Early Stage Investment Dynamics in an Emerging Market

In early stage investments there are several risks and factors that investors should carefully mitigate and control. Here I isolated many factors that affects the performance of the company and focused simply hypothetical entry and exit valuations and three basic growth scenarios that an investor faces with.

Lets assume we have three companies, all three has a pre-money valuation of 2m and we invest 1m into all three. Within 24 months; company A reached a cash positive stage with a good EBITDA margin, growing and no need for working capital and new Capex. In this case, there will not be a new investment round and we will be seeking an exit at an optimum time. Assuming the revenue growth will be proportional to the invested capital, this company will make 1 to 3 million EBITDA in a few years and the valuations will be somewhere around 10 to 20 millions.

On the other hand Company B and C, will continue to grow and this growth necessitates new investment (either Capex or Working Capital need of the business plan). Assuming 5m new investment has been made with pre-money valuation of 10m into B and C. In company B, we took the lead at the investment and put 5m; in company C, we remained silent and a new investor did the deal. After new cash, the EBITDA of the company B and C realized between 2 to 12 million and the valuations will range around 20 to 100m in a few years.

The chart below shows our exit multiples at these companies. Note that we assumed, we were lucky enough to make exits at these fair values for all three companies.


It is interesting that if we do just a one round investment and make our exit at company valuations around 20m, we reach about 7x exit multiples. Whereas, in order to catch these multiples in other two companies we need to reach valuations 70 to 110m respectively.

The capacity to create 100m+ companies in a few years would be limited in Turkey, on the other hand creating gazelles* being valued around 10 to 20m is more likely. And an investor who can solve the exit puzzle in these gazelles will have a very satisfactory return performance and will have abundant of opportunities to invest.

* please refer to previous posts for the definition of gazelle

We are hunting Gazelles

While I was checking the updated 2014 data about SMEs in Turkey I saw that a significant change in our SME’s comparative performance indicators among EU countries (see figure below from SBA Fact Sheet 2014). This is not only due to evolving competitive climate for SMEs but also a change in scoring criteria which I presume now represent Turkish case better.

The same report also says: “Turkey has an excellent overall score in this area, far above the EU average and without any sub-par results. This puts the country amongst the best performers. Turkey does particularly well on entrepreneurial education thanks to a strong institutional support framework. Entrepreneurship is an integral feature of Turkey’s lifelong learning strategy, accompanied by an action plan which also addresses entrepreneurship in secondary education. This might explain why the country shows a higher rate of early-stage entrepreneurial activity than the EU.”

Good. Lets keep going….






By a definition made by Birch, Gazelle is a high growth SME which usually constitutes 3-8% of all industry, other SMEs are either life style businesses or surviving with no growth. In fact, the biggest contribution to the growth are coming from Gazelles. Criteria for high growth is somewhat different, OECD uses a definition of: “All enterprises up to 5 years old with average annualized growth greater than 20% per annum, over a three year period”.

We have about 34K small & medium enterprises (gazelle definition starts with 10+ employees). But we don’t know the proportion of Gazelles in this mass (it requires measurement of growth) in Turkey.


source: SBA Fact Sheet 2013

Another interesting piece of information in SBA Fact Sheet, is that our SMEs have far more higher performance on entrepreneurship among their EU peers, whilst they fall behind on almost all other criteria (think small first, internationalization, second chance,…).

Good, we have the spirit at least, despite all odds our founders strive to be the best. But the upsetting piece of information is at the measurement criteria of the entrepreneurship. We are falling behind EU average only at the “opportunity driven entrepreneurship”, which I believe this measure create Gazelles.

We should focus on both at macro and micro levels to create and support Gazelles. Opportunity driven business is one of the ingredients of the growth. The support mechanisms should be able to distinguish this parameter. Venture Capital, naturally seeks for growth and opportunities. We don’t like life style businesses, and it is a nightmare to have a lifestyle business in a portfolio. Therefore we are out of the steppes looking to hunt Gazelles.

Additional Data:



“Sending entrepreneurs to US”, what’s in it for us?

I have been hearing lately, several entrepreneurial events with winning prices as sending entrepreneurs to Silicon Valley for pitching their projects/start ups or events where several North American Venture Capitalist / Angel Investors meet up with Turkish entrepreneurs.

“How effective are these” is another question, but lets assume it worked. At least the investors have the luxury of seeing pre-screened best of the best Turkish projects. At the very early stage, the company will be easily migrated to US either through acquisition or by offering a job to the entrepreneur. If that is the case, the mere result will be the loss of an SME who might have a substantial contribution to the national economy or in the least form loss of an intellectual talented entrepreneur.

Today I learned Sweden, has far more number of hi-tech acquisitions from US when compared to all EU countries. When I asked the reason why, the answer was: almost all these Swedish companies had US based investors at early stages who than introduced these companies to the acquirers. The same officer was also complaining that the acquisition of an hi-tech company was usually causing the loss of export generating company.

All these examples brings newer questions for Science and Technology Policy researchers, “what’s best for the country at the macro level?”.

From our perspective as being local VCs, we may nurture the local entrepreneurs before they go to US prematurely, perhaps bring in foreign investors who might contribute to the global business plan of the company. With that, contribution to the local economy will be higher until we make exits.

Can VC bridge the divide between Universities and the Industry?

We have been following the IP 2014 conference at Boğaziçi University in the last two days. One of the main subjects was university-industry partnerships. Research institutions were criticizing the industry because of their reluctance to R&D, whereas panelists from the industry were measuring their R&D performance with square meters of technopark space they built.

Another colleague who is managing a TTO was telling the needs of their local industry were being found too primitive (not to be leading an invention to be published) by the academics or if the research subject is good, the industrialist were requesting full IP ownership which is an unfair model.

Although Venture Capital is not a solution for all, it might play a critical role as a catalyst for the above defined problems.

We seek a technology and innovation which enables a competitive advantage in our targets. Therefore Venture Capital pushes the companies to have or to build IP within their enterprise. One of the companies in our pipeline had a good business model in an emerging market segment, but the products they were going to deploy was going to be imported. After two months they met with us, they added critical R&D components into their business plan, they partnered with two research groups from two Turkish universities and applied for R&D grants. We will be conducting a DD on its technology whether this is a cosmetic move or not. But in any case we drive a push function.

On the other hand, for TTO originated projects or university spin offs, we are a partner having different objectives than the industry. As long as we hit our return targets, we don’t have an agenda to own or roll the IP into our enterprise, instead we have aligned interests with the universities and the inventors once we become partners.

I believe Turkish VC market can easily capture yearly about 50m USD investment (as a comparison Israel receives 1bln USD investment per year constantly since 2002) with increasing volumes each year. This now requires about ten investing VC Funds to be in the market, where only two investing funds we have (as a comparison Israel has 70 VC funds). And VC may bridge the divide between the universities and the industry with measurable results.

“Access to Finance”, Is it that hard in Turkey?

Quote from KOSGEB country report prepared for COMCEC :

“Despite their importance, SMEs have some weaknesses and constraints, such as

  • the poor grasp of technology, R&D and innovation;
  • low usage of bank credits;
  • insufficient access to finance,
  • insufficient credit guarantee system,
  • inadequate usage of modern marketing techniques,
  • unawareness of quality and trademark concepts,
  • insufficient educational level,
  • lack of capital for high technology investments,
  • lack of institutionalization,
  • low level of cooperation,
  • lack of harmonization with global standards.

Because of their small size, SMEs usually lack management capacity and often “don’t know what they don’t know”, and their capacity is generally poor.”

Another observation from a recent VC/entrepreneurship conference, two different international VC Fund Managers convey the same message:

“Turkish start ups do not make compelling presentations in their screening meetings, usually the investment case is seen as incomplete”.

What I understand from these comments is, they do want to invest and seek for compelling projects but there are better deals somewhere else other than Turkey. Better? I guess, less complex, well structured, technology trends aware, having good marketing and management skills/plans and know what to know for a VCist (exit). And if we look at the success stories having received multimillion dollar VC investments in Turkey, we see these characteristics at the founder teams/plans.

In fact this is only half way to the end of the story. Receiving VC funding would be a success for the founder, only if the VC investor make a good return from its investment, the story will have a happy ending for all.

If the building blocks of the business is there:

  • competitive technology/innovation and/or capability to enhance that
  • sound business/market potential,
  • product combined with a service which can be perfected with right contributions
  • committed team, trust among the partners and trust to VC investor
  • connectivity and openness to ideas, new experts/partners and willingness to collaboration

than I say presentation does not have to be perfect. As long as we, VC fund managers understand the nature and culture of local entrepreneur ecosystem (and SMEs), we can seek and pick the building blocks from imperfect presentations. It is our value add, to enhance, target and polish before and after deployment in addition to the capital we provide. Not to mention that, we have better entry valuations and conditions in these cases.

This puts more responsibility to the local VC teams but what extra advantage we have other than the global/regional VC competitors. We are close to the investees and we are happy with that.

A VC Strategy in Turkey

Should the common VC investment strategy, “a few of the investments in the portfolio outperforms other majority bad performers and normalizes the return of the fund”, be working in a market like Turkey?

The path to the answer is at the definition of outperforming. One of the key elements in VC is the diversification. You can increase the likelihood of having outperformers in a portfolio with diversification. This implies increased number of investments, and this results investments being made only into the the projects having outperforming potential. Therefore this causes several decent small businesses not to be receiving VC sourced capital.

On the other hand, there is a quantitative evidence that the risk on a VC investment gets lower as the rounds of investments (series B, C, D,.. ) increases. If you can imply a staged investment strategy (it also has its pitfalls), you may receive a normalized high return (lower than the return of the 1st stage) while lowering your risk and increasing the concentration of investment with the target return in a portfolio.

Turkish micro & small cap (from early stage to SMEs) has abundance of investment opportunities that has sound business potential to bring 6x or more returns (but little chance for a 10+X return) and if receive further funding provides a normalized return prospect (3-4X) with lower risks. This implies the common VC strategy may not be appropriate for Turkey. Focusing on decent businesses and increasing the weight of the staged investments in the portfolio would be an achievable approach at the current market dynamics.

As this is the case, instead of pushing founders and SMEs to unnaturally transform their business into a global business setup or make it disruptive, we may let them do what they can do best (outliers are always welcomed). In the mean time we should be focusing more on creating a deep and liquid secondary market in Turkey to solve the next big problem “exits”.