What We Look For
Divergent Capital is primarily focused on early-stage Information, Communications and Technology and (ICT) businesses. In assessing investment opportunities, Divergent Capital will take into account many tangible and intangible factors that drive the risk and reward of each deal. We encourage potential applicants to consider these factors and how they apply to your business when you approach Divergent Capital.
Our criteria include the following:
Capital Requirements & Finance Risk
Divergent Capital is an active partner who invests up to A$1M (average $500K) into companies that have less than $4M revenue per year. We typically own between 20% and 50% of our investees and in many cases have board positions. We believe that a business should raise sufficient capital to fund it through to a cash flow positive position and hence only invest where this is the case. That is, we are averse to investing in a business that will need a further funding round prior to cash flow sustainability. We believe these businesses will be subject to the vagaries of the capital markets and the risk of not raising further funding on acceptable terms is not one we wish to be exposed to. Note that we are supportive of our investees that have reached profitability seeking to raise funds to leverage the opportunity, as this is done from a position of strength.
Management
More than anything we back the management team. The key qualities we look for in a team are:
With business being so difficult, Divergent Capital looks for opportunities that have a clear pathway to success defined by:
The aspiration is for a business model in which profitability and growth are not mutually exclusive – there are many companies/start-ups that can grow fast … and many that make profit … but a truly great company and management team can do both at the same time.
Market Size and related factors
Our examination of the market landscape is a balanced assessment across a range of factors three of which have particular importance: Market size…while bigger is better and having a potential market of $100 billion is nice, we believe you can also build a successful business in a market with potential for $100 million. We seek to focus on a few key questions…what is the ‘true’ market size? Financial services may be a trillion dollar industry but selling staples to financial services companies is considerably smaller…this ‘confusion’ occurs quite regularly with Gartner, Jupiter, et al statistics being taken out of context. What is the size of the addressable market today? (as defined by dollars spent…nothing more, nothing less)
A great strategy is one that is practical to implement. There is no point having a rock-star management team and perfect business model if the implementation of the plan is fraught with risk and difficulty. Implementation risks can range from access to key resources (people, assets, etc) to customer hold-up (lengthening sales cycle) to fluctuating capital markets. As per our philosophy for business model, we look for businesses where we can see a clear path of implementation with proper risk assessment and mitigation in place.
Transaction Parameters
We seek to back entrepreneurs who are both optimistic and realistic about the value of a business – assumptions or justifications that look good ‘on paper’ may not stack up in the real world. When assessing businesses we are always interested to know how peer companies have performed. Whether they are direct competitors, similar companies in different markets or analogous business models – their performance and exit valuations are critical information. Prospective deals in which the return profile of our investment differs markedly from that of other investors or the overall growth and performance of the company would, prima facie, not appear to adhere to the golden rule of seeking to both maximise and align the incentives of all stakeholders.
Achievements
While we will consider funding complete start-ups, we prefer businesses where the founder has proven their tenacity and ability to achieve results on a shoe string. There is obviously a catch 22 of needing money with which to get results, and needing results with which to get money … but somehow some people just manage to notch up achievements on the smell of an oily rag. Achievements might range from winning awards to trialling products, however actual revenue and/or profit often hold the most weight because amongst other things they usually imply a reduced downside.
Flexibility
While the above philosophies have been developed over time and make a lot of sense, we are an opportunistic investor and will evaluate any business on its own merits. No business opportunity is perfect and in all cases we accept and attempt to manage a multitude of risks.
Art
Venture capital investing is as much an art as it is a science. As important as the above factors is that our team is excited for the opportunity. If we aren’t excited about it then we are probably not the right partner for you.
Our criteria include the following:
Capital Requirements & Finance Risk
Divergent Capital is an active partner who invests up to A$1M (average $500K) into companies that have less than $4M revenue per year. We typically own between 20% and 50% of our investees and in many cases have board positions. We believe that a business should raise sufficient capital to fund it through to a cash flow positive position and hence only invest where this is the case. That is, we are averse to investing in a business that will need a further funding round prior to cash flow sustainability. We believe these businesses will be subject to the vagaries of the capital markets and the risk of not raising further funding on acceptable terms is not one we wish to be exposed to. Note that we are supportive of our investees that have reached profitability seeking to raise funds to leverage the opportunity, as this is done from a position of strength.
Management
More than anything we back the management team. The key qualities we look for in a team are:
- Integrity - people of their word, who's handshake is as binding as their signature.
- Commitment - young, hungry entrepreneurs who have something to prove – and are willing to make genuine financial and personal sacrifices to achieve a “win”. We do not fund “side” businesses, side projects, etc ...you either believe in it 100% or not.
- Capability - people who have the drive, common sense, knowledge, experience, and tenacity to build a business (which statistically is beating the odds!). Sales ability is almost mandatory for the entrepreneur as this needs to flow from the top and can rarely be “outsourced”. Ability to deliver, and be accountable for results are critical as all the energy and vision in the world can’t usually compensate for a lack of this.
- Win/Winners – people who understand that greed and conflict usually shrink the pie, while flexibility and working together increases the pie to the benefit of all. Alan Greenspan sums it up well: “I have found no greater satisfaction than achieving success through honest dealing and strict adherence to the view that, for you to gain, those you deal with should gain as well.”
With business being so difficult, Divergent Capital looks for opportunities that have a clear pathway to success defined by:
- An identified market need or demand which is highly compelling (the “vitamin versus painkiller” argument) and growing fast.
- A technology-driven product or service that carries an order of magnitude advantage over alternatives (preferably via defensible IP) in addressing this unmet or under-served market need.
- Large profit margins. Obviously your cost of production needs to be way lower than what you're selling your product for. Small margin businesses are often a lot tougher to grow.
- Sales acquisition cost low enough to allow profitable growth. Many software products have very low marginal cost of production but significant cost of sales acquisition. Margins look great until you look at the work required to get the sales. If it takes 10 man days of work prepare and do a pitch, and you win 1 in 5 pitches, then your gross profit margin on each sale has to cover 50 man days of sales acquisition cost!
- Scalability … building upon points 1, 2, and 3 above – if (when) success occurs can the business cope with, and indeed fully exploit, growth. What are the likely bottlenecks to hyper-growth (sales, production, service, etc) and how can they be overcome? If we can't see the business being able to cope with fast growth we are less likely to get excited by it.
- Limited downside – we avoid those businesses which are in the ‘boom or bust’ category. Single project ventures, IP licensing or sale strategies (v trading businesses), and faddish products may be examples where an investor must accept an all or nothing outcome.
The aspiration is for a business model in which profitability and growth are not mutually exclusive – there are many companies/start-ups that can grow fast … and many that make profit … but a truly great company and management team can do both at the same time.
Market Size and related factors
Our examination of the market landscape is a balanced assessment across a range of factors three of which have particular importance: Market size…while bigger is better and having a potential market of $100 billion is nice, we believe you can also build a successful business in a market with potential for $100 million. We seek to focus on a few key questions…what is the ‘true’ market size? Financial services may be a trillion dollar industry but selling staples to financial services companies is considerably smaller…this ‘confusion’ occurs quite regularly with Gartner, Jupiter, et al statistics being taken out of context. What is the size of the addressable market today? (as defined by dollars spent…nothing more, nothing less)
- Growth rate – again fast growth is preferred and in particular demand outstripping the growth in supply will ease competitive tensions which may otherwise impact upon pricing and other profit drivers. Its easier to take a piece of a growing pie than to take pie away from someone else.
- Competition – less is more…to a point. The total absence of competition may raise question marks about the validity of the market opportunity. Ideally there are "competitors" who have proved it can work, but ideally they are not threats. (eg. they are inferior solutions)
- ERP Software … market is huge, slow growth rate, many participants with fierce competition – overall market dynamics not attractive.
- Digital Cameras … market is huge, growing fast, but existing suppliers are catering to it very well … in fact it’s extremely competitive – overall market probably not attractive for a new business opportunity.
- Casual Gaming … market is sizeable (~$2BN) and growing quickly but is not yet saturated with suppliers…in a market with a ‘rising tide’ often the suppliers are quite co-operative because everyone is winning at the same time – overall assessment very positive.
A great strategy is one that is practical to implement. There is no point having a rock-star management team and perfect business model if the implementation of the plan is fraught with risk and difficulty. Implementation risks can range from access to key resources (people, assets, etc) to customer hold-up (lengthening sales cycle) to fluctuating capital markets. As per our philosophy for business model, we look for businesses where we can see a clear path of implementation with proper risk assessment and mitigation in place.
Transaction Parameters
We seek to back entrepreneurs who are both optimistic and realistic about the value of a business – assumptions or justifications that look good ‘on paper’ may not stack up in the real world. When assessing businesses we are always interested to know how peer companies have performed. Whether they are direct competitors, similar companies in different markets or analogous business models – their performance and exit valuations are critical information. Prospective deals in which the return profile of our investment differs markedly from that of other investors or the overall growth and performance of the company would, prima facie, not appear to adhere to the golden rule of seeking to both maximise and align the incentives of all stakeholders.
Achievements
While we will consider funding complete start-ups, we prefer businesses where the founder has proven their tenacity and ability to achieve results on a shoe string. There is obviously a catch 22 of needing money with which to get results, and needing results with which to get money … but somehow some people just manage to notch up achievements on the smell of an oily rag. Achievements might range from winning awards to trialling products, however actual revenue and/or profit often hold the most weight because amongst other things they usually imply a reduced downside.
Flexibility
While the above philosophies have been developed over time and make a lot of sense, we are an opportunistic investor and will evaluate any business on its own merits. No business opportunity is perfect and in all cases we accept and attempt to manage a multitude of risks.
Art
Venture capital investing is as much an art as it is a science. As important as the above factors is that our team is excited for the opportunity. If we aren’t excited about it then we are probably not the right partner for you.
