Technology Innovation Funding & Exits: From DotCom to Today

After an exciting week in Cambridge mentoring start-up technology businesses on Cambridge University's Centre for Entrepreneurial Learning Ignite programme it is apparent that there is no slow down in technology innovation. A number of course participants, small technology businesses or technology concept owners that may become businesses in the future, will at some point, seek venture capital to develop and market their products; a few may be successful. Gone are the times when money flowed from Venture Capitalists' (VC's) pockets and was invested in perceived 'unbeatable' products and concepts. Market realism hit in mid-2001 after many crazy stock market valuations of technology based businesses, my own included. What changed and what might be a better start-up strategy than to immediately seek venture funding?

My own business began in 1997 and grew profitably by providing consulting services; profits were invested in developing a product which needed funding to 'round off the raw edges', to ensure that product met customer demand and to take the product to market - a very expensive exercise. Understanding that to gain VC investment a business founder must first show personal financial risk a £70k business loan was taken out with the home as security. With 'dodgy' prototype and self investment done the next step, to be ready for investment, was to bring on board an experienced management team. In 1999 every 'Corporate man' and his or her dog (whether suited or not to the start-up environment) were 'leaping' at the chance to join an energetic, 'buzzy' start-up with dreams or making his or her own fortune. Some risked their own security and left the 'day job' to join full time, taking a lower salary and equity or the promise of; others offered services as non-exec or chair for 'free', until funding was found.

The business eventually raised sub half a million pounds after about 8 months of hunting. At that time the business model was raise cash, burn it, raise more cash, burn it too and, at round 3 investment, go to an Initial Public Offering (a float on a stock market) or trade sale exit hopefully making original investors and founders very happy (and rich) people; even if the business was still to make profit. Instead of second round VC funds we took an opportunity to list on London's Alternative Investment Market (AIM). Why? It was my personal ambition to float the business and a viable exit plan, my experience of VC's had generally not been good and mostly because the opportunity was there. The floatation process itself, a reverse take over of an already listed property company, was time consuming, risky and costly but risk, at that time (and still is for all small businesses), was the 'name of the game' and we took it. The process meant 'eye off the day job' for many months but the eventual float and resulting bank balance (we raised in excess of £4M) made the team's efforts worthwhile.

Buoyancy of the market gave the business a £22million valuation at its peak - totally unrealistic given the development stage of the product and business, but great for investors whose shareholding was not locked in and who had the opportunity of selling their shares on the market. Market sentiment in 2001 began to turn sour for small listed technology businesses and our dizzy heights of success were short lived.

In today's market it is highly unlikely that a small software business in a similar state of development would be taken seriously by the stock market. The arduous requirements of public company reporting are not required until the business has a real solid foundation. The current lack of fluidity in share trading on AIM makes it a less attractive exit for technology based businesses (and indeed any business) and other exit routes need to be considered.

There is no lack of entrepreneurs and great technology yet to be commercialised (Ignite continues to grow). The old rules of venture capitalism still apply; the founder must show financial commitment and invest their own capital (founder's sweat equity (time worked for free) does not count), the management team must be more or less in place (the founder still needs to be able to 'blag' skills on board at a price they can afford to pay; usually much lower than market rates) and there must be the semblance of product (often a chicken and egg situation); ideally with happy customers. To complete the product and take it out to the market the business founder may still need start-up finance at the risky, early, generally market-untested stage. There is still the 'friends, family and fools' stage of funding to be wary of, but what better way to 'soft start' than by selling consulting services based around the desired product to be developed? De-risk the start-up by showing revenue, customer demand and a happy customer or two. If successful VC money is undoubtedly required to 'polish the product' and expand the market but initially revenue is king - so sell, sell, sell and then look for money - the business valuation will be better and less equity will change hands when it comes to investment. Chances are in these times 'corporate men and ladies' will not be 'falling over themselves' to be involved; those showing an interest are likely to have a true interest in early stage technology business and are worth a review, however swift - wrong people can kill a great business; and the right ones make it fly. The old 'build it for exit' still applies. Trade sale may be a more appropriate in the current market climate but as we all know the market changes from bear to bull and back again, so after many more tomorrows the desire for IT stocks may be back but here's hoping that we don't return to the silly state of the dotcom era.

Jane Garrett
Global Composition July 2008