Texas Venture Growth Forum 2015 Infographic

Texas Venture Growth Forum 2015

The Contractor Startup --Why this gives the investor pause

I hear many entrepreneur pitches and the one point that stops the conversation cold comes when the entrepreneur says he can start building the business just as soon as he raises funding.  He goes on to explain why he can't do anything unless he has funding.    An investor hears that the entrepreneur and his team can't (won't?) build the product unless someone is paying them and apparently there's no customers to pay the team.  Again, the team can't (won't?) sell the product unless someone is paying them.

I call this type of business-- the "salaried startup".  They only work when money is available to fund the process.  Bootstrapping, sweat equity, and doing it for the passion just aren't in the mix.  If the investor asks for traction or other evidence of progress the excuses fly fast and furious--a thousand reasons why that's just not possible.  The investor then imagines this conversation at a post investment meeting and hears "I can't grow sales unless you give me more money to hire more people," or "I can't build more product unless you give me more funding."

At scale, this is certainly true. In a seed stage startup this is certainly not true. The investor is looking for a team that is building and the growing the business now.  It may grow slowly but it is moving forward.  In the early days the founders are building it and selling it.  They're not waiting for someone to pay them to do so.  Those who take that path are "contractors" not "entrepreneurs".

You can start building your startup now.  You can grow it with or without funding.  If the fully funded startup is your only path forward, you'll find fewer investors willing to climb aboard.

You have to look beyond your backyard

Recently there as been a lively debate about the lack of funding in Texas. It's actually not a new debate but rather an ongoing dialog between entrepreneurs and investors.  Entrepreneurs feel that funding is scarce in Texas compared to other parts of the country.  Investors counter that they would invest more and more often if the deals were further along and better prepared.

The debate is not new.  It comes up every year.  The solution is to change the way fund raising is handled.  It's no longer in your backyard.  You must have a national focus on your fund raise from day one.

When I was the director the Central Texas Angel Network we had just restarted the formal angel community in Austin.  The previous group, the Capital Network had gone out as they were tied to the dot com world and when that went away, they went away with it.

At that time, it was a great boost to have a formal angel group in Austin so central Texas entrepreneurs could raise money in their own backyard, so to speak.  It worked for awhile.  When we started, we had 15-20 deals on each round of which 4 would receive presentation slots and 2 would get funding on average.

As the years progressed two things happened.  First, the number of deals grew.  Today it's not unusual to see 75 to 100 deals considering CTAN of which 4 will get to pitch to the membership and 2 will get checks.  The funding rate is higher because there are more members, but fundamentally, entrepreneurs looking for funding have a 2% chance of getting it from the group.

Daunting odds.

The second thing that happened is that crowdfunding came into its own.  After several years of debate and government (in)activity, the rules are starting to change.  It's now possible to raise from non-accredited investors as well as from accredited investors who are not in your backyard.  At CTAN, we all gathered at the Headliners club in downtown Austin to see the live pitches.  With crowdfunding, one can source angels from across the country if not further because the pitches are on-line.  The tools are improving and the entrepreneur's ability to use those tools are increasing.

The world of angel investing is going vertical.  The chance that an angel investor interested in your particular application (mobile apps, enterprise software, consumer product good, etc) is in your backyard is shrinking.  To reach an investor interested in your stage and type of deal, you much reach across the country.

Crowdfunding is how you do that.  By placing your deal online angel investors can now find you.  You can now reach angel investors from a broader area.

It's helpful to have some support from your local area, but from day one entrepreneurs should have a national perspective on their fundraise.  If you have a real business (not just an idea) you probably have an investor out there who would be interested in your deal.  He's just no longer in your backyard.

River Cities Capital Fund Venture Profile by Patrick Dunnigan

What is the history of River Cities Capital Funds?

River Cities has been making principal investments as an institutionalized fund since 1994, however, you can trace the firm’s roots all the way back to 1978 when the founders, Glen Mayfield and Ted Robinson, began doing business advisory work and merchant banking. So while we’ve been making investments under the River Cities Capital Funds moniker since 1994, the firm’s been helping entrepreneurs since 1978. Initially, the firm focused on smaller, more venture-oriented investments. Since then and over subsequent funds, RCCF has moved to growth-stage investing focused specifically on healthcare (services, devices and IT) and b2b technology, where the firm has developed significant expertise.

Tell me more about your fund and the checks you write.

We’re currently investing out of our 5^th fund, which is a $200 million vehicle, where we’re looking to make $5 million to $12 million minority investments in high potential companies with outstanding management teams. With our LPs we can syndicate deals up to $30 million. While that’s a wide range, we like that we have the ability to flex up and down, allowing us to back the best teams and opportunities.

Ultimately, we view our business as providing capital and business acumen to innovative companies that want to grow at an accelerated rate. We believe a crucial part of our job is helping entrepreneurs wherever we can, as our business will always be dependent on talented entrepreneurs taking risks and envisioning a different future by building new products and technologies – often leading to a need for growth capital and good partners. Thus, we’re always looking for ways to help entrepreneurs, even if it doesn’t make sense for us to invest at the moment. We try to keep an open door policy with all entrepreneurs and want to build relationships over time.

What are your criteria for companies?

Given our growth-stage focus, we look for companies doing $3 million to $50 million in revenue, growing at more than 30% annually. VCs are good at saying a lot of obvious things, so I’ll say the higher the growth the better. We don’t expect the businesses to be profitable (yet), given the growth rate they are trying to maintain, but we are careful and thoughtful about cash burn. We are also looking for compelling ROI on sales and marketing spend and validation of customer satisfaction (and therefore retention).  That’s a high level answer, but obviously each industry has specific metrics and criteria that are important.

Our two sectors are b2b IT (tech-enabled services and Saas) and healthcare, which includes everything except drug development, so we’ve made investments in healthcare IT, healthcare services and medical devices.

In our IT practice, we aren’t averse to software businesses that have a services component.  Generally speaking, we like businesses that are solving complex problems, and services can sometimes be an indicator that the problem you’re solving isn’t easy to solve. Said another way, we’re leery of point solutions solving less complex problems that might struggle when more competition inevitably shows up. In a world where start-up costs for software products are so low, possessing some level of barrier to entry is critical to create sustainable value over the life of the investment and beyond (again, obvious things investors say).

Do you look at consumer businesses?

We tend to shy away from b2c companies, not that there is anything wrong with them. It’s just not what we know. We try to stick to our knitting.

How do you handle syndication?

We welcome opportunities to co-invest alongside other firms, particularly firms who share our partnership-approach to investing. We view ourselves as investors for the long haul and aspire to be known as a great partner not only when things go well, but when things inevitably get challenging. It’s easy to be a good partner when the company is hitting plan, but in our experience there will always be challenges along the way and that’s usually when having a good partner is most important. We want to make sure our co-investors also have a similar belief system and reputation.

What is the strength of your services to portfolio companies?

Continuing with the partnership theme, ultimately, our most consistent value-add will always be the collective wisdom the firm brings to each investment, compiled over more than 20 years and through more than 100 investments. That history is full of a lot of things going right but has no shortage of challenges. Having a partner at the table who has navigated similar challenges and witnessed both sound and poor decision making, can help a management team avoid critical mistakes – we believe that breadth of perspective is crucial for young companies.

We take a very metric-driven approach to portfolio management and offer benchmarking tools and reports to guide management teams to successful unit economics. We offer benchmarking regarding compensation, SaaS operating metrics and valuation, healthcare CEO roundtables and more.

(And going back to the fact that) it’s never been cheaper to start a company, it’s important to keep in mind that the cost to scale a company is essentially the same as it’s always been. Once you have proven you have a product and service to build a business around, you still need smart people and prudent decision making. And people are expensive! So while we’re bullish on the fact that there will be more high quality, disruptive companies, than ever because of the steep decline in infrastructure costs and the ubiquity of information, we also have conviction that there will always be the need for experienced capital and sound counsel to grow and scale those businesses. 

Where do you focus geographically?

We have a national footprint and can invest anywhere, however, we try to stay out of the high-traffic corridors of Silcom Valley, Boston and NY. We’ve always sought to be one of the trusted capital providers for all of the great entrepreneurs and management teams outside of those markets, in places where there tends to be much less resident capital than in those coastal markets.

We are big believers in the entrepreneurial/technology ecosystem in Austin. Innovation and entrepreneurship are in the city’s DNA and our firm believes this area of the country will continue to produce high-potential disruptive technology and healthcare companies, which is why we are spending time here on a regular basis. We’ve talked to a number of promising companies in Austin and hope to invest part of Fund V in this market.

Funding Analytics--How it helps you raise funding

Fund raising is moving from a local exercise to a global one.  One can still get a loan from a local bank or an equity investment from a local angel group, but the availability of capital throughout the world awaits those who know where to find it.

Investment Analytics shows investors how to make better investment decisions.  Funding Analytics shows entrepreneurs how to find better investors.  By researching the track record and criteria of venture capital funds, private equity funds, and angel group portfolios, the entrepreneur can more accurately target the right investor group for their deal.

Funding Analytics includes the current market rate for valuations -- always a key decision in a negotiation with investors.

Funding Analytics shows the best way to approach the investor and keep them informed of your progress.

Funding Analytics shows which investors have funds ready to deploy versus those who are still raising their next fund.

Funding Analytics shows what due diligence documents are required and how to build them.

Total capital investment throughout the world is over $100 Trillion. The funding is there -- to find it you'll need Funding Analytics.

Five Universal Principles for Startups

Startups are great.  They provide new careers.  They constitute new jobs.  They are the path to the next generation but it's not for the fainthearted.  There are five universal principles in the world of startups:

1. It always takes longer than you think -- this goes for building the product, closing the sale, and growing the market. 

2. It costs more than you thought -- most entrepreneurs are off by a factor of 10 when it comes to estimating time to complete the software, the work required to raise funding, and the effort needed to close the sale.

3. There's always a better idea -- no matter how great your idea is there's always a better -- it's called progress.

4. The journey is the reward -- in retrospect building the company is best part of having a company.

5.The team is what you will remember -- products come and go, markets go up and down, but the team and the relationships you build will stay with you in the long run. 

5 Things Investors Love to hear in a Pitch

Investors hear pitches continually throughout the year.  There are so many that one's eyes can glaze over.  From time to time, an entrepreneur will make a pitch and the investor's eyes light up.  It's because investors are listening for a few key things that show you have a real business with real growth.  The rest is filler.  Every entrepreneur has a story--many are interesting, some are not.  But for investing purposes there has to be 5 key elements to capture their interest.  Here they are:

1. Real traction--entrepreneurs who have sales and show it are head and shoulders above the rest.  Most talk about the traction they will have in the FUTURE but not what they have today.  In an investors mind, this equates to "No Traction".

2. Real pain point--the entrepreneur has found a real pain point in the market and is filling it.  Someone once said, customers pay for pain to go away -- they don't pay for nuisances or inconveniences.

3. Real team -- they have someone building it and someone selling it and those team members know what they are doing.

4. Real product -- the product works and is non-trivial to build. It's more than just spin marketing.

5. Real growth prospects -- the market opportunity has strong growth potential and is not going to run out of steam in a year or two.

Those are the elements that light up the investor room if you really have it.

Grayhawk Capital by Sherman Chu—Venture Capital Profile

What is the background of Grayhawk Capital?

We’ve been around for about 20 years based out of Phoenix investing primarily throughout the Southwest US.  We also have investments in Kansas City and the Bay Area, but mostly we invest in the southern California to Texas corridor. 

I originally came out of Banc One in Dallas. In 1995, I moved to Phoenix to help run the first fund.  Since then we’ve expanded the team.  Brian Burns has been with us for about 15 years now.  Brian Smith joined in the latest fund about four years ago.  We each have 20+ years of experience in the industry.

What do you invest in?

In terms of our investment profile, we are looking to invest $1M to $5M in early growth stage software companies.  For first rounds, we’ll generally come in for $2M.  We invest across various sectors, including healthcare IT, Fintech,   Big Data, Cybersecurity, IoT, and enterprise/business productivity. In Fintech we’ll invest in B2C models.

How big is your current fund?

Our current fund is $70M under management.  We have 9 companies in the current fund with dry powder left for about 6 more deals.

What criteria do you look for in deals?

We like to come in when the company is looking for capital for sales/marketing execution.  We want to see a completed product that is in the marketplace.  Most companies we invest in typically have $1.5 to $2M in revenue run rate all the way up to $8M in annual revenues.

How do you handle syndication?

We’re not a large fund so it’s not atypical that we help round out the raise with a syndicate. We are comfortable leading deals.  With round sizes getting larger, we’ll probably lead fewer going forward.

The landscape has changed quite a bit over the last ten years. We are always looking for new syndicate partners.  In Texas we have looked at deals with S3 and Mercury.  In SoCal, we are working with Avalon and Anthem. Kickstart, Growtech, and Boulder Ventures are regional funds we have worked with.  We have also invested with Bay Area firms such as Trident, NEA, and others.

Most groups offer Innovation Days and other expertise—how about Grayhawk?

A lot of it comes down to chemistry.  Investing in early stage is like getting married.  You have to be really comfortable with each other.  We add value in various ways.  We can help with the capital markets, i.e., if the company needs more equity/debt. We have expertise in the M&A arena. We have on the HR side a lot of connections so we can help fill gaps in the team. We also help with strategic connections and general strategic guidance. 

Keller Capital by David Phillips – Venture Capital Profile

Keller Capital is the private investment arm of Gary Keller, co-founder of Keller Williams Real Estate International, and a few select partners.  As a family office, we are active in real estate community as well as growth capital for Texas based businesses.

What do you look for in potential investments?

Most important to us is to do business with founders and teams with a track record of integrity, intelligence and drive. Keller Capital looks for businesses in the basic industries with strong moats.  We evaluate investments primarily by looking at free cash flow, risk level and cash on cash returns.

How do you invest?

We provide growth capital for Texas based businesses with $2M to $50M in revenue.  We prefer to write $2M to $5M checks.  We don’t need control.  We don’t need a short-term liquidity event so we don’t push for a quick merger/acquisition.  We bring a long-term partner approach to the process. We do prioritize the return of capital and pursue deal structures with this in mind.

What sectors do you look at?

We are industry agnostic.  Our rule of thumb is that we need to be able to understand it. And if you can’t explain your business to a 10 yr old, it’s probably too complex for us. 

What else do you bring to the investment?

Three things: (1) a long term partner approach, (2) a hiring expertise and (3) Gary as a mentor or advisor. And obviously we have a real estate expertise that can be helpful from time to time.

How do you syndicate deals?

We will from time to time. We are open to syndicate deals with other groups—mostly family offices with whom we have a relationship.  

SSM Partners by Ed Nenon and Hunter Witherington

SSM Partners was founded in 1973 as a consulting firm working with family owned businesses on how to grow their company including acquisitions, growth strategies, and exits.  In the 1990s it transitioned into a direct investment firm with the same consultative, partnership approach.  Many of our investors then are still with us today.  Today we are investing out of our sixth fund.  We focus on a growth equity strategy and invest nationally but focus on the Southeast, Midwest, and Texas .  We partner with the entrepreneur and the management team to realize their full potential down the road through an exit.

Who is in your sweet spot?

We invest in businesses with $5M in revenue and up. The first category is software and technology, particularly recurring revenue B2B software businesses, which fits well with our Austin experience.  We spend about 1/3 of our time in healthcare IT and also healthcare services. Finally, we look at internet and e-commerce businesses as well. 

We’re looking for a proven product/service with a lot of customers who love it. In many cases they are increasing their spend on the product.  The proof it works is there.  They often have a unique differentiator that gives them a leg up.

Where do you invest in healthcare?

We focus on healthcare IT and services and have strong experience in the revenue cycle technologies.  We’ve taken a hard look at telemedicine and patient pay solutions as well. We do not invest in therapeutics or devices. 

So what kind of check size do you write?

Typically, our check size ranges from $5M to $15M.  We’ve done some north of that range where we partner on the funding. 

What stage do you invest in?

We invest in businesses with $5M in revenue and up.   A good number of our investments were bootstrapped and have not yet raised an institutional round though could have as the entrepreneur has built up a $5M to $10M revenue per year company.   We also invest in the more traditional path where the company has raised an institutional round and now they are looking to expand further and need another round of capital to grow.

How do you handle syndication?

In the last ten years, we’ve co-invested in about half of our deals. In syndication we want to make sure management and other investors are aligned especially on the company strategy, risk profile, and target exit.  Specific to SSM as part of a syndicate, we want a meaningful voice and impact in the company and so we’re typically leading or co-leading it with another firm; we don’t want to be $5M of a $75M round.  We’ll most often have a board seat and are active at the board level.

What Texas companies have you invested in?

Texas represents approximately half of SSM’s investing activity over our 20+ year investing history, about 14 of which are in Austin.  Dating back to the 90s, we were investors in 360Commerce, Dazel, Motive, and others; the three most recent Austin investments we made were All Web Leads, Bulldog Solutions, and New Era Portfolio. 

What did you think of Austin?

It’s been one of our best geographies for investing for a long time.  We have a great network here that continues to develop and evolve. We would like to spend more time there.  We’ve had good success in finding quality people, investment opportunities, and successful exits.