The Moxie Sessions: What’s the difference between early stage investing and a ponzi scheme?

OPINION

Lucy Luo

PledgeMe founder Anna Guenther

It was Christmas Eve 2014, and one of the founders I worked with was stuck between a rock and a hard place. Either take money from some local “angels” on onerous investment terms and verbal commitments, knowing that at any time the plug could be pulled, after months of prolonged discussions and “due diligence," or struggle through the Christmas and New Year period not knowing whether they would have enough money in the bank to make payroll for staff in New Zealand and the US. Talk about a jolly festive season.

Early stage investing in New Zealand is like birthday cake at a kid's party (very popular, but you have to be prepared to live with the consequences) – with the likes of Xero [NZX: XRO], Vend and Wynyard Group [NZX: WYN] paving the way for enthusiastic investing in tech companies. We’re isolated from world markets, and so of course software companies are the way to go. Trying to raise money for your amazing hardware start-up? Good luck with that one.

We rounded up some people knee-deep in early stage tech in New Zealand, and convened a discussion in Wellington about what it means to invest in high-risk companies that may or may not get on to the high-growth trajectory.

Mark Clare, founder of Clare Capital and regarded by some as the Marc Andreessen of New Zealand (not just due to the similarly styled hair), started off by pointing out that TradeMe [NZX: TME] and Xero led the way for not only Wellington but the New Zealand tech community. These two “unicorns” showed what could be done in tech from New Zealand. Mr Clare says early stage investing is not about investing in cool ideas – it’s about chasing big opportunities and backing founders with ambitious vision. 

Growth today looks very different from even three years ago, especially for software as a service companies. Mr Clare sees huge growth come through local companies, citing Xero’s 80% annual growth and another (private) client’s 26% monthly growth as examples. 

What are you doing?
At the same time, there are still some who see Xero as the biggest ponzi scheme out. Mr Clare says they don’t understand that “losses are fine, as long as value is being created." If Xero suddenly started prioritising profit, Mr Clare would be scratching his head, thinking “what are you doing?” 

Another speaker who gets the ponzi scheme poke is Anna Guenther, founder of equity crowdfunding platform PledgeMe. A main concern of the public is a company might just take the "free" money and disappear into the ether. But Ms Guenther reckons this concern runs counter to the philosophy behind equity crowdfunding. “You’re transparently going to a crowd of people who know you. They won’t go for you if you have a history of being dodgy – which they would quite readily talk about online and on social media." There is a huge amount of publicity to get an equity crowdfunding campaign off the ground – and that transparency is self-regulating for any company that successfully raises. 

Ms Guenther spends her time tackling a real problem: a lack of financial literacy, on both the investor and company side. Beyond the hype of beer and drones, investors have to understand what kind of financial risk they are signing up for. A lot of what PledgeMe does is to coach the company on its financials – how will the money help them grow, and how will they exit or provide a return to investors? Even though disclosure requirements are more relaxed for equity crowdfunding than a public listing, there are still investor protections, such as an investor must click through warning statements before they can actually commit money to a campaign. 

New Zealand is ahead of the curve on equity crowdfunding – our neighbours in Australia, also a young tech community, are still only thinking about it. The most established platform worldwide is CrowdCubed, which started out in the UK four years ago. Time will tell if their model is successful. Regardless of how much money has been raised, the real indicator of success will be how much return investors will eventually get from their money. 

The final speaker was Mark Vivian of Movac Venture Capital, which one might say is New Zealand’s only remaining VC fund. Movac’s first two funds were angel/seed funds, while its third and soon-to-be-raised fourth funds are focused on growth stage ventures. These companies will be post-revenue, so there is less of a product risk, and it becomes more about allocating capital for marketing and growth.

Ready for risk?
For Mr Vivian, whether he invests depends on how far an entrepreneur can go in terms of skills and appetite for risk. To apply this filter, Mr Vivian and the Movac team spends a huge amount of time building relationships with founders – it took four years from when he first started talking to 1Above before he invested in it. He looks for evidence of how well a team will work at scale with increased velocity, and whether it has the right people in place to execute internationally. Many opportunities come across his way that are better suited to a low-growth lifestyle business, and potential enterprise value just doesn’t justify VC investment.

The ground is constantly shifting beneath an early stage company, which needs to continuously review strategy, critique and update. There needs to be a CEO and board who can navigate through that uncertainty. Unfortunately Mr Vivian thinks that most early stage boards in New Zealand are not up to the task, as they’re “far too risk-averse and compliance-oriented, and not enough strategy or growth-oriented.”

Mr Vivian urges companies to find advisers who are fit for purpose, diverse (will challenge each other and think differently), and be the right size for the right stage of company. He acknowledges there is a limited pool of quality early stage directors in New Zealand. The best are always in demand and always lacking time – but if you have the right pitch and persistence, he believes you can get them. Instead, many early stage companies are “bogged down with more chiefs than Indians, and the founder is in the middle getting a whole bunch of advice before the company even knows where it’s going.”

One participant observed New Zealand is exceptional at getting stuff started, but “s*house at taking it from start-up to SME level.” There’s no easy solution. Mr Vivian called for improved collaboration between investors to create efficiencies in early stage funding. For example, angel investors should talk to each other more so ‘due diligence’ doesn’t drag out endlessly (horror stories were shared). 

Mr Vivian also commented there’s occasionally a fine line between a company’s long-term tenacity and zombie status in the hope of getting out of start-up phase. Unless real progress is being made, continued capital injections may well delay inevitable closure, and investors need to be prepared to walk away. Talent would be far better deployed in another company with better momentum that needs their skills. This way, zombie companies aren’t getting propped up, and the limited amounts of capital and talent that exist are deployed in a smarter way, to have a better chance at growing start-ups into SMEs. 

Snowball effect
In case you’re wondering what happened to the opening story, on the afternoon of Christmas Eve the founder entered into a convertible note for some bridge financing to tide the company over until the new year. A month later the round closed with a sophisticated investor who bulldozed away the onerous terms and also joined the company’s board. Business-wise, the company had been doing well – it just needed the right funding and people to fuel its growth.

It takes a lot to get a company off the ground, or from New Zealand to the world. In the past few months I have been working as a VC in Southeast Asia, where tech activity is rapidly increasing and investment is pouring in. My observation is the number of people who have worked in the Valley or exited companies has a snowball effect for this region. Success begets success.

The more people we have who have been through the start-up to exit journey, the more successful entrepreneurs who feed their smart money and experiences back, the better Kiwi start-ups will fare. Perhaps then we’ll no longer have start-ups giving away too much equity too early on or begrudgingly accepting onerous investment terms – and more angels who appreciate the real risk and potential that comes with investing in early stage companies.

At the time of this Moxie Session, Lucy Luo was a lawyer for early stage tech companies at Simmonds Stewart (a boutique law firm focused on the technology space). She is now based in Singapore, working at a venture capital fund that invests into tech start-ups across Southeast Asia. Any opinions expressed are her own.

Every month, The Moxie Sessions brings together a small group of business thinkers to discuss ways New Zealand can take advantage of the Internet to boost its national competitiveness. For more, see http://themoxiesessions.co.nz.

Thanks to Alcatel Lucent and its ng Connect programme for their generous sponsorship that helps to make The Moxie Sessions possible.

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1 Comment & Question

Commenter icon key: Subscriber Verified

That Christmas story sound very familiar.

Punakaiki Fund gave what is now Melon Health a vanilla convertible note around Christmas last year and subsequently invested, converting the note into equity at the same terms. Melon Health, led by the redoubtable Siobhan Bulfin, are having a great year - with some very large client pilot programs underway, stints at Techstars/Sprint and a Mayo Clinic program and continued great outcomes for patients who use their m-health product.

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