Funding partner is such a big deal for start-ups

INNOVATION TALK:'HAVE I GOT a deal for you!" asserted Jim Green, of Sun Microsystems (now a part of Oracle), to my two IONA co-founders, Annrai O'Toole and Sean Baker, and myself. Having courted various venture capitalists, the three of us instead decided to enter negotiations with Jim for a trade investment which armed us with considerably more fire power than merely further deepening our balance sheet. With the subsequent explicit endorsement of the then Sun CEO, Scott McNealy, we achieved major industry wins with Motorola, Boeing, and Bell South and thus in turn many others.

Raising capital is the second preoccupation of most start-up CEOs. Fortunately for tech companies today in the software space – including web, gaming and mobile app companies – the amount of finance needed is usually relatively modest compared to capital intensive start-ups which produce physical goods, like many semiconductor, bioscience and telecommunications companies.

Using the internet and the web as a global distribution channel, alongside pay-as-you-go cloud computing, means that private “angel” investors and diminutive seed funds can now provide the financial base for such start-ups. Furthermore the Obama administration, in its recent Jumpstart Our Business Startups (JOBS) Act, has institutionalised crowd-sourced funding so that for-profit start-ups can legitimately raise seed capital from the public: one wonders if Enda Kenny can show comparable initiative in reforming Irish securities regulation.

I said the “second preoccupation”. The first is the necessity to find, entice and keep great staff. I wrote about this last month. The two challenges go hand-in-hand: you can’t attract talented people without convincing them that your funding is in place, and you can’t attract deep funding without convincing investors that you have hired great people committed to your vision and your leadership. However compared to say a decade ago, there is now in Ireland a stronger base for both early stage financing and experienced people looking for their next career opportunity.

If you are lucky, seed stage funding may be all you need. Based on your initial investment, perhaps sales will expand to the extent that you can use cash flow to expand and conquer the global market as a billion euro company. However, almost all start-ups need further investment to expand operations, not least in marketing and brand momentum. Secondly, most firms “pivot”, as they learn that although their idea is good, they are addressing the wrong opportunity and must change direction – and need further financing to do so.

High quality investors have the financial muscle to sustain a company through the challenges of growth. A start-up rarely gets its proposition correct first time, and may need several rounds of finance as it grows and develops its strategy. Good investors work with a management team, not least through their industry networks and experience, and reward success whilst protecting themselves against any demise of the firm.

A common deficiency of risk capital in Ireland today is inadequate capacity for follow-through. The Innovation Taskforce (of which I was a member) observed the deficit of early stage risk capital in 2010, which has now been modestly addressed by national policy. But the Taskforce did not suggest – nor expect – that greater seed stage capacity would be at the expense of growth stage capital.

In practice, it would appear that several seed stage funds operating here have shallow pockets for expansion capital. When seeking out new investors to continue the momentum of a company, it is not unusual for CEOs in Ireland to become mediators between current and potential new shareholders. New investors can bring substantial finance, and want the CEO and management to be aggressively motivated. But existing investors who have insufficient resources to further invest may become sidelined and even attempt to veto the entry of the new backers.

To any start-up CEO in Ireland, I urge a clear investment strategy from an early stage. I see experienced serial CEOs in Silicon Valley lay out a precise multi-year investment strategy: raise this amount of seed stage capital now, in the full expectation that we will achieve this specific business goal by next year; then in consequence raise a Series A round at about this valuation; so that in two years time we will be able to achieve this second business goal and then be able to raise a Series B at this much higher valuation; and so on. Having a clear financial investment plan, they then select financial partners who can support their journey in full: most avoid a potential partner who has no stamina for a longer race.

“Have I got a deal for you!” This should be the assertion from CEO to the investor, and not the other way around. The CEO should be selling an opportunity to investors, with a clear, transparent and credible plan for growth, and subsequent wealth creation for all shareholders. In our own case in IONA, Annrai, Sean and I were able to convince Jim of an even better proposition of how IONA and Sun could work together than the deal which Jim had brought to us. In the event, the three of us returned more than a hundred times Sun’s investment back to Sun after 38 months.