When building a business you need financial backers. At the outset you might want an angel investment, then to keep growing, tap the venture capital industry, and in later stages use private equity.
The funding options are varied for entrepreneurs, so Business Insider decided to contact a bunch of investors, from venture capitalists through private equity, to find out what they look for when they invest in a company.
Almost without fail, the first thing they talked about was the people behind the companies. Founders and managers need to have ambition, tenacity, experience and intelligence, as well as an understanding of the customer. For an early stage investor, a strong team – 2 to 3 people – is one way to mitigate significant risk. For a later stage investor, a strong executive provides reassurance that investor interests will be looked after.
But a bulletproof team also needs a good product. It needs to be solving a real problem, not just one the founders and a few of their friends faced. A real problem with a sizeable, addressable market allows for scalability and a defensible position: two things important for large investors looking for quick and sizeable returns.
Here are the key issues identified by the people we spoke to:
“For early stage companies, particularly ones that are attempting to be disruptive, the real challenge is not the technology or the market they are facing” says Stuart Richardson, founder of Adventure Capital.
He says investors need to make sure that “the people that are pursuing this opportunity are the right ones and can face the adversity, which is going to get them to be successful. Can they chart the course?”
On top of energy, work ethic and intelligence, Richardson adds another quality that entrepreneurs need to have: humility. Without it, they won’t listen to others and if you don’t listed to customers that can be bad news for the product, while ignoring your staff can unleash another whole set of problems with an organisation’s culture.
“If you are a venture investor you are looking for venture class returns, and as a result the investee company needs to be able to deliver something extraordinary which takes extraordinary performance as a team. and it can’t just be one individual, because that is rarely the case.”
It’s not just investors in high-growth technology companies who feel this way. David F. Jones, Executive Chairman of private equity firm VGI Partners, values hard work, intelligence and energy, and integrity and morals are also incredibly important too.
“While you are backing a business proposition, you are also backing a brand and backing a set of attitudes and a set of morals” explains Jones.
“Businesses are always faced with making trade offs and making decisions where sometimes they can do things that might be expedient in the short term but not a good thing in the long term. Or things that might be OK for the company or the managers and not necessarily for the shareholders.”
Scalability and network effects
On top of personnel, when Jones looks to invest in technology companies there are two important aspects – scalability and the possibility of network effects.
There needs to be a platform that can be rolled out quickly, and with little marginal cost.
Think of a business like Instagram, which is delivered exclusively through apps and online. Much of the business – the product, code and staff, etc. – are essentially the same whether there are 10 or 10,000 users. Instagram had just nine staff in 2012, when it had 2.8 million users and took down Kodak.
Instagram is also a company that benefits from network effects – the product gets better the more users there are. It also becomes a lot more defensible, as users choose to go where their friends are. A company that faces minimal marginal cost and a user-generated moat is incredible attractive to investors.
“You’ve obviously got to look at the product, the market, the offering and all the competitive positioning,” Jones says.
Defensibility and scalability are also important because many investors face short time horizons to make their returns. In Australia a company that can look past the 24 million domestic audience and aim for seven billion is prime for investment.
“I generally like businesses that can scale globally. If I’m investing in a business that’s just targeting Australia, I’d like it to have the potential to scale to hundreds of millions of dollars in revenue” says Benjamin Chong, founder of Right Click Capital.
Solving a real problem
Daniel Petre and Craig Blair at Airtree Ventures both emphasise the problem being solved.
“Is this a business idea, or a technology, where they can articulate and we can understand, that this is for customers and it really matters to someone?” asks Petre.
The business needs to solve a problem experienced by a lot of people. When a product really matters to that many, not only will scaling be easier, but it also solves other issues for the business. The churn rate will be lower, and the also assist with the marketing via word of mouth and social media.
Alan Jones, from startup accelerator Bluechilli, recounts stories of people who have pitched businesses with imaginary problems.
“Nobody expects to be unusual” Alan Jones explains. “I meet founders all the time who are solving problems that they suffer from, and they imagine because they suffer from it, and they are just like everyone else, other people suffer from it as well.”
“And that is often not the case.”
When entrepreneurs are addressing a critical issue, like Xero with its cloud software, there’s an eager market and it can also provide an extra motivation to succeed. Resolving an critical challenge lends emotional attachment and a sense of mission.
“When there is a real passion, a real drive to solve this problem and its not just a business model, that makes a big difference” explains Alan Jones.
“Because all early stage businesses have hard times and it’s that kind of need to solve that problem that makes someone stick it out and get through it.”
In the end, it all comes back to the people running the business. It takes certain qualities to make a successful entrepreneur. Marry those with the right product, solving the right problem, and you have catnip for investors.
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