August 22, 2013
Disclosure – Lance Wiggs, the main person behind both Lance Wiggs Capital Management and the Punakaiki Fund, is a personal friend. He’s cast his eye over some investment opportunities I’ve taken to him, and I’ve considered investing in some of his companies. This post puts aside any of that history and looks at Punakaiki at arms length
This week saw the launch of one of the most interesting things to happen in the early stage investment community in New Zealand with the release of the Punakaiki Fund prospectus. The Punakaiki Fund is looking to raise between $20M and $50M to fund a range of high growth businesses. The fund will be main used for early-growth and growth opportunities in the $200k – $2M range, but the fund will also look at some earlier seed investments as well as some “Turnaround and Transformation” opportunities.
There are a variety of things to look at when assessing this offering in the New Zealand context, here’s my thoughts on some of them.
Is there a capital gap?
The premise of Punakaiki is that there are a good selection of New Zealand companies that are in need of capital to fuel their growth. The theory goes that there is a chasm they need to cross in order to scale and that existing funding sources aren’t a good fit for them. They rightly point to the immaturity of the general early stage investing community in New Zealand (both institutional and individual). The money quote comes in an email conversation I had with Wiggs where we discussed some early stage deals that have happened of late. As he said:
Poor founders. Leave them alone and let them get on with building a business
I’m with Wiggs on this one – having been part of funding three New Zealand early stage companies in the past couple of months. I’ve been frankly staggered at the complexity of due diligence investors demand, the general irrelevance of questioning that potential investors come up with and the misunderstanding about global opportunities for these sorts of companies – all of which means that a paltry $200k funding round requires a founder to work full time on providing due diligence answers for a couple of months. This isn’t sustainable, and I’m pleased to see Punakaiki is intending a lighter touch approach to due diligence.
While the fact that currently investment analysts are falling over themselves to talk up Xero to their audience, we shouldn’t forget that these analysts only found out about the company once it had begun to shine on the NZX – it’s not only the individual investors who are a little immature in their approach, the institutions simply haven’t got the scale to get the advice they need to qualify the early stage stuff.
As such I don’t believe that there is a fundamental capital gap per se, rather there is a dearth of capital that is prepared to invest in a flexible manner, to make quick decisions and to be realistic about valuations given global potential for the company. The net result of these factors is a quasi capital gap as local startups give up on funding or seek easier capital from offshore.
Is there enough deal flow to utilize the fund?
This is an interesting one. As my disclosure statement shows, I’ve a fairly extensive portfolio of early stage domestic investments, as well as at least one successful exit where a local investment was acquired by a North American company. With a good half dozen active local investments, along with a fairly extensive list of companies I’m either a director or an adviser to, it would seem the ecosystem is vibrant. Programs like the Lightning Lab (a Wellington program modeled on TechStars) have created a reasonably good cadence of startup development.
With all of that however, I’m not sensing a massive quantity of good opportunities in the pipeline. If one takes the totality of startups that exist at anyone time, a significant proportion are uninvestable due to issues with the team, the proposition or other factors. Of the remainder there are those who are in a position to go directly to offshore or alternative funding parties – had Punakaiki existed when Xero was founded for example, would it have been seen as a potential funding option? I suspect not. If we take out these two groups then, we’re left with a fairly small number of companies – it’s interesting that of the cohort from the Lightning Lab program, only four companies got founded – my belief is that this wasn’t due to a lack of ready capital, but rather a lack of solid business value.
Having said all that however, there are a significant number of employees within our more mature companies (TradeMe and Xero for example) who are tiring of the slower, more corporate way of life, and are looking to go out on their own. I’m aware of a number of new and interesting startups being founded by the alumni of these companies – this indicates a coming blooming of the local startup scene. Add to that the fact that Punakaiki is talking a very logical and broadminded approach to the sort of businesses they invest in (not just SaaS or BioTech for example) and things sound positive. Too often we get blinkered to only look at one particular sector, a fund that has a broader approach is a positive sign of maturity.
Net/net, with a growing ecosystem of tech startups, and a broad enough view of what falls within the Punakaiki realm, there should be sufficient deal flow to utilize what is, in all honesty, a relatively modest amount of capital, even at the fully subscribed $50M mark.
Does Punakaiki offer the founders value?
Part of the allure of high profile Venture Capital firms in the US like Andreeson Horowitz, and the Foundry, is the amazing networks and experience the partners have – these two companies alone have founded or funded a huge proportion of the massively successful companies of the past few years, they’re also part of a self fulfilling network were the most successful companies get funded by the same firms, creating ecosystems and synergies by default. We don’t have that in New Zealand, while Wiggs can point to his work with TradeMe prior to its acquisition by Fairfax, and his involvement with Pacific Fibre, there isn’t the history of tech business in New Zealand to really create a significant value add in terms of network.
I put this to Wiggs who reverted with several points to justify the value Punakaiki can offer founders:
I’m pretty well connected to and have experience from to the US – 5 years there. So think of this as a US trained and experienced guy being in town. Yale and McKinsey networks are both strong and smart/well connected/deep. I’m pretty well connected to very smart folks here – Don’t underrate what we have here, and nor shall we think that we are the center of everything… I can ‘get’ pretty much any technology and business in the non biological sciences, some very well and most very quickly. That’s what I do. e.g. At McKinsey we would do DD work for Kleiner (not me) or others making investment decisions (yes me). We would call industry experts to help us for short bursts, but the secret was in asking them the right questions.
To a degree I buy into this explanation – Wiggs has undeniably got the consulting background, he has help in terms of due diligence and can call on his extensive network for specific subject matter help. I do worry however that a deficit still remains. If I look at the two startups that I’ve been involved in that have exited in the past couple of months, Appsecute and Connect2Field, both were highly specialized offerings – one SaaS for SMEs and the other developer tools for enterprises. While arguably Xero has created a few people in New Zealand with contacts in the former, it’s fair to say that there are very few people that are boring enough to follow the minutiae of DevOps tools (and I can say it’s boring, since I’m one of them). As such it’s going to be critical for Punakaiki to actively engage with the limited breadth of subject matter experts they have available to them via their networks, in order to make up for the lack of this skill in-house (which isn’t a criticism, a $50M fund can never possibly hope to cover the breadth of their investment areas with in-house skills).
The other real concern I’ve had with domestic funding approaches is that they’ve had a tendency to insulate the founders from making the hard decisions they need to make to grow. As many people point out, the best sort of investors are customers paying real money for the product you sell, getting some funding domestically is sometimes a replacement for startups doing what they should do and getting on a plane to Silicon Valley to immerse themselves in the real hub of technology (and here I’m talking about IT in particular, but there are no doubt similar analogues for the other areas Punakaiki will invest in).
The approach I’d like to see Punakaiki take is one similar to that taken by berlin-based early stage funder Point Nine Capital – Point Nine picks up growth opportunities that are already showing good revenue and helps them get to the next stage. The key thing with Point Nine companies however is that they tend to use that funding to fuel their moves into the real markets that matter – both Zendesk and Vend, Point Nine portfolio companies, took the German money, but used it to scale in the markets that matter. I’d like to see Punakaiki emulate this approach and encourage its portfolio companies to go ahead and jump on that flight to SFO, rather than to tuck up in safe old New Zealand.
The management fee structure question
One of the parts of the prospectus that will raise a few eyebrows is the fee structure section – broadly the management fee is set at 2% of the Net Asset Value per annum, with a minimum $300000 level. On top of that there are performance fees of 20% of increase of market value beyond a 10% benchmark growth rate. These are big numbers here in New Zealand, but I’m actually pretty relaxed about them – personally I’d rather see the $300k minimum dropped, and the capital management company accept more risk of under subscription and go with a flat percentage. That said, the main concern about the fees will come from the usual Kiwi knocking machine that says $300k is a little too rich.
It’s about fair recompense for fair value – and this is where a more performance orientated fee structure would be better – I’d have no problems seeing LWCM earn a seven figure fee, but only if the fund was making returns commensurate with this – the minimum fee level somewhat dilutes this feeling of “skin in the game”. It’s not a biggie, but sometimes it’s the little things that count.
Should Mum and Dad investors buy in to Punakaiki?
I have to be honest, when I first heard about Punakaiki I was dubious. It seemed like a bit of a get-rich-quick scheme (where the fund manager is the one getting rich). I also doubted the ability to secure dealflow and failed to see where the fund could offer value. But I was looking at it from the perspective of someone who has done a couple of dozen investments in the past two or three years, spread across the US, the UK, Australia and New Zealand. I’ve managed to get in on early stage opportunities in some very specific and compelling areas. Mum and Dad investors have zero opportunity to do this – the closest they come is through listings like Xero or SLI – and while Xero is certainly making all its investors smile, it’s very much an outlier, the vast majority of capital gain that has been made by high growth investing in New Zealand has been locked up to a very very select group of institutions and high net worth individuals. Punakaiki democratizes that for every day investors.
It shouldn’t constitute the totality of an investment portfolio – but based on a minimum initially investment of $2000 it’s the sort of thing that most Mum and Dads can be a part of. It’s certainly high risk, but with some good management, a bit of luck, and an increasingly vibrant startup ecosystem, the exit of New Zealand’s next TradeMe will make a great number of people, rather than a very select few, enjoy a significant capital gain And for that reason, Punakaiki should be applauded.
(And another disclosure, I’m not an investment adviser of any description, caveat emptor)