Everything you need to know about winning an investment as a start-up or scale-up!
Peer Group Meeting # 78 | This autumn a diverse group of investors and technology firms met at our offices to discuss what makes a good PropTech investment. Robbert Heekelaar (VP Architecture & Emerging Technologies at Prologis), Daniël Langerveld (Business Analyst at Endeit Capital), and Yvo Velthoen (Technology Analyst at Venture IQ) answered the various financing questions of the entrepreneurs present during a two-hour session. Below we have listed some of the questions and answers in order to provide a summary of the discussion for those who were not present.
Which KPIs do investors focus on?
Daniël: Which KPIs an investor focuses on depends on the position of the company in the investment cycle. We focus on companies with a turnover of €2 million or more. This is a strict requirement of ours. With such a turnover, a Software-as-a-Service (SaaS) company already has serious traction. We see the €2 million revenue as a proxy to show that a company knows who its target customers are and how they can best be approached. At this turnover level, the firms are also focusing on specific KPIs that are aimed at further scaling up growth. Examples of these are: 1) costs to acquire a customer (e.g. Google ads, sales people, etc.), 2) the value of a customer, such as sales per customer per month (ARPA) and the churn costs per customer per month. With points 1) and 2) you can then determine what does a customer deliver, the Long-Term Value (LTV), and what does it cost to get the customer, the Customer Acquisition Cost (CAC). The relationship between the LTV and the CAC can be represented as LTV / CAC of a company. This ratio is the most important for us. It shows how much risk can be taken with the expansion of sales teams, increasing marketing spend and rolling out abroad. There is of course a risk here, but this is somewhat mitigated because the company already has ‘proven’ traction in the market.
During the initial funding phase, the so-called “seed funding”, it is more about having a good idea. As a founder you have invested time in the company, but you still have little traction in the market (solid revenue growth) and you do not yet know exactly what and to whom you will be selling. The product, the approach and the type of customer may change a few times in the first phase. During this phase, the startup is valued in a different way than when scaling up and will do well to find an angel or seed investor. These investors usually invest smaller amounts. This is logical, since the valuation will be lower, because there is more risk. After all, there is still ‘little’ traction.
Robbert: We also only start to invest after the seed round. Our investment branch is not our core business, which means we do not have the capacity to help a seed level firm thrive. For a first round you really need to look to angel investors or a large investment fund that invests in different seeds. When we invest, we look at the applicability of the firm in our own sector and might also become the first scaling customer of the company. Because of this, it is useful if the startup is already settled. Once a company advances past the seed round it is clearer what they can do for our sector and we can find the right partners immediately. In addition to making an investment, we can also propose customers to implement the product.
Yvo: For us, the investment criteria are determined by our clients (often these are corporates) who, in addition to investing, are also interested in other forms of collaboration. Our customers are often looking for a specific solution to a problem and would like to see all companies worldwide that can offer a solution. That is why we often pay particular attention in the first instance to the track record that companies have at that specific point. By mapping out all the companies that offer a possible solution, we give our customers a complete picture of the playing field. If our client wishes to invest, we then apply a minimum turnover filter and let all companies that fall outside of that range fall away. An alternative for a corporate can however be to enter into a partnership, which can be more beneficial for both parties.
How is the turnover of a company calculated?
Daniël: That of course depends on the industry. We assess SaaS companies we invest in by looking at both actual revenue and run rates (annualized revenue that is extrapolated from the current revenue). For example, if €110K is converted in January and €160K in July, then we could expect a turnover of €160K multiplied by 12 months. At such growth rates, however, there is a good chance that the company will continue to grow to €190K, so then we may take that amount times 12 months. We will sometimes make an exception and use this higher revenue rate. For us, the run rate x 12 should be around €2 million. In short, turnover can be viewed in different ways.
What does the investment process look like and what are situations in which you want to abandon the normal course of events to make a bid faster?
Daniël: We first look at the commercial aspect of the company. Based on the commercial aspect and the associated traction, we will then decide if we want to make a deeper analyse. If all traffic lights turn green, a non-binding initial bid (NBO) follows. As soon as there is agreement between the scale-up and the investor with regard to the NBO, the due diligence investigation will start. We then really dive into your books, your forecasts, your accounting system, your Google Analytics, etc. In short, we try to map the most important KPIs (e.g. LTV / CAC) and underlying factors. In addition, we would also like to talk to your customers and to market experts. We also do a technical due diligence: are you AVG compliant, is the IT platform scalable, is there a technical debt, are there key personnel risks, etc. We will then make a binding offer based on this deeper investigation. This entire process normally takes between 3 and 4 months.
How long does it take to secure an investment?
Daniël: This is hard to say, but assume 3 to 4 months for the official process. But for that you must first determine what you are looking for in an investor and which investors you would like to talk to. You can easily take two months for this. Every investor has a specific focus. Some believe in the product, others will not.
How long does consulting between the investor and the company take after the investment?
Daniël: Consulting is a continuous process, communication is ongoing. For example, we have a Slack channel with the company where we can chat and we can immediately be asked for help. If necessary, we will also assist and therefore work temporarily for that company. This also ensures that we can keep up to date with what the company is doing.
How much goes wrong after collecting the investment?
Daniël: That differs. Plans turn out to be more expensive than expected, twice as many salespeople are needed to achieve a goal, conversion rates are lower, customers churn faster. This is not all clear in advance. That is why we always ensure that there is room to really support the entrepreneur ‘hands-on’.
Robbert: It can go wrong in many places. For example, with the actual operational application. Or there appears to be a mismatch between investor and company as it becomes clear that the startup has profiled itself differently than it is in reality, despite our due diligence and all discussions. Or it appears that some things take a lot more time than expected. It is also true that when the product is implemented somewhere, new things always pop up. It just depends on the situation whether we can continue despite those problems. There are gradations in acceptance. Also, it could be that while the pilot is running, everything works out well, but when you start scaling you are always confronted with unexpected challenges. That is why you must always first test very well in a large organization. Sometimes things go wrong because of us. In such cases we want to implement the product in all warehouses, but we get ahead of ourselves and deploy before we’re ready.
What is the biggest challenge you face when analyzing firms?
Daniël: In the SaaS market, all parties claim to have invented the new Slack / Uber etc. It is difficult to see through their plans to determine how good they really are and whether they are better than other companies that do about the same.
How do you differentiate the same idea among different startups?
Daniël: This is very difficult to say. That is also the reason why we invest purely in scale-ups and not in start-ups. We are good at scaling up companies, we are less good at distinguishing similar startups and helping to find initial traction.
What is it that makes the collaboration a success?
Robbert: When both parties have the same product and definition of success in mind. The gut feeling must also be correct. You have to gradually grow towards each other, or it will start to come apart at some point.
Do you help firms to get in touch with potential advisors?
Robbert: Not at the moment because there is enough room to do this within our organization. We will put a plan in place to do this later as the need arises.
If you are dealing with complementary startups, do you advise them to merge?
Daniël: Hard to say. This purely depends on the synergies that can be achieved (e.g. are the products complementary and can cross-selling take place?).
Robbert: We have a warehouse close to San Francisco and we invite companies there if we think their products are complementary. There they can try out a collaboration in a fictional operational warehouse, very protectively, to see whether they can actually merge solutions in practice.
How do you exit?
Robbert: We have not yet encountered such a situation. We invest in a company with the intention of staying in it for a long time.
Daniël: Depends on the situation. You don’t have to expect exits in the beginning, but after about five years they’ll start to come. The scale-ups that we invest in are often sold to the next Venture Capital fund, or we pass the baton on to a Private Equity fund, or to a strategist. The sale of our shares happens in close consultation with the other shareholders.
How many investments do you make per year?
Daniël: We try to make around 4 investments per year.
What is the most efficient way of matchmaking?
Daniël: Through these kinds of meetings [peer group discussions] or conferences. Or when you are linked to each other via your network.
Yvo: We believe in volume. We search worldwide for companies that can offer our clients a solution and then bring that list back to a manageable shortlist based on high level criteria. In this way we maximize the chance that we will find the best partner that exists worldwide.
What is important to look at when selecting an investor?
Daniël: You really have to click with them. After all, they’ll become the co-owner of your company for several years. You must also be able to reach agreement on certain issues and the investor must be able to help you.
Do you have any general tips for us when approaching investors?
Daniël: What I would do, is that when talking to an investor, is to share with him or her all the information or data from your company. Have the potential investor sign an NDA and open up everything for them (accounting system, Pipedrive, Google Analytics). In this way you get fewer questions and you exude confidence.
Yvo: Our advice to start-ups is to be careful when collecting money and to postpone it as long as possible. Many start-ups underestimate the high demands that an investor imposes after the investment has been made. If you are not ready for that yet, your dream can quickly become a nightmare.
What is a good pitch deck?
Daniël: A deck that really shows what the company does and what the company’s USPs are. In short, how does the company distinguish itself from its competitors and what ‘problems’ does the company solve? This of course should be supported by the discussed metrics. It is also important to be realistic and say: we would use the funding for this, this is what we as founders can do well, this is what we need help with, this is what we are looking for in an investment partner, etc.
Robbert: It is also important to consider who you pitch to. With Americans it has to be a bit more ambitious than in Europe because they expect you to become a unicorn. What we call a realistic pitch in the Netherlands can be seen in the US as a lack of ambition. But what in turn is seen as ambitious in the US is labeled unrealistic in the Netherlands.
How do you look at female founders?
Daniël: Whether the founder is a man or a woman is never a criterion. You invest in a company and the people behind it. Selecting by gender does not add any value.
Does a PropTech company have to stay in the Netherlands or can you go abroad?
Daniël: Depends on the phase you are in. If you still have a limited number of customers, but you feel you have a good product, look for more customers in the Netherlands. Stay in the Netherlands for the next x years of intense growth. You can then partially copy the plan that you implemented in the Netherlands and repeat it abroad. A foreign investor from the country you are going to will help you to grow there and can also bring in your first customers.
Are you very strict with your management agreements?
Robbert: We think management agreements are very important. That is the soft part of the negotiations. You negotiate an investment agreement with a specific group of people. If they leave, who will pick up the idea?
If you look at PropTech, what opportunities for great growth do you see for SaaS companies?
Daniël: What we now see happening a lot is what companies like Mapiq and Lonerooftop do. They not only connect to the hardware that delivers data, but they also do the analytics to determine what the data means for your company and how you can leverage it to create the best value.
Any other tips?
Robbert: From the perspective of a property owner, I would like to say that we see many startups who come with the ‘we have a platform’ pitch, offering a great vertical solution, from A to Z. However, many property owners do not want this, they have their own data environment. They are not looking for a total solution, but prefer to choose from different modules, a kind of pick-and-choose and a little less of a vendor lock-in. With this you also get fewer data ownership discussions. It is important to emphasize the stratification in your pitches and to know in which area you are very good: is it in the hardware, the software or in extracting the data and making the translation into what this means for the company?