Buttonwood has posted an excellent analysis of why financial markets are unlike other markets for goods and services:
This apparent contradiction can be resolved. Financial markets do not operate in the same way as those for other goods and services. When the price of a television set or software package goes up, demand for it generally falls. When the price of a financial asset rises, demand generally increases.
Which explains why bubbles develop and burst and why ‘market fundamentalism’ does not generally serve us well when thinking about financial markets (as opposed to other markets.) Buttonwood also alludes to the fact that bubbles often develop at times of great change (has he read Perez???):
Why not just let the markets rip? Some would say that bubbles tend to coincide with periods of great economic change, such as the development of the railways or the internet. Individual speculators may lose from the resulting busts but society gains from their overoptimistic investments. However, this argument is harder to sustain after the recent bubble in which society “gained” some empty condos in Miami and holiday homes in Spain.
His conclusion is that because of these structural characteristics of financial markets, central banks (and possibly regulators and/or governments) have a natural, pro-active role to play in trying to mitigate or counter these problems.
Of course a few investors – the most high profile being Warren Buffet – have successfully arbitraged this weakness in capital markets buy being countercyclical, being “greedy when others are fearful, and fearful when others are greedy”; but as most people know this is bloody hard to pull off and exposes the investor to significant liquidity/solvency risks if they get the timing wrong. As Keynes said, “the markets can stay irrational, longer than you can stay solvent…” If you have an edge, even a small one, doubling down will usually work as long as you have an infinite bankroll. Ooops, small fly in the ointment. (Besides, if you have an infinite bankroll, what the hell do you need to bother about worrying about returns!)
Well I have neither an infinite bankroll nor the skills (and/or luck) to adopt a Buffet-esque investment strategy. But I do have some skills. And some experience. And I can recognise patterns reasonably well. And I have conviction. And a reasonable track record for building new markets and adopting and executing novel business models. So a few years ago I figured out that by focusing these modest talents and skills on investing in and helping to build new businesses, with a lot of hard work and days and months of research and reading I could generate pretty decent financial returns that were (almost) completely uncorrelated with the massive tides that buffet the world’s financial markets. And most importantly, this lack of correlation is structural – ie it doesn’t disappear in violent bear markets when almost all mainstream asset classes discontinuously jump to near perfect correlation (much to the chagrin of the VaR boys.)
It’s not hard to understand why. In fact it’s pretty obvious. For a new business, the ups and downs of the market, GDP, etc. have at best a second or third order effect on the company’s value. These factors are overwhelmed by the single most important factor driving value creation which is of course, can the company successfully sell it’s products or services to paying customers (or be more and more clearly on that path.) As someone wise once said: a “start-up is not GM” ie They are not correlated to GDP.
Now don’t get me wrong, I’m not suggesting that investing in new companies is without risk. In fact as most people would glibly observe, investing in start-ups is ‘very risky’. Well yes, but the risk is almost entirely idiosyncratic and manageable – much much less dependent on vast, uncontrollable, macro-economic trends and forces. And just because the risks are easier to identify and name, doesn’t mean it is easy to manage them, just that they are potentially (more) manageable.
So if this is true, why have venture capital returns generally been so poor (at least in the last decade or so) and why don’t more smart people try their hand at this (rather than trading/managing other types of assets)? Answering the second question first, I suspect this is because failing together is much nicer than failing alone, and so if the global financial crisis wipes out your hedge fund or investment bank or savings, well that sucks but, you know, shit happens. If however you pour your own (or worse your investors’) capital into a couple of dozen new companies that crash and burn, well that’s just a very lonely place to be. The answer to the first is not simple and you could probably write a book on this (perhaps Paul Kedrosky will?) but with the disclaimer that I don’t pretend to really know, my short and dirty take would be that there are two related factors at the heart of this failure. First, investing in new companies is hard to scale – at least compared to many/most other asset classes and secondly, the traditional structure of the industry is poorly adapted to this reality. Private equity legal and economic structures (which is how most venture partnerships are structured) doesn’t really fit the risk/reward/resource profile needed to invest successfully in new companies. Of course their are exceptions – both temporal and human – but just because their are some investors clever and/or lucky enough to make it work doesn’t make it right.
I could of course be wrong. And I could fairly be accused of hubris, especially as at this point I don’t have a long enough track record and/or enough exits to prove without doubt that my approach is correct. And while I am confident in my own abilities and have backed that up with a lot of “skin in the game”, I am even more confident in my larger analysis that while the venture capital industry might be broken / poorly organized, the risk-adjusted returns available to those who chose to invest – methodically and with a well-calibrated capital and incentive structure - in new companies, are excellent and, for the VaR-boys out there, truly uncorrelated to mainstream asset classes. The challenge is of course to find these investors and not to swamp them with too much capital. This problem isn’t solved but it looks a hell of a lot like the problem facing hedge fund investors (in most strategies that also do not scale beyond certain amounts of capital) and the asset allocation community would do well to try some of their more successful solution there on finding and seeding managers in this asset class.
And if you ask me, the rise of the ‘super-angel’ much talked about in venture circles these past months, is a step in the right direction and perhaps an indication that asset allocators are (finally) waking up to this opportunity.
You may have noticed that I haven’t posted much in the last couple months and given all the interesting things going on in the world it certainly wasn’t for lack of material. Breaking my arm obviously didn’t help increase my productivity (or make typing very easy) but it wasn’t the main reason for the silence. It’s much simpler than that: I was busy!
Busy investing in a whole bunch of super exciting and interesting new businesses. Busy working on the sale of ODL Group (where I was the lead independent non-executive director) to FXCM to create a true global leader in FX trading. Busy working with my partner Uday and FT Advisors on a number of interesting strategic advisory projects, in particular focused on the electronic and algorithmic trading space. Busy helping two of our portfolio companies raise follow-on financing. Busy working on our own corporate structure and capital raising where I hope to be able to communicate some exciting news in the not too distant future. Busy.
So what have we been investing in? Here is a quick rundown (in alphabetical order):
Babuki – 2008 seedcamp winner, launching soon (will update) with an innovative platform for social gaming
Blueleaf – investment information management and planning software “to help people like you see all their savings and investment accounts in one place; understand their financial information more completely, more quickly; securely share information and collaborate with spouses, family or advisors; save their data, even if they change financial institutions; and maybe most importantly, help them stay financially safe and secure.”
Timetric – builds services to make sense of time-series statistics, based on the Timetric Platform: a proprietary service for publishing, analysing, and performing calculations on very large quantities of time-varying statistical data. Have a look at this neat little demo website they have built for tracking equity portfolios.
Metamarkets – provides global, real-time media price discovery by aggregating billions of electronic media transactions in order to deliver dynamic price data, proprietary price and volume aggregations, and comprehensive analytic media market views to sell-side media principals.
[not yet closed - will update soon]
Over the next few weeks or so, I plan to do a proper write-up on each of these businesses and the reasons we think they have bright prospects. So watch this space.
Huge congratulations to Stefan Glaezner and Eileen Burbidge for creating the White Bear Yard space for start-up entrepreneurs in central London. I’ve seen the space and it’s terrific with the only (very small) downside being a reasonably long walk from the nearest tube station.
Since we embarked on our Nauiokas Park adventure, one of the elements of our vision has been to create a common working environment allowing us to be close to the companies we invest in, but more importantly bringing together the hard-to-quantify but very real benefits of having a shared working environment. Having spent 15 years working on trading floors, I know what the advantages (and disadvantages) are and for very early stage start-ups. In particular the benefits of just having some people around are huge.
We have a few different – and hopefully smart, interesting – ideas of how we would do this but they will have to wait until we have the necessary funding. Until then I’m only too happy to heartily recommend that any London based start-ups looking for space (and funding) talk to Stefan and Eileen and try to get a desk or two at White Bear Yard.
Fred Destin wrote an excellent post mapping out the appropriate roles for a founder/CEO vs a non-executive/investor in a start-up. Actually, his advice holds true for any company but I suspect is much more often a problem in start-ups due to the executive teams generally having little or no real experience of working with and for a Board of Directors. I’m not going to rewrite or paraphrase his post, here is an exerpt but really if you are a start-up executive, please just go read it:
If you really believe in what you are doing, you come to the board telling board members what you are planning to do, taking considered advice on whether this is the right strategy, considering that advice and executing on what is, in your best judgement, the right path for the business. That’s what you are there to do. Take decisions fast, don’t fall for analysis-paralysis, trust your gut, execute and iterate. As Tim Ferriss would say, ask for forgiveness, not permission.
I particularly liked his list of why executives need to know how to manage their non-executives and filter their input:
Here are the top five lighthearted reasons why VC’s should not drive your strategy:
We forget 50% of what we said at the last board
We don’t know the people inside the company and hence have no clue what the team can really execute
We meet many smart people and hence we have way too many ideas that you cannot possibly implement
We are focused on the 5 year vision, yet we are focused on the quarter too, even we are confused
We don’t need to deliver on it, you do. We come and collect when the job is done.
Item 1 and 3 hit particularly close to home!
The (dysfunctional) situation Fred describes reminds me of American football where the coaches (non-executives) are constantly telling the players (executives) what to do. I think the dynamic that is needed in a corporate setting is much more rugby, the coaches work with the players throughout the season, helping them to develop both their individual skills and a positive team dynamic, scouting the competition and staying on the lookout for new talent, but ultimately when the players run out onto the field, they are on their own. They need to make their own decisions and they determine who wins and who loses. The coach? Well he sits in the stands and watches. I’ve never seen one yet who scored a try or kicked a goal.
As many of you know, last week was ‘seedcamp week’, the third one since following Saul and Reshma’s initial inspiration in 2007 when what was to become Nauiokas Park became one of the founding investors alongside the (better known and more established) giants of European venture capital. In fact I think it is fair to say that seedcamp may well have been the catalyst which tipped me down the path to creating Nauiokas Park which until that summer of 2007 had only been one idea amongst many percolating in my brain. So perhaps we are in fact the original seedcamp startup!
The concept and the competition has come a long way in a very short time and is testimony to Reshma’s energy and skills and Saul’s vision; I think the best gauge of their success is trying to imagine the European startup scene without seedcamp: hard to do. Perhaps the most exciting aspect of seedcamp’s evolution for me is seeing a more diverse and mature group of entrepreneurs rising to the challenge. And when I say mature I don’t mean older or later stage, but mature in the sense of marrying technical brilliance and/or an inspirational idea with a pragmatic and well-conceived business model. Gone (or mostly) are the ‘build-it-and-they-will-come-and-we’ll-sell-them-online-ads-or-something’ innocents of yesteryear. In their place this year we had a great, diverse and passionate group of talented entrepreneurs who not only had a lucid approach to building a business and making money but also seemed to be incredibly well prepared in terms of knowing exactly what they didn’t know and getting the best out of the amazing group of mentors that is the seedcamp community. Indeed my greatest regret this year was missing a day of mentoring due to an unavoidable (and unscheduled!) board meeting – not only because it meant I didn’t get to meet as many of the teams in person as I would have liked, but also because I didn’t get to soak in the advice and world views of the many other great mentors in parallel.
Judging this year was both easier and harder than in years past. Easier because almost every one of the finalists had a strong and reasonable claim on being a viable business; harder because it was less easy to choose from such a large and diverse number of relatively closely matched competitors. In no particular order, my favorites were Boxed Ice (whom I had originally met at mini-seedcamp London and been impressed), Erply, Codility, Talasim, Joobili and Fabricly.
Of the finalists this year, once again very few would fall within our investment universe and indeed that is something we’d like to help change going forward. Resource constraints – time, money, people – have not yet allowed us to pursue this but I would love to work with seedcamp to run a mini-seedcamp ‘Finance’ to source, develop and encourage more startups to go after a market that is just crying out to be disrupted. Indeed after the incredible success of the geographically focused mini-seedcamps in 2008/2009, perhaps it might might sense to extend the mini-seedcamp idea down a sectoral vector next. While the variety of sectors and business models represented in the applications this year is certainly more varied than in 2007 or 2008, in my opinion the relative lack of diversity is probably one of the few important remaining weaknesses of seedcamp (and indeed the startup ecosystem in general.) Erply, Pearl Systems and Fabricly, while on the edges of our investment universe are definitely companies we will keep an eye on going forward. Fabricly in particular could become more interesting to us if and when they focus on developing their position as a central clearing-house in the fashion supply chain; I thought they had an excellent team and were unlucky not to have been amongst the winners. I was also very impressed by the team at Erply and would question the thinking of anyone who would consider the opportunity they are pursuing as ‘boring.’ With respect to our investment universe, Codility and Advertag I would say are wildcards insofar as their current business models would not fit within our approach but I suspect both have technologies that could be repurposed to target financial services and markets more specifically. Ones to keep on the radar screen perhaps.
Although I am relatively less active than I might otherwise be as a direct result of my significant commitments (of both time and capital) to Nauiokas Park, I have managed nonetheless to make a handful of angel investments over the past couple years, three of which have been seedcamp winners or finalists: MyBuilder (2007), School of Everything (2007) and Kyko (2008, launching soon…) In this year’s class I’d definitely consider investing privately in Boxed Ice, Talasim, Joobili and Fabricly but unfortunately its clear there is no way I would be in a position to lead any of these given my constraints, but if/when they do decide to raise outside capital I’d love to see a term sheet…
If innovation grows at Nauiokas Park, some of the best seedlings come from the fantastic seedcamp nursery. We were particularly pleased that folks like Timetric, CityOdds and GymFu walked away winners from the London Mini Seedcamp in April after we had encouraged them to apply. And so with this in mind I want to encourage ambitious, intelligent and passionate entrepreneurs, young and old(er) to test out their vision, ideas and execution skills at seedcamp week 2009. There is only two weeks left to apply and I sense that the competition for places will be very keen indeed, so don’t leave it until the last minute to get working on your application.
On behalf of Nauiokas Park, I would particularly like to encourage and see more start-ups focusing on disruptive innovation in the financial services arena. There is so much opportunity in this vast sector of our economy and yet it seems as if many or most entrepreneurs tend to avoid applying their technological or business model creativity and innovation to this market. Clearly there are some barriers that don’t exist in other sectors or markets but by the same token, in many instances, the potential rewards are accordingly significantly higher.
In any event, for any ambitious start-up in Europe (or even further afield) today, applying to seedcamp is a no-brainer: even if you aren’t selected as a finalist, the work needed to submit a robust and cogent application will serve you in good stead as you look to build out and finance your new business. If you are a finalist, the contacts you make and the information you will absorb during the week are something that can not be bought for any amount of money. And if you happen to win – well that’s just icing on the cake! So what are you waiting for? Apply! You’ve really got nothing to lose.
The deadline (midnight, 6th April) for applying to Mini Seedcamp London is rushing up quickly (where does time go?) and for any budding entrepreneurs out there with a company up their sleeve or in their garage, I can think of no better place to start ‘growing innovation’ than in the seedcamp community.
Mini Seedcamp London aims to connect the UK and Ireland’s thriving startup community, but the buck doesn’t stop there. If you are a startup team that is ready to wow us and you hail from anywhere in the EMEA, don’t hesitate to apply.
Mini Seedcamp London will be bringing together 20 of the best seed stage web tech startups with experienced entrepreneurs, investors, and developers from the UK and all over Europe to participate in a day of intense mentoring, panel discussions and presentations at NESTA’s HQ in central London.
London is increasingly becoming the hub of the European entrepreneurial ecosystem, with a high concentration of investors, startups and talent and we’re exciting to see what teams and ideas emerge on 20th April!
Of course as founding investors in seedcamp we have a particular interest to encourage the best and brightest and most energetic entrepreneurs and engineers to join the community but I think you’ll find that it is worth it. We’d especially like to see more companies focused on disrupting financial services and markets. Media and consumer internet are fascinating sectors but there is more to life and if an industry ever screamed out to be disrupted, it’s finance in 2009…So what are you waiting for? Apply now!