Facebook’s US$19bn acquisition of WhatsApp got me thinking: how does the private investor get a piece of the next fly-to-the-moon, Silicon Valley technology stock? The answer: with great difficulty.
The recent wave of tech initial public offerings (IPOs) would seem a logical place to start.
However, many are staging posts for value realisation rather than a springboard for further wealth creation.
The roller coaster ride that was Facebook in the months after listing reveals that even the big boys struggle.
And, actually, the real returns were made by the social network’s early backers such as Bono’s Elevation Partners, which turned its US$90mln Facebook stake into US$1.5bn.
Here’s the point: getting in on the first financing rounds, while risky, represents a huge opportunity for value creation.
Founded by Alexander Morgulchik, German Kaplun and Artyom Inyutin, the trio behind the success of Russian media conglomerate RBC, it floated on AIM in 2010.
It has serial entrepreneur Igor Shoifot on board as a US-based consultant who provides TMT the Silicon Valley introductions usually reserved for billion dollar funds.
To date TMT has raised US$28mln and made 30 investments and has successfully exited four companies where it has built stakes.
Its investments range from start-ups such as Vital Fields, developer of farm management software, to more established firms such as online retail phenomenon WANELO.
The portfolio straddles the business-to-business and business-to-consumer markets.
“We like mobile apps, anything to do with productivity (collaboration, data and project management); also online advertising, cloud, and social network-related service applications,” says executive director Alexander Selegenev.
“We look for excellent management teams, and good products targeting big markets.
“We need to see the potential for the company to become something big, even if it is a niche player.
“This means the niche needs to be big enough so the leader or second-largest company in that niche can be sizeable.”
Rigorous analysis is carried out before any money changes hands. So far it has analysed close to 900 companies, met almost 200 and submitted 60 cases to the investment committee, of which 30 have been rejected.
“We look for real Internet companies, not traditional bricks-and-mortar businesses with a website,” says Selegenev.
“The point of an internet-based company is it relies on the internet to make it grow. A lot of our portfolio companies do just that.”
He cites the example of WANELO (it stands for want, need, love), which has risen from a lowly ranked social shopping site to one that attracts millions of users every month and has some of the world’s top fashion brands falling over themselves to be on the platform.
“It’s had zero marketing budgets and spent very little on PR – its growth has been viral and it has spread like wildfire among users at zero cost. This is what we mean by a real Internet company,” explains Selegenev.
Meanwhile, TMT’s investment ‘exits’ have ranged from the stellar such as Astrid, a task-tracking service which was sold to Yahoo! and returned 57% IRR in just over a year, to the less impressive 5% internal rate of return earned from people search site peekyou.
There has been one write-off, a failed start-up called hotlist, which isn’t a bad record for a company at the early-stage venture capital end of the investment scale.
Some of its best investments include the aforementioned WANELO, where TMT’s initial US$350,000 is now worth US$5.3mln, and Wrike.com, a developer of collaboration and project management software, where its stake has doubled in value in just over a year.
The full-year results revealed the net asset value (NAV) has risen quite steadily since inception to US$1.30 at the end of 2013, as has the share price, which trades at a premium to the NAV.
One of the most popular ways of investing in these fledgling companies, other than taking a plain vanilla equity stake, is to offer convertible notes (debt) that pay a coupon.
This is coupled with what’s called a cap, which means that the group always converts its debt into equity in the business at a pre-agreed maximum (“capped”) equity valuation.
So, for example, if the cap is US$5mln and the next funding round values the business at US$10mln, TMT converts its debt into equity at the lower figure.
This gives it a larger stake in a business it backed in the formative, more risky phase of its development.
There is a downside to this: convertible notes are recognised as debt rather than equity investments under all international accounting standards, so any value uplift won’t be recognised until the debt is converted into a share of the firm.
While this accounting issue is undoubtedly an irritant to Selegenev and the team, it provides a hidden kicker to investors.
Almost fully invested, TMT will undoubtedly come to the market for more cash to fund the next round of opportunities.
It has done this before at lower share prices, meaning those who backed the team are already making a decent return. The plan is to eventually plough closer to US$100mln into these early stage firms.
“The idea from the beginning was to put together a really big company,” says Selegenev. “So we are only really just starting.”