-fi MVPs to test out a few business model hypotheses. Real seed money needs to support a team of 3+ working full-time for 9-12+ months plus expenses.

    As a result, I think we need syndicates of the courageous very-high-net-worth investors.

    3. Finally, the primary goal (IMHO) should not be to get traction, acquire lots of users, or even make a profit, it should be to validate a business model and a sales process, with solid data as a result of running experiments, to make a strong case for Series A investment of a few million $s to scale.

    It’s a long play for courageous seed investors, not a chance for a quick return.

    • Yep, absolutely. I was restricting my analysis to that early stage $25-50k. Which can buy founders 6-9 months of road. Not the larger “buy a job” money that allows a few to take salary until they reach cash flow positive or another round. That higher amount requires more sophistication and would be even harder to get in Perth. I’m talking about easy punts spread far and wide so we could see which ideas might take.

      • I agree Charlie but (IMHO) the first thing new founders should not do is spend that $20-50k getting a mobile or Web app built (even if it is a minimal product) in the hope that if they build it customers will come… There’s so much brand new founders can do without spending much beyond their time and effort to validate the business model. If anything the money encourages these founder do many things (like incorporate, pay for a nice Web site, graphic design, videos, trademarks, unnecessary patents and other things) that do very little (if anything) to validate (or not) the business model, i.e. they are wasting money and are not lean. With something like Vocus Startup, this money is excellent for more established startups with a high-fidelity MVP to run some significant experiments to complete Customer Validation (see my comment below). It shouldn’t, generally speaking, be used for product development or similar.

  2. Here’s a few more comments from my LinkedIN friends…

    Téa Smith –

    I tend to be in the number 2 camp, but it is hard, especially for older (ie not 23 year olds) Founders with responsibilities, to refine their idea, work on their value proposition for customers etc without seed money. I am a fan of bootstrapping (I like to own my ideas) but at the same time, some really great ideas die because they run out of money/can’t develop it. I know a few of mine have over the years. There’s some amazing talent in this town and it is a shame that the VC/Angel market is so stretched.

    One thing I see done better in SV is that they often back *people* rather than a specific business idea/UVP with a marketing plan, and nurture/develop people, knowing that they are capable of creating something amazing.

    There are a lot of issues that are partly Perth-culture and partly startup-culture that need addressing to truly support innovation, IMO. (sorry for the multi-comment post – LinkedIn didn’t like it as one comment.)

    I think that startup culture generally favours young, single men, or older men with supportive partners too. There’s an issue of access for women too, to get to the level where they are pitching. Most of us just can’t access it. I know if I was backed I would have several successful ventures… but I spend all my time trying to pay the bills. lol don’t mind me, just having a whinge 🙂

  3. And another one …

    Sven Stenvers –

    I love the Perth startup scene, it’s vibrant and there’s a tonne of quality.. good ideas, and scalable with the right approach and support. I agree with some sentiments in the article too, but I also think there’s often gaps to be bridged; between founders pitching ideas as just ideas, without any meat on the bone of a thoughtful and thorough g2m strategy and financial projection – to back the money they’re asking an investor for. Sure, projections are like opinions – everyone’s got them, some passionate – but not all that many are well considered. As an investor I want to at least see a founder has given quality thought to the risk. Many have, but many haven’t. Beyond that, it’s a matching game on a personal level. Between the founding team themselves, and between that team and the investor. Mutual respect, receptivity, coachability. 60% of startups fail due to problems between partners. Half marriages end in divorce. Getting the fit right is probably the single biggest determinant of success in my opinion. It’s not a quick and easy path to tread.

  4. And another…

    Téa Smith

    Absolutely Sven, and its a delicate balance between due diligence and giving people a shot. That’s why I think backing people should be the main game. They either ‘have it’ or they don’t IMO.

    Clare McLaren

    A really thoughtful article Charlie – having run two non-tech based businesses in the past while working full time for others, and now stepping into the tech based scene full time with 2 new companies, I’ve been pleasantly surprised that there’s a lot of willingness to invest in all kinds of ways. Bootstrapping a tech startup in Perth seems to be more about your connections and your ability to work with the enthusiasm for a new venture, than looking specifically for cash.

  5. Pretty spot on – the Simply Wall Street example is a good one to illustrate the issue. I dont see their pitch but I have spoken to a few people that have and the feedback was that the valuation was too high. The issue with this is that Perth investors are making a valuation based on how you would value an established business (ie revenue). Like Ashley mentioned a startup should be valued on whether they have validated their idea, validated their customers and their growth model – as well as the strength of the team.

    I think the responsibility for this lies with both the investor and startup – I have seen too many pitches from startups where they talk about their revenue and forecasted revenue, but no proof to back these forecasts up. Demonstrating that you have validated your products value and growth model would be a good start. Without this it really is hard to justify some of the valuations the startups are seeking.

  6. Amen Jesse 🙂 This all fits nicely into Steve Blank’s “Investment Readiness Level”:

    http://steveblank.com/2014/02/25/is-this-startup-ready-for-investment/

    Of course, Investors can (and should) invest whenever they think appropriate (and to not miss an opportunity). However, within the Customer Development approach to Lean Startups I think there are three clear evidence-backed points for investment:

    1. At the start, where investors back the vision and founders directly, based on its plausibility and the founding team. This could be the $20-$50K angel investment Charlie is talking about. If that’s not on offer then founders should invest this sort of money themselves, skin in the game and all that.

    2. After Customer Discovery, when the founders have validated high risk hypotheses in the the business model canvas using low-fidelity experiments that don’t cost much to run (mostly “getting out of the building” and talking to customers). This would be a larger $200-500K seed investment to support a team of three doing the next stage, which is Customer Validation for 6-12 months.

    3. After Customer Validation, when the founders have 1) validated the business model is repeatable, scalable and viable with a high-fidelity MVP and 2) validated the sales process / funnel (be it physical or Web channel) by running more experiments (costing more to run). This is when everything is go and the VCs invest in the millions to scale the business and make tens (if not hundreds) of millions!

    As Jesse suggests, it is up to the startup to gather the evidence (funded at different stages by investors).

  7. Agree – I was keeping my discussion to that early stage $50k (assuming also, as mentioned in the post) that the founders had already devoted at least this themselves. Usually they have, and more. Hence, in my analogy, the nobility are the HNW’s and the peasants are the long suffering hard working startup founders, devoid of cash (I’m excluding the fly by nights looking for a fast buck and easy money).

    “Let them eat cake” was the continuation of the analogy that the HNWs seem to be a bit out of touch with the early stage start up experience/reality. It’s easy to blame the startups all the time – but they are now getting well educated at FI, Upstart, Energise, Seedspark, Flux, Unearthed … what we need now is education of the HWNs??!

  8. Pingback: Digital disruption and women – opportunities and threats | CharlieGunningham.com

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