The Investment Conference at the School of Informatics is the biggest event of the year for all of us involved in technology investment in Scotland and we are very fortunate to have such a buzzing entrepreneurial eco-system. The research report which has just been published on university spin-outs across the UK which places Edinburgh at the top of the list is a testament to its achievements in commercialisation.
I am privileged to have been asked to do one of the key note speaking slots with Stuart McKnight of www.ascendant.co.uk. Within the short space of an hour we have given ourselves the challenge of outlining the current environment for technology investment and exits in the UK with some thoughts on the peculiarities of the local Scottish market and some of the issues which we have encountered on a number of the major exit transactions we have been involved in over the past year.
It has made me pause and reflect on how I would go about raising money for a new business venture:-
• Investors have learned the hard way that a pre-revenue business is no more than an idea. Ultimately, it is customers and the market who will judge whether it is a good idea or a bad idea. The value of the proposition will be greatly enhanced to investors if the business has some customer traction or the very least some evidence of interest from customers. Experienced investors know that the cost of achieving market entry can be as great if not greater than the cost of technology development;
• Experienced investors are aware of the very substantial risks involved in financing technology development which always cost more and takes longer than anticipated. Any technology risk would therefore have to be clearly identified and minimised with a view to securing revenue at the earliest possible date;
• Investors back people and it is essential to get the right team together at the outset, preferably with at least one member who has a successful track record in business and some experience of fundraising and exits;
• Investors will expect to see a clearly identified and well articulated strategy for market entry. If this involves channel partners, the necessary agreements will need to be in place with a well defined estimate of sales volumes and values;
• The financial projections are of much less importance than the assumptions which lie behind them. These will be scrutinised in great detail by investors to determine whether they are robust. Unrealistic or erroneous assumptions will quickly be spotted by prospective investors;
• “We plan to exit by trade sale or IPO within five years”... This appears to be the concluding paragraph of every Business Plan because it is assumed that it is an essential statement which investors have come to expect. The reality however is that it now takes about eight years from first round of finance to exit. Investors will want to be reassured that the business is capable of becoming cash flow positive within that period and that it is not going to need to be supported by constant rounds of re-financing with attendant dilution for investors who are unable to follow their money;
• In the current environment, investors are able to take a much more realistic view of pricing. They know that their return ultimately depends on investing at the right price as well as exiting at the right price. However, a well-designed share option scheme is often used to meet the “expectation gap” between management and investors;
• The market is evolving very rapidly and a number of template documents have been produced as exemplars of “best practice”. Anyone looking for finance should acquaint themselves with these terms and conditions, understand them and feel comfortable with them before getting involved in detailed negotiations. Experienced investors know their way around and they are unlikely to go to the time and expense of designing a one-off deal. If you want to accept investment therefore you should be prepared to accept the norms of established market practice;
• Many businesses ask for a relatively modest amount of money because they think that is all that they will be able to raise. However, a business which quickly runs out of cash and has to do an emergency down round to keep going is bad news for all concerned. It is far better to raise the “right” amount of money, even if that involves a little more dilution at the outset;
• Finally, like everything else in life the success of an investment will to a large extent depend on the strength of the business relationship. The established Business Angel syndicates generally enjoy a very high standing in the business community and quickly form successful relationships with their investee companies. However, there are some “devils” out there and it is essential that anyone thinking of raising money should do their homework on their prospective investors. We have a small tightly knit business community in Scotland and anyone looking for investment should identify an experienced advisor who knows their way around the market and be guided carefully through what might seem to be a bit of a jungle for those who have not been through it before.
There are many small owner-managed businesses worth next to nothing, only a few are deserving of investment. While investment inevitably means dilution, a well judged investment can bring about a rapid acceleration in shareholder value for the benefit of all concerned.