(an edited and shorter version of this article appeared in the Financial Times on the 14th of April, but this is the original article)
Venture Capital as an asset class is frequently derided as a failure in Europe. Speak to any fund of funds firm in Europe (and I have spoken to a hundred of them), and they will tell you that no one makes any money on venture capital in Europe. The big names in European early-stage venture in the late 1990’s have either moved upstream to buy-outs (Apax), disappeared (3i, NetPartners), been acquired (Quester, Frontiers Capital) or the investment teams have moved on (Benchmark, Add Partners, Atlas Ventures). Even the big venture capital firms do more growth capital than early stage/seed investments today.
The reality of entrepreneurship in Europe however over the past decade and a half has changed dramatically. We have today successful >€100 million firms such as Shazam, Spotify, Monitise, and Seatwave. Exits such as Autonomy and Skype where they have become major business units for their acquirors have shown the significance of the “start-ups” which are being built.
But Monitise, now with a market capitalisation of nearly $500 million, and backed by VISA five times, wasn’t backed by a venture firm, but a systems integrator – Morse PLC. Dialog Semiconductor was floundering on the Frankfurt Stock Exchange until the current CEO Jalal Bagherli got into the cockpit. Other European big hits such as Net-a-Porter, Rovio (Angry Birds), Tiscali, SAP weren’t backed by VC’s until it became clear that they were going to be successful or at all; that is, it wasn’t risk capital. Rather, once the founders took the risk and built the firm, investors came in to profit from their hard work. Non-tech firms like Ella’s Kitchen are becoming major players without outside funding.
New venture teams like Amadeus Capital, Edge Investment Management, Enterprise Ventures, Dawn Capital, DN Capital, Mangrove, Wellington and Northzone have developed in parts of Europe creating franchises with strong teams. And yet very successful entrepreneurs like Glen Manchester with Thunderhead, his second venture, or Alex Cheatle with Ten UK, or Sara Murray of Buddi, her fourth, have bypassed the venture community entirely.
So, new successful tech-enabled firms are growing in Europe. Exits are happening providing returns to shareholders. And yet, the institutional investment teams that would put pension fund money into venture funds remain resolutely against venture capital as an asset class. Very successful US funds like Kleiner Perkins, Sequoia Capital and Bessemer Ventures have felt that they could stay out of Europe, and just do one off deals from a Partner flying in.
What’s wrong with this picture?
First let’s take a tour through the (incorrectly held) home truths that are commonly accepted, and some of the bad advice that the venture community operates on in Europe today.
- Raise at least €200 million in your venture fund and/or as much as possible
New fund managers are told by institutional investors that they have to have €200 million to be credible. Fund of funds want to deploy no less then €15 to 25 million, so it's not worth it to invest smaller amounts. Also, a key driver for the larger funds (north of €50 million) is to have large management fees so that the venture funds' partners can pay themselves larger salaries. (They should be focused on making capital gains). Typically investment teams don’t like to crowd into small cramped offices; black marble feels so much better.
Once you have hundreds of millions under management, the temptation to overinvest in tech firms is enormous. You want to put lots of capital to use – not because the start-up has hit a big milestone necessarily, and figured out what their operating model is – but because you have a big fund, and doing small deals won’t deploy the capital fast enough. The reality is that you don’t need a lot of capital to grow a tech firm today. The cost of technology has plummeted due to the standardisation and componentisation of technology. Beatthatquote, a financial services price comparison firm, had no more than £500,000 of investment in total, and was sold to Google for £37.7 million five years later. Many many VC-backed tech start-ups in Europe pre-2006 raised too much capital and will never get a return through a tradesale because the multiples just aren’t there. I could name names here, but I won’t.
- Don’t use your own capital; whether a venture capitalist invests his/her own capital is not the point
Fund managers are like most people – if you can have the luxury of spending someone else’s money, why not?; one of the most important considerations for a fund of funds manager to look for in selecting a venture capital fund to back is how much the General Partner has invested of their own capital. One of the dirty little secrets of venture in Europe is that most VC’s are really just employees, and aren’t risking their own capital. Nothing wrong with being an employee, but if you are there to select the winners, and haven’t built and sold your own business before, it’s hard to see what you bring to the table. You can’t do venture capital – at least in the early stage, high-growth end of the market, by analysing the market as a McKinsey or Bain consultant would. Go to market strategies are inherently adapted on the ground fast; a good entrepreneur can interpret market signals that he/she has the right product but the wrong business model, for example, and pivots fast. If you are coaching that entrepreneur, and you’ve never been in their shoes, and never experienced the near death experiences that they will be facing from time to time, you will as a venture capitalist either panic or be annoying to the management team who are probably working 100 hours a week to drive the business forward.
- Control the founder. He probably can’t make it as the CEO. Alignment of interests is for wimps.
This has been one of the most crippling “beliefs” in European venture capital – that the entrepreneur doesn’t have what it takes to become a Bill Gates, Larry Ellison or a Steve Jobs. Nothing trumps founder passion, and everyone is a first time CEO once. Actually, what you want with an entrepreneur is the strongest guy possible – NOT someone who you can easily keep under your thumb as a VC.
Furthermore, there are so many things that go wrong with a high-growth tech start-up that alignment of interests must be the basis of the investment or you have a truly dysfunctional experience which emerges. Many VC’s put in liquidation preferences, which give the VC a preferential return, which stack the deck against the management teams, creating animosity between investors and management.
On one of my first investments while I was an Assistant Director at New Media Investors in 1998, I was taking a start-up around the London VC scene, and one by one, each VC asked the founder when he was going to get a real CEO in to run the business. As we would leave these venture firms, he would turn to me and say, “Julie, take their name off the list; we’ll send them the press release when we go public for a billion.” The entrepreneur did indeed go public, and sold his firm to an industry player for $600 million within a decade of having founded it. He is widely perceived as one of the UK’s leading entrepreneurs, and yet more than a dozen VC’s in 1998 discounted his ability to become a good CEO.
So what’s the answer? I think it’s really very simple: follow the entrepreneur. He/she has the market insight. He/she has creative genius. He/she is the hero.
Throughout history, capital has always followed the ideas and those with the ideas who have shaped the era. Whether it was Michaelangelo or Christopher Columbus, the financiers of the day knew that it was really the adventurers, artists, creators who were building the future, not themselves as the financiers.
In fact, money is like a heat-seeking missile – searching for the best return. What fascinates me about the much-trumpeted financial services industry in the UK, is that it has forgotten that it isn’t an industry. It is a service industry to industry. The proper role of the financier or venture capitalist is to find the industrialists of the day and to back them. When they move outside of that scope, when they don’t risk their own capital, and they don’t align themselves with the growth plans of the industrialists that they back, then bad things happen which destroy economies and tear apart societies.
So I argue that we must get back to basics. As a venture capitalist, it is not your job to be the smartest guy in the room, but to find her (or him). Your job is not to thump the table and demand to know where the sales are, but to free up the CEO/entrepreneur to not worry that he/she will be tossed out or crushed by the venture firm so that he is capable of closing big deals for the firm.
Europe and the UK are being redefined by their entrepreneurs at this time. We are fortunate indeed that there exists a group of people who are willing to live abnormal lives to bring the future to us. For all of society benefits when one of them breaks through, and when a team tastes financial success. All of society benefits when a supernova exit occurs and that man or that woman can plough his capital gains back into backing the next crazy guy who’s willing to live an abnormal life….