It can be really challenging to analyse some sectors, as by their nature they have lots of moving parts and it’s hard to predict how a company within the sector will do – especially when that company is a start-up with little or no track record, and operating in a dynamic and constantly evolving, fast-moving industry.
Pharmaceuticals is one such sector, given many of the new treatments are novel and unique, originate from small research silos and have huge barriers to negotiate to get their product to market. Likewise, the technology sector is in a constant state of flux with new products and services being developed all the time. In some parts, the sector is dominated by global behemoths – it is going to be hard for any company to supplant Apple or Google any time soon – although the storied history of BlackBerry and Nokia illustrate that it can be done.
At the other end of the scale, we don’t know where and in what direction technology can take society. A case in point is the frenzy of interest in Artificial Intelligence with the rise of large language models like ChatGPT or Bard. Some commentators, no doubt wearing tinfoil hats, are predicting AI will lead to the doom of civilization. Others find AI, especially large language models interesting, but practically can’t see them having a seismic effect on society. Some financial analysts are urging investors to fill their boots to the moon; others can’t see how you monetise a clever web browser that sometimes understands sarcasm.
The situation is further muddied with many of the new players in the tech market being tiny, innovative companies, exemplifying the typical start-up tendencies. But despite these challenges the technology sector has the potential to be hugely rewarding for investors, with some companies offering triple-digit returns. These would be the fabled unicorns – but telling a unicorn from a donkey is an art, both have four legs, neigh and generally canter around. One will take you from virtually zero to a billion dollars, the other will give your money a good kicking and stubbornly refuse to move in any useful direction without a beating.
There are few unicorns out there – the best-known in recent times have been AirBnB NASDAQ:ABNB., and Uber NYSE:UBER but unicorn hunters need to be wary as some donkeys are often disguised as unicorns – Theranos being a case in point. That’s why it is sometimes better to err on the side of caution and outsource the stock picking and research to a specialist.
One unicorn hunter, that has been in the business for over a decade is Alexander Selegenev, executive director of AIM-listed TMT Investments LON:TMT who explains how his fund is striving to find the next big thing in tech.
Unicorns are mythical creatures that inspire the imagination – and imagination, as Einstein was fond of saying, is everything.
In the tech investment world, the term ‘unicorn’ is used to describe technology companies that have achieved a USD1bn-plus valuation. But achieving such a valuation, as we have dramatically witnessed in recent years, is a moving feast dictated by the market laws of supply and demand.
Richard Branson’s Virgin Orbit assets are currently being sold off for just USD36m, less than 1% of the USD3.7bn the company was worth when it went public in August 2021. At the other end of the spectrum, Chatbot Character.ai, launched less than six months ago, was valued at USD1bn in March this year, following a USD200m funding round as excitement builds up around the potential of AI to disrupt everything.
Given that valuations come and go and are impossible to predict, what is the ‘north star’ that guides our investment decisions? Well, we believe we have already found five unicorn companies since TMT was admitted to AIM in 2010. We would put Wrike, Bolt, Pipedrive, Pandadoc and Backblaze in this category and I’ll share a few of my own insights below.
Is it the people or the idea?
The journey to building a unicorn company is laced with sweat and tears, not words and ideas. It is this capacity to work hard, extremely hard, as well as being adaptable, creative, smart and agile, among so many other qualities, that we need to back as investors.
Therefore, when it comes to investing, our overriding criterion needs to be the people we back. If faced with choosing between people or idea, people will always win. Ideas without outstanding people to implement them will remain just that – ideas. No matter how innovative a business idea may be, the chances are that someone, somewhere, is already working on the same thing. Outstanding people capable of brilliant execution will therefore make all the difference.
Once we have identified outstanding qualities among the co-founding team, we need to check that their company project has high growth potential based on a product or service that can be scaled-up globally, the key words here being ‘scale-up’ and ‘global’. Scaling-up means having a business model that adds revenue at a higher rate than the growth in corresponding unit costs. The bigger the difference between these two growth rates, the more attractive the investment opportunity.
We also need to confirm that the total addressable market is sufficiently large to be worth it. Some of our portfolio companies (we have over 50 in the stable) operate in huge, established markets, such as Bolt in ride hailing and transport solutions, now active in over 500 cities globally.
Others operate in niche sectors, such as Timbeter in the timber logging management industry, whose services reduce waste in timber management and is active in over 61 countries, servicing over 10,000 users in 11 languages. Two very different companies in terms of revenue size and sectors of operations but both with large total addressable markets and scalable business models that can be applied globally.
In terms of practicalities, we favour companies at a growth stage: companies that are already generating revenues with a typical minimum revenue threshold of USD100,000 per month, at Pre-Series A or Series A funding stage. This provides reassurance that there is a proven market for the product or service, whilst still being at an earlier stage of growth that provides lots of potential growth upside. As an initial investment, TMT will typically invest USD500,000 to USD1m in each company.
Last but not least, we want to see a viable exit opportunity. This means assessing the level of M&A and exit potential from the very beginning. In terms of investment sectors, we focus on areas in which we have long-standing expertise: SaaS (software-as-a-service), marketplaces, big data/cloud, EdTech, FinTech, e-commerce, and FoodTech solutions, whilst investing selectively in other sectors when attractive opportunities present themselves.
Energy, focus and speed to market
Energy, focus and speed to market are three things we look for in people, together with ladles of resilience and the ability to achieve a work-life balance that sets them up for long-term success and avoid burn-out. You only really get one shot as a start-up: in the current funding environment if a start-up hasn’t made significant progress when it comes to its next funding round, it’s likely to be curtains. Unable to raise its next funding round, the start-up will lag behind its peers and enter into a vicious, downward spiral, and most likely start braying, like a donkey. Again, the wisdom of backing the right team becomes more evident the further the company progresses through its funding journey.
We’ve all likely met, or at least seen on TV or in presentations, the founders of tech companies whose eyes gleam brightly and ooze energy and passion about their business idea. While that is good to see, it can also be a warning sign if behind that passion and energy we discover that the founders carry inherent flaws that will turn out to be their Achilles heel, for example if they don’t really understand their market clearly, or if they have a stubborn streak that impedes them adapting their model to fast-changing circumstances. That is why we really value humility in the founding team.
One of the main reasons for investing in Scentbird, the perfume, wellness and beauty product subscription service, was co-founder Mariya Nurislamova’s excellent understanding of the challenges, as well as opportunities, that Scentbird was set to tackle.
Scentbird had been selected for Y Combinator’s cohort at the time TMT invested in 2015, arguably the world’s most prestigious accelerator, and in a lively presentation to alumni Mariya’s openness to learning from mistakes is truly refreshing to see. Scentbird went on to raise millions of dollars in new funding. Since then, it has expanded into wellness and beauty products once its hundreds of thousands of subscribers confirmed its leading position in the US’s perfume subscription sector.
We also like to see two or more co-founders running the company. Getting a start-up successfully off the ground is one of the most stressful activities imaginable. Co-founders truly benefit from sharing and testing ideas together, and providing moral support and companionship in what will be an arduous and long journey.
Linked to this, the founder or co-founder team should still retain a majority control of the company at an early stage of development when raising pre-Series A or Series A rounds. We need to see that founders remain motivated with sufficient equity as they are diluted with each successive funding round on the road to unicorn status.
Unicorns past and present
As an investment company, our job is to make positive returns for our shareholders. This means being attentive to suitable exit opportunities at the right time. These are hard to predict of course, but as the saying goes, a bird in hand is worth two in the bush. We therefore carefully consider and capitalise on exit opportunities when the right opportunities present themselves.
Prime examples include TMT’s exit from project management software company Wrike, which generated a USD23m cash exit and a return of 23x initial investment when it was acquired by Vista Equity Partners in December 2018, and the USD41m disposal of TMT’s interest in sales management software company Pipedrive to Vista Equity Partners in December 2020, which generated a total cash return of over 51x on investments made in 2012 and 2013. Another chunky return was the USD20m in total cash exits from Depositphotos we realised in 2016 and 2021, which generated a total cash return of 5x.
We reinvested the proceeds of those exits together with the USD19.3m fundraise carried out in October 2021 into building TMT’s cohort of potential future winners. In the fast-moving tech world, we remain committed to reinvesting both cash and accumulated experience into identifying the budding unicorns of the future, in whatever guise they present themselves.
Unicorn-hunting isn’t for the faint-hearted. It’s a lot of hard graft, toil, sweat and sometimes tears. However, should you find the next big thing all the time and effort you put into your search will be worth it.
Happy hunting!