How do you become a venture capitalist?
There is no straight line to follow to become a VC. Going to university and studying finance or commerce is not going to guarantee you a shot at making it as a start-up investor.
One commonality between the country’s VCs – both newly appointed partners and those with decades of experience – is that most have operational experience as either a founder, or working inside a start-up.
Square Peg Capital’s Paul Bassat is renowned for co-founding Seek, Blackbird’s Rick Baker started two software companies before shifting into investing (Right Party Connect and IDC Global) and AirTree partner Craig Blair founded Travelselect before selling it to Lastminute.com in the early 2000s .
Folklore’s Alister Coleman is an outlier among the partners of the country’s longest-running VC funds, having started his career in investing as a senior analyst for a family office before shifting to Fairfax Media and overseeing its M&A strategy. But, he too got operator experience before moving into VC, co-founding ShippingEasy in 2011.
A newer member of the local VC scene, Jackie Vullinghs, was promoted to partner at AirTree in mid-2021. She has never been a founder, but did work for a start-up before joining the fund.
“I studied history at university, then sold equity derivatives on the trading floor at Merrill Lynch and Citi in London for six years,” she says.
“Throughout my time in banking I had the itch to start my own business, but didn’t have the confidence to go out on my own straight away so joined Lystable, a seed-stage B2B SaaS start-up in London, as chief of staff. When I decided to move to Sydney in 2017, I thought I’d experiment with blending my interest in investing and my love of start-ups by trying venture capital.”
Vullinghs and Coleman agreed that for anyone wanting to enter the industry, your ability to get a job in VC has more to do with your mindset than your experience.
“You want people who have independent thought, are insanely curious, are good at deductive reasoning and taking on information but not anchoring themselves to all of it, and people that accept there is a lot of uncertainty in the world and are not discomforted by it ,” Coleman said.
How do venture capitalists make money?
Partners in venture capital funds are paid a salary and also receive carry in the funds. Carry is a form of profit share, and they only earn this portion if they deliver strong returns for the fund’s investors. Carry hurdles mean that if a certain agreed upon rate of return is not achieved, the partners do not get to share in any of the profits.
For most VC funds, total carry dispersed to partners tends to be between 15 per cent and 30 per cent, with 20 per cent being average.
Carry is the way in which VCs make the big bucks, but, with many funds having a 10-year lifespan and returns often not starting to flow until six or seven years into the fund’s life, it pays to be patient.
What does a venture capitalist look for in a start-up?
How you evaluate a start-up is dependent upon its maturity. An investor buying into a company when it’s already raised a few rounds of capital will be able to examine metrics such as revenue growth, average revenue per user, customer acquisition costs, its cash burn rate and its pathway to profitability – something that’s become increasingly scrutinized amid this year’s tech market correction.
But, when a company is still in its infancy, there’s next to no financial data to examine and this is where curiosity and intuition have a role to play.
Factors VCs consider include the experience of the founders and their team (some funds prefer founders who have personal experience with the problem they’re trying to solve), their ambition, the potential market size and their personalities.
It’s also common for start-ups to get to know their eventual investors for months, or a year, before ever raising capital. This gives the VCs a chance to get to know the business and witness the founders’ ability to execute on their vision.
“The most critical part of the decision happens in your heart – do you love this company? Do you want to go on a 10-year journey with this founder? That is more art than science,” says Blackbird Ventures partner Nick Crocker.
Vullinghs says AirTree does two to four weeks of legal due diligence on its investments, but the fund assesses far more than just the terms of a deal.
“We seek to understand in detail the experience and motivations of the founding team, the unique insight which led them to start the company, the market opportunity, how the product works and whether it engages users, the sales and marketing strategy, the unit economics and financials, and the competitive advantage over time.”
Coleman’s fund Folklore specializes in early-stage investing, and he believes he can “get a feel” for a founder in less than 30 minutes.
“The fastest we’ve ever made a new investment is five days. The fastest we’ve ever made a follow-on investment is 17 hours,” he says.
“When that happens, the bonding chemicals have gone off in everyone’s mind. [We like founders] who are wildly ambitious, have very clear thinking, they’re honest and … understand the catalytic power of the team.
“We’ve also spent six to seven months [assessing an opportunity]. Swoop Aero took seven months because we didn’t understand drones, and we wanted to understand the environment they operate in, plus Swoop wasn’t ready to raise at the time.”
What red flags does a venture capitalist look for?
Lying. Both Coleman and Vullinghs say there have been times when founders had lied to them during the pitching process and said it was an immediate red flag.
“We also do legal due diligence and background checks to ensure there are no skeletons we need to know about,” Vullinghs says.
Coleman says if a founder is evasive or dismissive that’s also a warning sign.
“You’re trying to help these people, but they see questions as something to be stymied and avoided,” he says.
How does a venture capitalist manage market hype?
Every so often, a sector goes from hot to scorching. If you’re an investor who picks the top of the market, this can mean eye-watering gains, but if you miss it, the losses will come thick and fast.
There’s no better example than the buy now, pay later sector, in which companies like Sezzle and Zip are down more than 86 per cent in the last year.
Coleman says Folklore always tries to invest in trends before they are discovered.
“You want to invest at the front end, before it has crystallized as being a thing,” he says.
“You don’t want [the trend] to never be discovered, but you need to understand if something is real and durable.”
Crocker, however, says Blackbird pays no attention to hype.
“We might fund a start-up at the peak of the hype cycle – like bottom-up SaaS (software as a service) in 2021, and we might fund a start-up when everyone thinks the sector is dead – like crypto in 2013 .
“A great company will take more than a decade to build. Wherever that company is on the hype cycle when you meet them won’t be where they are a year, or 10 years, from now.”
How are start-ups faring this year?
Since interest rates started rising this year, funding has slowed considerably and venture capitalists are experiencing the most challenging investment environment in more than a decade, AirTree’s Vullinghs says.
The higher interest rates go, the lower investors value future earnings, and as a result both valuations and the number of new deals took a hit this year.
In 2021, more than $10 billion was raised by Australian start-ups, while this year to October 31, around $6 billion has been invested, according to Cut Through Venture.
(Despite this drop in investment, the amount invested in October this year – $490 million – still exceeded the entirety invested in 2016, which was $465 million.)
Founders are now dealing with the very real consequences of the mega rounds that were raised at high valuations in 2021 when cash flowed freely and competition to get into deals was fierce.
The tech sector has experienced a downturn with stocks (S&P/ASX All Tech Index) falling 31.7 per cent so far this year.
Investors are now advising portfolio companies to make their capital last longer, leading to layoffs across the sector, reduced rates of hiring and lower spending on things like marketing.
“We’re encouraging companies to continue building products and leaning into growth, but to focus on efficient growth – continually assessing the efficiency of spend and keeping a close eye on forward-looking demand metrics to understand if customer demand is slowing, then making quick decisions to extend runway if they need to,” Vullinghs says.
However, optimism among investors remains high, with VCs pointing out the long-term nature of start-up investing.
To manage the current uncertainty, Crocker said Blackbird’s approach was to focus on the progress of its portfolio companies, not “the emotions of economists”.
“We will never be good at predicting the future, but we can get good at predicting which founders will make progress on their vision regardless of what’s thrown in front of them.”