Smart Answer for StartupSmart Entrepreneurs

Q. Is there any money for businesses in sectors such as retail or manufacturing? Or are these industries toast?

StartupSmart

Investment Director - Tony Glenning

A. It is true that the vast majority of venture capital funding is invested in tech businesses, but not all.

Starfish Ventures specialises in tech investments, including technology driven retail and manufacturing sectors, so we do not have the insight on VC investments into other traditional business sectors.

However, we can offer an explanation why the majority of funds are invested in to tech businesses.

Venture capitalists prefer to invest in “entrepreneurial businesses”.

Regardless of their size it is more about potential for growth. As a general rule, unless a business can offer the prospect of significant turnover and capital growth within five years, it is unlikely to be of interest to a venture capital firm.

Venture capital firms are fund managers for institutional investors such as superannuation funds.

The institutional investors are interested in seeing a return on investment which is better than the return on an alternative investment.

Technology businesses have historically been the higher growth sectors than retail or manufacturing, so institutional investors are less likely to want to invest in these areas.

Just looking at the BRW Young Rich and Fastest Growing Companies lists, it’s clear that it is the technology companies who are defying the gloomy results and forecasts of other sectors, making it the obvious choice for the investor dollar.

Yes, the tech sector has traditionally received a large portion of investments – web technology, business software, energy efficiency, semi-conductors, etc.

However, there have been tech-based investments in the retail and manufacturing industry in Australia.

To clarify, VC does not invest directly in retail chains like PE investments in Witchery or Myer.

Rather, VC has invested in technology that are found within the retail space and manufacturing space.

Dealised, Our Deal, and travel.com.au are examples of investments in the retail space. Another example is the Starfish Ventures investment in Zoom Systems which is a retail platform provider.

There have also been VC investments in industrials and manufacturing.

Starfish Venture portfolio company MIGfast produces a consumable MIG welding contact tip that offers a quantum change in welding speed.

Traditional bricks and mortar retail and manufacturing will never be toast, they are just going through a transition period that is forcing them to adopt more efficient models and are forcing out businesses that do not make the necessary adjustments.

At the end of the day, people will still need cars, furniture, food, and clothing. Entrepreneurs looking to get into these industries should look at sources of funding from angel investors, incubators, family and friends, and of course banks are an option.

This question was answered in consultation with Australian Private Equity and Venture Capital Association (AVCAL).

Smart Question – “How can I convince an investor that I’ve got a long-term proposition?”

Read the Smart answer by Starfish Ventures at StartupSmart

Ask a Venture Capitalist

Here at Starfish we like to demystify the world of venture capital, and are happy to answer questions.

Thanks to a question from Startup Smart, this week Investment Director Anthony Glenning sheds some light on:

Proof of Concept: What is? Why do you need it? And how to attain it?

Anthony Glenning

 Each potential investor may have different questions in mind when they asked for a ‘proof of concept’ (POC), but I’ve asked for many POC’s and I can certainly tell you what I am thinking.

In a nutshell, having a POC is about risk mitigation. When an entrepreneur pitches an opportunity there are always a number of premises that underpin the rosy outcome. Premises are often in the areas of:

• technology (“once I develop cold fusion”),
• commercialization (“I just need to scale production to get the COGS down”),
• customer acquisition (“my existing users will tell 5 of their friends”)
• and/or business model (“I’ll use a SaaS model and charge by the month”).

Each premise generally constitutes a risk factor. The point of a POC is to reduce or eliminate the risk associated with the premise not actually being true.

And by risk, I mean risk as perceived by the investor. Everyone comes to the table with a different set of experiences and knowledge base. Someone with a good understanding of JavaScript and HTML5, may not be that concerned about the development of a 3D real-time visualization tool in the browser, but much more concerned about the market adoption of such a tool for house design by architects. However another person, may know of the burning need within architecture firms for collaboration around design, but have no idea whether such a thing is possible. They would each assess the risks around those premises differently.

When I ask for a POC, generally I am asking to see a demonstration of an aspect of the business to reduce my perceived risk around one or more premises. Most often a POC will centre on a technological risk. So for example, if your pitch was to start a business that would solve the world’s energy problems through a cold fusion reactor, then I might ask to see a POC around generating a small amount of energy from a cold fusion reaction, such that the energy input was less than the energy output. For me, I would be willing to accept the premises that (a) if you could show this, then there would be market demand for such a product, and (b) if it can be done on a small scale, then it can be done on a large scale.

But sometimes a POC might focus on the business model. For example, before Google it was not clear that if you offered advertising to the long tail of advertisers (those with an ad spend too small to justify a sales phone call, let alone a sales visit and therefore did not traditionally advertise), whether there was significant revenue there. There was! So now while people understand the long tail phenomena better, an investor might still ask for a POC that illustrates the value of the long tail for a given business in a particular sector. In this case the POC might be to run the business on a very small scale – say just within one suburb – and show the revenue potential justifies investing in growth.

To conclude, if a potential investor asks you to demonstrate a POC, then your first order of business is to ask what particular concerns that the investor has (if they haven’t already told you), and think of a POC or trial or pilot program that would mitigate that risk, including defining end points. For savvy investors, most will share the same concern, so a well constructed POC will be useful for all your fund-raising, and, you never know, you as the entrepreneur may learn something that improves your offering too!