Venturing a healthy response

In the August issue, Frank Downes expressed his views about the venture capitalist industry. It prompted venture capitalist Tom Beecroft to enter the fray.

Venture capitalists have long been viewed as tight fisted, short sighted, risk averse, lazy, overeducated, overpaid, arrogant SOBs who don't understand small business. I heard these comments for 12 years in the US, and have heard the same comments in Australia for the past seven, with the only difference being the accent and slightly different unprintable additions. When you hear someone talk about venture capitalists this way, it usually means they have suffered one or perhaps several rejections of their business by a venture capitalist. Most mature adults recognise this for the sour grapes it is and politely ignore the comments. But occasionally these views make it into print in national publications like this one, and begin to be believed. Since I'm tired of being referred to as short-sighted and risk averse (the other epithets I can live with) I'll try to let you walk in my shoes. I believe the best way for an entrepreneur or adviser to avoid disillusionment with venture capitalists is to understand what we do and what we're looking for before they go splashing their business plan around the country expecting funding and end up angry and bitter when they don't get it.

First, there are certain things we do not do. We are not charities throwing money to all worthy recipients. We do not invest in small companies that we believe will remain small companies. We are not interested in building a robust SME sector. And we typically invest more than a million dollars at a time. Entrepreneurs who do not believe they can build a very large business, or who need a few hundred thousand dollars should not waste their time talking to venture capital investors. That is just not our business. The venture capital business consists of raising money from people that have a lot of it and investing money in unlisted companies that need it to support fast growth. The largest investors in Australian venture capital are superannuation funds. Banks, corporations and other money managers are also big contributors. These sources account for nearly 80 percent of the venture money under management in Australia. About 3 percent of venture money comes from the share market, with another 3 percent from the government. This is important because most venture capitalists have quarterly or annual meetings with their investors where their performance is called to account. Poor performance over time results in a career change for the venture capitalist.

The process of venture capital investing is a slow one. Most venture funds have a four to five year investment window. In each of these years, we typically look to invest in only four to six companies. To someone unfamiliar with the process, this can make us seem timid or gutless. It is neither. It is a calculated strategy. There are several funds in the US and Europe that invested very rapidly in 1999 and 2000 and incinerated the bulk of their investors' money. The rest of us have presumably learned from their mistakes and will not repeat it. An established guideline is 1 to 1 1/2 new investments per manager per year. We are looking for companies that may be quite small today but have the potential to be quite large in a short period of time. This requires a large and growing market to sell into, the ability to go global quickly, a strong technology base, an outstanding management team, a well-conceived strategy and plan and enough cash to make it happen. One statistic that has held fairly steady over the past 20 years is that a venture capitalist will finance between 1 and 2 percent of the opportunities they see. Unfortunately, this process can create hard feelings among the 98 to 99 percent of entrepreneurs who walk away disappointed.

Australian venture capitalists invested in 160 new companies in the year ended June 2001, investing a total of $1.6 billion. Both of these numbers are records for the industry. There is more money available for investment in Australia than at any point in history, and it is being invested. It just won't happen overnight. What happens after the money goes in? Typically, a venture capitalist will require a seat on the board of the company. Most venture firms expect their managers to have five to seven board seats at any one time in addition to evaluating business plans and doing due diligence. I have been a director of over 20 companies and I am not in any way unusual in that regard. We expect monthly board meetings, and usually spend additional time outside the board meeting working with the company and management. We help with strategic planning, forecasting, personnel issues, banking and fund raising, among other things. Although we may not fully understand their industry, we will have seen their problems numerous times before in other companies, and can call on that experience to their benefit.

It is a common complaint to say venture capitalists don't understand small business. This is usually thrown at us by entrepreneurs who disagree with our conclusions. Most venture capital firms have managers who have first hand experience in running small but fast growing companies, if they don't you should look for another firm. Perhaps more importantly, we have an enormous wealth of experience as directors and advisers to small businesses, having had the opportunity to work with literally hundreds of companies over the years. The critical difference is that we do not expect our companies to stay small. It is our particular expertise to understand how and why companies grow quickly, and focus our time and our investors' money to accelerate and amplify that growth. When we do that well, the benefits to the Australian economy, and our investors, are substantial.

* Thomas Beecroft FAICD is an investment manager with Nanyang Ventures in Sydney. He may be reached on 02 9247 4866 or tbeecroft@nanyang.com.au

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