Busting the myths about startup investment
In this week’s episode of Platform Diaries, as I sat down to talk with Jordan Green, a thought leader who has founded/co-founded more than 20 ventures on three continents and has established as one of the most active start-up investors in the country, Melbourne Angels, I didn’t think he would argue that investment was not required to scale up a business.
“It does take money to grow a business, but that doesn't mean that it has to be investment capital. Frankly, the companies most appealing to most startup investors are the ones that are able to generate their own capital and their own revenue.”
DISPELLING THE MYTHS
To my slight surprise, Jordan began our chat by dispelling what he calls the “VC pipeline myth”, or the dream scenario that happens for a lucky few founders. You've probably heard of (or dreamt of) the story. Firstly, a founder gets funding from family or friends, then they go out and get some formal investment. After that, they look to obtain VC investment and ultimately move onto a public listing. Straight forward? Jordan doesn’t necessarily think so.
“That’s a possible pathway,” Jordan admits. “But it’s the least likely to succeed and the hardest to navigate.”
Jordan tells me that last year in Australia, angels invested in about 17 times more companies than venture capitalists did.
“If this was the pipeline model, that would mean that angels knew that only one out of every 17 companies they invested in was likely to have any chance of success… if it truly is a pipeline and the only path to success is through VC, then the angels are basically wasting their time, and that's not the case.”
Jordan tells me that all his best returns on his angel investments have been from companies that have not taken on VC investment. While for many founders looking to scale, a VC investment may appear to be the silver bullet to solve all business problems, although Jordan stresses that it is not the only solution.
PROOF IS IN THE PUDDING
One Australian success story that proves the VC pipeline myth according to Jordan is Catch of The Day (also known as catch.com.au).
“That was fantastic for the founders because the founders did actually seek some venture capital investment early in the cycle and the VCs looked at them and said ‘no, we're not interested in you, you're not going to do anything good”, so the founders were a bit annoyed and disappointed, but they went ahead and built a fantastic business anyway. Some years later, the VCs came knocking on Catch's door and they told him to ‘p*ss off’ because they didn't need them anymore,” Jordan shares, with a slightly satisfied tone.
Other successful start-ups that Jordan talks about in this week’s episode include American natural deodorant company Native, Melbourne graphic design business 99 Designs, Melbourne travel company Rome to Rio, and Canva. These companies are proving that VC investment is not a prerequisite for success.
Despite this, I had read somewhere that Canva had taken on VC funding but strangely, was not making use of it. I asked Jordan why this might be the case. Admitting that he is not inside the tent and could only speculate as to why this was happening, Jordan proposed that Canva may have done this to produce an early partial exit, meaning they were able to take a large chunk of money out and give it back to their investors. He also believed that it provides security by having money in the bank and that it is there to fuel rapid growth if it is required.
While we began chatting about those doing it well, I had to get Jordan’s opinion on what are the biggest mistakes founders make (and what can be done to avoid making them).
“I think one of them is taking on too much investment too soon,” he shares. “When you overvalue a business early on, the problem is you have to keep increasing the value of the business. If it's overvalued now, and as you move forward things don't quite go according to plan (and let's face it most of the time they don't), then the likelihood is you won't be able to justify a significantly increased valuation when you need to raise some more money.”
The consequences of overvaluing can be observed in what is called a “down round”.
“That is when you face the next round of investment, things haven't gone according to plan and you can't sustain even the valuation you had at the last round, so your valuation has to come down.”
This step backwards can be fatal for many businesses according to Jordan, who thinks raising or maintaining the value is always better than having to take a step backwards.
Another mistake, which is debated in the industry, is the best structure of investment people should take. Convertible notes and SAFEs are becoming more popular, but Jordan warns that they’re not particularly good tools.
“If you're a startup investor you should be shooting for the clouds along with the founder for the success, not worrying about whether or not you're going to lose your money.”
The last mistake that Jordan cautioned against was to not take the money from the first investor that offers it.
“Even if they're not a huge investor, they can be a great help to the founder or a horrible thorn in their side. They can make your journey really enjoyable and successful or they can make your life a misery,” Jordan warns.
Ensuring that the investor will be a constructive part of the team is essential when considering accepting their funds. This illuminates a difference in the decision-making process of Angel Investors and VC investors.
“Early stage founders like angels tend to align themselves with the success of the founders. The later stage investors tend to align themselves more strongly with the success of the company.”
WHAT ARE INVESTORS LOOKING FOR?
Given that early Angel investors tend to align themselves with the founder, I wanted to know what they were looking for in this person.
“One of the first things that creates a really compelling founder is to be able to really understand what value they are creating and for who.”
Another concept that Jordan finds appealing in a founder and their business is presenting something called an “unfair, sustainable competitive advantage”. Elaborating, Jordan took me through what this looked like in practice.
“Advantage means you're able to sell what you're selling with an advantage over your competitors. The competitive advantage is that people will choose to buy from you, or you can sell at a lower cost, or in a faster fashion. Sustainable means that you can sustain repetitive advantage overtime, 'cause often a competitive advantage for a startup is all about doing something new in the marketplace, and that's an unsustainable competitive advantage, 'cause other people will then copy you,” Jordan says, reflecting how After Pay was the biggest of their kind but there are now plenty of buy now, pay later companies. “Then the unfair piece relates to finding a way to stack the deck in your favour so that your competitors can't copy you.”
This succinct, yet very comprehensive phrase, is something Jordan thinks is the fundamental building block of constantly scaling a business.
If you want to hear more from an investor’s perspective, or perhaps need more advice as a founder on how to best leverage investment for scale, you should head to Melbourne Angels and join one of Jordan’s workshops, where you can network with investors and learn more about the Angels.