AMEE announced today that they had closed a new round of financing. I think this is a fascinating company and compelling opportunity. Given the chance, would I have for certain chosen to invest? Based on what I know of the company and its management, I would like to say yes. Probably. I’m forced to hedge my opinion because I just don’t know enough, especially with respect to the financials and the attractiveness of the valuation given the opportunity. But given what I do know, I would have loved to have them in our portfolio. And I’m certainly more than a little disappointed that we weren’t in a position to throw our hat in the ring, do our homework and at least make an offer…
Which brings me to an idea I’ve been toying with for the past several months. I’ve been contemplating publishing a virtual portfolio of venture and private equity investments – ie the investments we would likely have made (and would make) had we the capital available. A sort of an analogous take on Covestor or Marketocracy but for private investments.* There are however a number of reasons I have not taken the plunge. Perhaps most obviously is the issue of proprietary knowledge. After all, the heart of the value proposition we make to prospective investors is that we have a unique and robust investment thesis and that based on this foundation, we have identified (and will continue to identify) exciting young companies who are naturally adapted to grow and prosper in the coming years. If we tell everyone who these companies are, why would anyone need to pay us a fee? Why wouldn’t they just invest directly. Or more likely, why wouldn’t competing investors just ‘free-ride’ on our research and analysis, using our list as a filter or more? And what if the companies we listed failed (see below)? What benefit would there be to publishing such a list?
Further, there are a number of structural factors at work that mean that the ‘Covestor’ metaphor is imperfect at best and fundamentally inappropriate at worst. Investing in private companies involves a number of challenges that are different/additional to those faced by a public company investor. A number of these factors are interrelated but for the sake of clarity I’ll try to enumerate a few:
deep information deficit: for most of the companies that would appear on such a list, our information is significantly limited, especially with respect to financial aspects (budgets, sales, valuation, etc.) As a practical matter it is usually not possible to obtain this level of detailed information unless one is actively engaged with the company in view of a potential investment. Obviously it would be completely disingenuous for us to misrepresent our capacity and intentions simply in order to be able to put our slide-rule over the financial model. Further, without the potential pay-off of being able to follow through and invest in companies that pass due diligence and valuation muster, quite frankly we don’t have the luxury of doing such a deep analysis even if the company was happy to provide us the data.
price (valuation): while perhaps less important (within reason of course) the earlier you are in the life-cycle of a company, it is obviously a key input that is quite often unavailable. To be fair, one could possibly – at least for the purposes of such a list – assume that if respected investors participated in a given financing round that we would have been ok with the pricing too.
value enhancement: call it hubris if you like, but one of the key inputs in our investment process is understanding to what extent our participation as an investor can help reduce risk and accelerate success. Elements of this analysis can be done from ‘outside’ but without a deeper understanding of the business and in particular a personal relationship with the management team, it is hard to properly assess what value, if any, we can bring to the table. Some companies that look great to us from afar might just not be a good fit.
managing destiny: (a variation/specific case of the point above) particularly for seed and very early stage companies, one of the biggest risks they face is securing follow-on finance. In this context, a theoretical investment and a real investment are fundamentally different: there are many ways a company can fail. Failure is failure of course but I suspect there is a risk that some of the companies on our wish list might indeed fail to raise follow-on capital, whereas had we invested for real, we would be prepared to follow-on in most cases, mitigating if not eliminating this risk. Of course it’s probably impossible – even ex-post – to definitely identify companies whose failure was ultimately unavoidable (market driven) from those whose failure was only due to a financing gap.
The case for publishing such a list – assuming you can overcome some of the structural limitations outlined above – really boils down to building reputation and trust, both with potential investors and existing and aspiring entrepreneurs in particular and within the wider venture capital / private equity ecosystem in general. Part of me also likes to think that there is less risk, in terms of ‘giving away’ intellectual property, than would be the case for say a hedge fund manager focused on public equities: anyone can buy a public security, the same is not true of private companies. Wanting to invest is not sufficient to allow one to invest. Further, let’s be realistic: for better or worse, I’m not Warren Buffett or John Doerr or anyone really…will the fact that I say AMEE is a must own company really make a difference to anyone? More importantly (to me!), will it make it more or less likely that I will be able to use my skills to make a living identifying and investing in great young companies?
Basically the only potential downside to publishing a virtual or ‘wish-list’ portfolio I can see is the fact that one would have to assume that any nuance and qualifying information attached to such a list would ultimately get lost and that for better or worse, the companies would be inextricably linked to me without qualification. I was thinking that a list constructed as ‘Probables’ and ‘Possibles’ might just allow some useful qualification without diluting the impact. And yet, I hesitate. And I’m not sure why. So I thought I’d ask you.
Why should I not publish such a list?
What (if any) qualifications should I include, were I to publish such a list?
Why don’t other investors publish lists of deals they would like to or would have liked to have done? (before outcome is known of course!) (Or if any do, please tell me who/where.)
Today Markit Group announced that General Atlantic has invested $250 million, valuing the 7 year old company at a whopping $3.3 billion. Founded by Lance Uggla, Kevin Gould and Rony Grushka in 2003 to address the growing need for quality data in the burgeoning credit derivatives market, what followed was several years of unbelievably good execution and disciplined acquisitions which has positioned the company as a critical component at the heart of the trillion dollar OTC derivative markets. The products they provide aren’t considered sexy (something that is often given all too much importance in this status conscious industry) – but their data, valuations, indices, trade processing and other products and services are the plumbing that is key to the continuing operation of many financial markets. They are a great example of creating value by building a great platform and understanding how to monetize data. I had the good fortune to be a non-executive director from 2003 to 2006 and I can say without hesitation that this team is one of the best I’ve ever seen and fully deserve the success they have achieved. (Congratulation guys. Awesome, truly awesome.)
And I am certain there is more to come. Their primary constraint has and will likely continue to be the physical/logistical limitations of growing as fast as they have but each year they only improve and in terms of acquisitions the company they most remind me of (in terms of disciplined and deliberate execution) is Cisco. Besides, General Atlantic doesn’t invest in companies where they don’t think they can make 20-30% annual returns or more.
And yet many (most) people in the ‘start-up’/'tech’ scene whether in the UK or the US have never (or only vaguely) heard of Markit. (For example, I counted only about 50 or so tweets referencing the announcement today, less than for any TechCrunch launching start-up…) Why is that? Obviously I can’t say for sure but (in no particular order) would guess the explanation perhaps lies in the following:
not venture capital funded; funding initially came from it’s cornerstone customers, the investment banks, and then later from some very smart hedge funds
focused on the wholesale financial services industry (and not on consumer or media or other mass markets)
key products and services (and associated economics) unknown to those outside finance and even worse generally considered ‘boring’
management team laser focused on execution, not PR (although to be fair they had this luxury not needing to sell to the mass market)
and so folks like TechCrunch and VentureBeat don’t know or write about them (aka “if a startup isn’t listed in CrunchBase does it really exist?” syndrome)
Indeed for me, Markit is a poster child for the cognitive, cultural and expertise chasm that exists between ‘Wall Street’ and ‘the Valley’ (or the ‘City’ and the ‘Roundabout’ to use the less good UK-centric metaphor.) They might as well be on different planets. Indeed bridging this divide is at the core of what we set out to do at Nauiokas Park and was the driver that led Paul Kedrosky and Tim O’Reilly to launch the Money:Tech conference in 2008 (which sadly didn’t survive the financial crisis and quite frankly was met by a deafening indifference by the vast majority of the Wall Street side of the equation.)
And yet, the opportunities available to those who can successful bridge this gap are enormous. Well, anyway that’s what we think. And the crisis in venture capital ostensibly caused by too much capital? I’m going to disagree with Paul and Fred and suggest it’s not too much money overall; rather it’s too much money concentrated with too few investors, focused on too few sectors, who end up all chasing the same deals. So to the LPs out there my message would be: don’t shrink the pool, enlarge the opportunity space. Oh, and try to make sure you’ve got exposure to the next Markit Group.
This week NEA announced the close of their latest fund at $2.5 billion. That seems like a lot of money for one venture fund, although perhaps if the intention is to focus on (highly capital intensive) clean tech and/or biotech they will be able to deploy this amount effectively. Of course NEA, founded in 1978, has a long and successful track record, with I imagine many long-standing relationships with LPs and excellent ‘brand recognition’ within the universe of potential LPs, and so it is hardly surprising that they are able to raise such large funds. After all – especially with respect to institutional investors – the analog to the ‘nobody-ever-got-fired-for-buying-IBM” paradigm operates in their favor.
A couple years ago, when I first started thinking about what would become Nauiokas Park, a good friend told me that private equity was all about raising capital, not investing it. Of course I understood what he
…private equity is about raising money, not investing it.
was saying, but thought he was using hyperbole to make the point that raising capital was more important than just a means to an end (investing.)
Now I understand that however cynical it may sound, he wasn’t trying to be clever: the way the institutional marketplace for private equity (including venture capital) is structured is all about raising capital and only incidently about investing that capital.
For better or worse, the year-end is typically a time to step back and take stock, to reflect on the year that was and the year to come. And indeed I have been thinking about what we could have done better or differently last year and what we need to focus on in this new year. And the short answer is we need to spend less time thinking about the economic and industrial landscape, developing our investment framework, sourcing potential investments and nurturing our existing investments, and more time soliciting potential investors: pitching our skills, our approach and the opportunity we believe exists to people and institutions that will determine whether or not we can turn our vision into reality. And like any start-up, we are going to have to be hard-headed about how we approach this as the proverbial runway is running out. As they say, there is a fine line between tenacity and obstinacy. I want to try to stay on the right side of that line.
Of course, once the lightbulb goes on it becomes obvious that raising money would be the most important talent of any prospective private investment firm: your LP’s, shareholders, investors are your customers (and not your portfolio companies.) They are they ones that ‘pay the rent’. They consume your service which is to invest their capital. Ah but the better the service, the more customers you have and the more successful you will be, right?
Well not exactly. In investment management generally it is very hard to determine a priori the quality of service one is likely to receive, which is why so often prospective investors – be they retail or institutional – fall back on historical performance to make their judgements. This reliance on historical data is clearly imperfect. However, when considering (many types of) hedge fund or mutual fund, given the typical investment horizon and liquidity profile, a consumer of these services can at least adjust relatively dynamically if they make a mistake. The effect of this is to reduce the psychological barrier to ‘taking a risk’ on any particular investment manager in these asset classes. But given the long time horizons and relative illiquidity in private equity, investors cannot exit a decision easily and so are (even more) inclined to stick with well-established firms and are less open to considering newcomers.
Basically “track record” is the box that needs to be ticked. And is much more important than having a coherent, well-researched and plausible investment thesis. After all, if you have the money, the deals come to you. But a track record in private equity is hard to come by quickly. (And it needs to be the ‘right’ kind: the first time I was told (by a prospective investor) that having been a founding investor in two multi-billion dollar companies didn’t ‘count’ because I wasn’t “a professional investor” when I made the investments was frustrating and somewhat irritating I have to admit.)
A company active in a two-sided market provides it’s services to two distinct constituencies. Often times, they provide those services for free to one side of the market, in order to increase the value of the services they provide to the other side of the market. For example, Visa provides consumers a free payments service (and actually often pays consumers to use their service via loyalty programs, cash back, etc.); in so doing they can charge merchants to use their services which have value to the merchants because of the number of consumers who use their platform. In effect, Visa sells ‘access to consumers’ to merchants. In a different context but the same vein, Google sells access to consumers to advertisers.
Successful private equity and venture capital firms “sell” access to dealflow to their investors and limited partners. It is a two-sided market. And so it is natural that network effects apply and rational for investors to be pre-disposed to the biggest, most established players. It is reasonable to think that NEA (and KPCB, Index, etc.) or Blackstone (and KKR, Carlyle, etc.) will see a high proportion of the best deals. So far, so true. But unlike electronic payments or algorithmic online advertising, investing (in private companies) does not scale and so unlike these markets, the law of diminishing returns kicks in much, much earlier. The industry (well, much of it) admits as much: I suspect if you offered the GPs of NEA a $10 billion fund, they would probably demur. Indeed I suspect if you offered USV a $500mn fund, they would probably turn it down. The key point is that for any given private investment strategy (sector, stage, etc.) there is clearly a maximum optimal fund size. For a company like Visa or Google, this is not the case – more customers, more merchants, more searches, more advertisers – it’s all good.
Jeff Bussgang recently estimated that the (US?) population of active VC partners was approximately 1000. I don’t know how many mutual and hedge fund managers there are but I suspect it is at least an order of magnitude higher than this. This seems intuitively wrong: investing in a private company is more work and there are more of them. You have a thousand investors looking at a universe of tens of thousands (or more) of investable private companies and tens of thousands of investors looking at investing in a universe of thousands of public companies…
Paul Kedrosky (and others) have written extensively and intelligently on how the venture capital industry needs to shrink. How too much money, chasing too few opportunities has destroyed returns. The logic is compelling. However I would posit that the problem is not too much money per se, but too much money with too few and homogeneous investors.
Let’s look at these two constraints sequentially (although they are co-dependent to a large extent.) If you double the number of GPs but provide ten times more investment capital, on average the valuations of the investments they make will go up five times (thus significantly compromising their future returns.) Ah but this logic assumes a closed system – ie that both the number and types of investments are held constant, and so increasing the ‘money supply’ drives inflation (and lower real returns.)
Well in a world where the number of GPs is constrained, and most of them come from similar geographic, educational and professional backgrounds, this assumption is likely to be more right than wrong. Indeed it is embedded in the initial conditions above – ten times more capital allocated to the asset class does not result in ten times the number of GPs. And yet the number of investments any GP can effectively manage is by definition bounded (at a reasonably small number.)(Which is of course why firms like Apax eventually exited venture capital and ‘graduated’ to private equity.) Perhaps an even more important gating factor however is the number of potential investments a GP can seriously analyze and consider each year (dozens? a hundred or two?)
And we uncover the Achilles Heel of the (otherwise extremely successful) ‘Silicon Valley’ model: the relative homogeneity of the environment leads inevitably to a collective narrowing of the universe of potential investments that is considered and amongst these, an additional narrowing in the way they are evaluated and considered. ie Everyone sees the same deals and runs the same slide rule over them. And so more capital simply means valuation inflation and ultimately, lower returns.
But what if we were able to disrupt this state of affairs? Having spent the past two years intensively researching the markets we are interested in, I simply don’t accept that the ‘problem with venture capital’ is a bounded set of investment opportunities. I’m sure there is some limit to the number of good entrepreneurs, viable business models and attractive market opportunities but we are nowhere close to reaching it. In fact, it is so far away we can’t even see it yet.
No, the problem is a failure of market design. (The irony being of course if this market design failure were in any other industry, venture capitalists would be aggressively investing in companies and business models designed to correct and take advantage of this failure.) The problem simply stated is too small a number of too many similar venture capital and private equity investors. The solution is more, and more diversity. The question is how?
I’m sure you won’t be surprised to hear that I have a few ideas on the subject, and for my first (and only) New Year’s resolution, I will endeavor to articulate these in a multi-part series I will call ‘Saving Private Equity’. Some earlier thoughts on the subject can be found here.
The more cynical amongst you might accuse me of simply ‘talking my book.’ Perhaps. Probably. A more flattering way to look at it is that I am living my convictions. And the lesson I’ve learned is that we need to focus almost exclusively on fund raising for now even if that means disappointing some of our portfolio companies or missing out on a great investment opportunity in the short term. It’s not fun or particularly interesting but like almost any other startup, without capital the rest is just theory. Time to stop thinking and start pitching!
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.
This post has nothing to do with new paradigms in finance or markets or anything like that. It does however have a good dash of entrepreneurial zest. But mainly it’s about skiing and how following one’s passion is a great way to start a new business. And it’s also a reminder that not all startups fit the Y Combinator model and that venture capital can (and should) be a broad church…
Just last week I’m happy to say I closed on a modest personal investment in an exciting new ski company called the Faction Collective:
Faction. n. ‘A minority group working within, and in opposition to, a majority group.’
When we founded Faction, our manifesto was (and continues to be) to build the best high performance skis we can, without compromise. Our focus is on providing versatile, progressive products that answer the needs of freestyle and freeride skiers – designed by riders, for riders. Every person involved in Faction, from the people working here in the office through to the guys in the warehouse and the team riders on the hill as well as you the consumer, has a say in how we design, build and manage our products.
Now as many of you know, I am an avid skier, however my true passion is racing. Fast, hard, steep. 5,4,3… So when my friend Alex Hoye first approached me about Faction (where he is co-founder and Chairman) last year, I was skeptical. First, I didn’t know the first thing about investing in a consumer goods start-up and secondly, I didn’t feel I had any way to judge the quality / desireability / competitive position of their products as Faction is focused on freestyle, freeride and big mountain (off-piste) skis. Give me a GS ski, well that’s something I can have an opinion on… But I had a look, and the vibe – reminded me of my teenage skateboarding days, kind of like a 21st century Powell-Peralta for snow: the new Dogtown (and Z-Boys)? – felt great and so I asked him to send me a couple pairs of skis to test. I had them for 2 or 3 weeks and not only did I test them, but I let a number of my ‘local’ friends try them out too, including a teenage ex-racer, a ski instructor and a ski shop owner. Everyone, including me was blown away. Not only that, except perhaps for the teenager, we were all pretty skeptical in an old reactionary kind of way to these ‘newfangled’ funny looking “skis” (if you could call them that.) All of the sudden, I rediscovered the joys of off-piste skiing – powder, crud, bowls, glades – it was so easy and fun. And I’ve never seen skis turn so many heads in a lift-line. The final confirmation that these guys at Faction were on to something is when the teenager didn’t want to give back the skis and kept insisting he would buy them off me! I decided I better dust off the IM and take a closer look…
They are only making about 1200 pairs or so this season (and just the folks I know will probably put a dent in that limited number!) so if you want the ultimate Christmas gift for your teenage son or daughter who spends all day in the snowpark, or if you want to go off-piste or tear up the powder and feel like you are a teenager again, I definitely wouldn’t wait too long to order yours, once they are gone, they’re gone…Contact the good folks at Faction and they’ll tell you who sells them close to you.
And once you’ve kitted yourself out in the latest, greatest gear from Faction, you’ll probably be thinking I need to book a place to stay! That’s where my next set of (non-tech) entrepreneurs come in. Martine and Laurent are good friends, who are living their life’s dream and putting the finishing touches on the brand new 4-star hotel they have built and will run in Meribel. For those of you that don’t know it, Meribel is an absolute gem of a resort in the French Alps, sandwiched between Courchevel and Val Thorens at ‘the heart’ of Les Trois Vallees – the world’s biggest ski resort. We’ve been going there for over 15 years now and I can tell you there is something for everybody. However one of the things that is in short supply in Meribel is hotel beds – the resort has c. 40,000+ beds but most of these are in chalets and apartments. Until this year if you wanted to stay in a luxury hotel, you really only had a choice between two and they were booked up years in advance. With only 20 rooms, and an ideal location, modern infrastructure (the advantage of building from scratch!) I’m sure after this season it will be equally hard to get a room at L’Helios.
Trust me, I had a tour a couple weeks ago – it is going to be awesome! And unlike most alpine hotels it is ready made for families and groups, with many interesting interconnecting suites and modular grouping of rooms, including many with duplexes. Unfortunately you can’t book directly online yet (has to do with banking/payment laws and the fact they are just starting up, don’t ask…!) but contact them via their website and I’m sure you will get a prompt response (especially if you tell them I sent you!) Sadly I’m not an investor in L’Helios but I’m sure it will be a roaring success. And if you do go let me know and maybe we can have a drink together on the sundeck. (I might even be able to get the owners to let us have it on the house!)
And just to make sure you are counting the days until first tracks, here is a little Faction video to get the imagination going:
To paraphrase Schumpeter, ‘successful business people are always conspiring to preserve the status quo.’ And one of the best ways to do that is to leverage your position in the market to influence, ideally control, the conversation around how the business or sector operates. Yet again it’s an example of everything you need to know, you learned in high school: “anyone who doesn’t do business by our rules is a loser.” Potential dangerous and should be ostracized. Of course this kind of self-interested ass-covering is entirely understandable in the context of human nature and for what it’s worth is fair enough: “I’m on top of the hill and I’ll use all the advantages that affords me to stay here.” Not enormously noble, but fair enough. What is somewhat more stomach-churning is when, in a vain attempt to rationalize their naked self-interest, these same incumbents wrap up their need to protect the status quo with some spurious justification that it is in fact to “protect” the “little guy.” What a load of crap. You want advice? How about running a country mile anytime someone who’s interests are clearly orthogonal to yours tells you they are looking out for you.
All industries operate within echo chambers; ironically the rise of the web has probably accentuated this as most communities go ‘deep’ rather than ‘broad’ in terms of information flows. Like any good flatlander, after having spent 15 years in institutional capital markets, I was certain that that industry’s echo chamber reverberated loudest. But now having spent a couple years around the fringes of the venture capital industry, I know that isn’t true. Further I suspect every industry and community suffers from this disease more or less equally. I’m not an anthropologist but I bet it has something to do with the evolutionary hard-wired pre-disposition for people to form tribes. I’m not sure why, but naively I expected the venture capital industry to be less political, less petty, less groupthink than the investment banking industry. Well it’s not. In fact it might even be more dysfunctional. And it certainly could use a few more traders within it’s ranks. (Just to be perfectly clear, that last opinion is completely self-interested, possibly self-centered and isn’t trying to help anyone except possibly me, including the poor entrepreneurs.)
I don’t mind the fact that this (or any other) industry is messed up. That’s where the opportunity lies. And being outside an echo chamber looking in is a wonderful – if sometime lonely – vantage point from which to recognize and capture these opportunities. And ifI’m right, just maybe I’ll have an edge. Everyone needs an edge. And if this edge helps me succeed (I mean really succeed) then just perhaps one day the frame of reference will shift. And I’ll be the one out there telling everyone not to rock the boat because, “y’know it’s really helping the little guys.” Not. Well at least I hope not. But I can’t guarantee it. So if this comes to pass, that’s when you should tune out. Find a new prophet…because you know it will just be so much baloney…
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…
A couple years ago, I had just decided to try to build what would become Nauiokas Park. I wasn’t entirely sure exactly how I was going to go about it but I had a vision of what it might look like and I knew the market opportunity – to develop technology-enabled disruptive business models in financial services and markets – was vast. Also, Saul and Reshma’s inaugural seedcamp had given me an excuse (or a push) to stop ‘mulling it over’ and ‘get started’ even if I didn’t exactly know what ‘it’ was yet.
One of the first things I did was to start building a database of startups and private growth companies that I thought fell into my embryonic firm’s new investment universe, and one of the first companies I added (on August 29th, 2007 to be exact) was Mint.com. I had first heard of them early that year when they were raising a Series A round and the concept had always appealed to me (and I had always wondered why banks had been so oblivious to it.) I had definitely hoped to be able to take a closer look once I had raised outside investment capital (they were already past the seed stage where I could have contemplated trying to play as an angel) and so it was one of the first companies on our internal ‘radar screen’. Well as they say in the start-up game, it always takes longer than you expect and here we are – one giant financial crisis later – in the fall of 2009 and Mint will now be coming off our radar screen (into our archives) having gone and gotten itself acquired by Intuit for $170mn.
On the one hand, it is exciting to see innovation in the space we are calling our own, succeed and be rewarded. And although I’ve never had the pleasure of meeting Aaron, I would like to congratulate him and wish him continued success with Mint and Intuit. Who knows, perhaps I’ll get to meet him in the future. Maybe when he’s contemplating his next venture? On the other hand, I can’t help but wonder if they sold too soon. I have to insert a disclaimer here – I have absolutely no idea what Mint’s financials looked like – so my view is entirely speculative, but I can’t shake the suspicion that if they had enough traction to get $170mn from Intuit, they had already hit and passed the inflection point and could have aimed at becoming (at least) a billion dollar company and owned the space.
Bittersweet? Well partly for not having invested as an angel but that’s just back-trading, so not really. Mainly it’s because – if the company was for sale – I would have really liked to have been in a position to run our slide-rule over it and, if it made sense, put in a bid, either alone or as part of a club deal with one or two private equity peers. If they have attained critical mass – which it looks like they may well have – it doesn’t take too much imagination (if you live in the sixth paradigm) to see them developing into a multi-billion dollar business over the next 5 years or so. Don’t get me wrong, I understand why management, the angels and the VCs, might find this exit attractive, especially given events of the past 24 months, but I can’t help thinking they’d done the hardest part and instead of letting a winner run, took their profits too soon.
PS If anyone knows where I can find Mint’s financials and projections, I’d love to have a look.
Recently there seems to have been a heightened level of existential discussion on the venture capital industry, its future and appropriate structure and objectives. Perhaps kicked off with Paul Kedrosky‘s report for the Kauffmann Foundation and taken up by people like Fred Wilson, Chris Dixon and others.
A few years ago, when I first started to take a close look at the venture capital industry, its structure and its business model, I must admit the first thing that leapt out at me was that it seemed just as settled in it’s status quo, comfortable in it’s received wisdom as the investment banking industry I had spent over 15 years navigating. Perhaps I shouldn’t have been surprised, however I couldn’t help but find it ironic that an industry ostensibly focused on finding and financing innovative technologies, business models and people, should itself seem so immune from these forces, almost to the point of being anachronistic.
And so I set out about educating myself as to why this was the case. Why was this just “the way things are done”? And unsurprisingly I found a couple good reasons buried in a mountain of inertia and vested interests buttressing the flimsiest of rationales. So answering my friend Max’s request for ideas, here are a few of my ideas on how to improve venture capital.
Greater diversity of economic models: monocultures are naturally fragile – my point is that the GP/LP with 2 and 20 isn’t necessarily wrong or right, but it has weaknesses that would be mitigated by competition arising from a more diverse ecosystem of economic models and approaches.
More emphasis on clear, well-defined sector expertise and specialization (both in terms of firms and people.) Clearly we are talking our own book here, but if don’t believe me, Marc Andreessen makes the point as well.
More permanent equity and secondary markets (and less frequent fund raising.) The most profitable private equity and venture capital firms are the ones that are much better at raising capital than investing it. You get what you pay for. Change the structure and incentives and you’ll change the outcomes. Further, the best course of action for any given company should obviously not depend on their investors’ capital structure and yet under the current industry structure, the dynamics of your partners, venture firm and/or individual fund can and does often drive strategic decision making. It’s called the tail wagging the dog and it’s as sub-optimal as it sounds.
Management fees at cost (not as a % of assets under management) and restricted equity as performance incentives. This one seems like a no-brainer: management fees have a minimum fixed component and generally are correlated with both the number of investments and the complexity of these investments. Typically there is some degree of positive correlation between these factors and assets under management but the implication (which underlies fixed % management fees) that it is mechanical and linear is completely wrong. You would think that investors (‘LPs’) would be 100% behind this innovation, and yet I have been surprised to find that many are at best ambivalent, and some actually hostile. The only reason I’ve been given for this attitude is having ‘certainty’ in terms of costs, although I think this is a total red herring: a cost-driven management fee would entail the venture capital firm getting their budget approved by their Board and given the relative simplicity of the business, would be relatively trivial to determine with a high degree of certainty, even over time.
Standardize investment terms by developing and adopting a document analogous to the ISDA Master agreement structure and pricing supplements (for individual deals.)* Not only would this lower costs and reduce complexity but it would also facilitate a more active and robust secondary market.
More syndication – lead underwriter rewarded for driving process forward; increasing use of ‘managed accounts’ (vs discretionary management.) The idea here is to bring together complementary syndicates of specialist investors, each bringing something slightly different and valuable to the table, as opposed to just a jump ball between a number of more or less identical generalist funds.
Price ancillary services (advisory fees, directorships, etc.) transparently and honestly. This is an area where I think venture capital could learn a lot from their private equity cousins by making more explicit – and charging appropriately for – services they provide to their portfolio companies. Clearly this approach is not perfect nor is it immune from abuse, but by combining with point (4) above and structuring much/most of the payment for services in equity rather than cash, it would actually reduce the scope for abuse and discrimination amongst shareholders and would force both companies and venture capital providers to justify any additional value (beyond investment capital) that venture capital firms or partners provide. Under the current operating model, the venture capital firm’s investors effectively subsidize the portfolio companies’ use of the professional resources of the venture capital firm. And there is a cross-subsidy within the portfolio, with companies that don’t need any services effectively subsidizing those that do.
In fact, if you take a step back and look at these recommendations, they would have the effect of making venture capital look a lot more like a collective, scaled-up version of professional angel investing. And as I was writing (and re-reading) these points, I fear that the short form of a blog post is probably ill-suited to make relevant and nuanced arguments as to the pros and cons of various elements of the venture capital business model. And yet I simply don’t have time to write an essay. I’m not Fred, but perhaps if I’m lucky, that essay will write itself in the comments here and elsewhere. So have at it!
* (via Wikipedia) The ISDA Master Agreement is a bilateral framework agreement. This means it contains general terms and conditions (such as provisions relating to payment netting, tax gross-up, tax representations, basic corporate representations, basic covenants, events of default and termination) but does not, by itself, include details of any specific derivatives transactions the parties may enter into. The ISDA Master Agreement is a pre-printed form which will not be amended itself (save for writing in the names of the parties on the front and signature pages). However, it also has a manually produced Schedule in which the parties are required to select certain options and may modify sections of the Master Agreement if desired. The Master Agreement would be modified to the extent the modification is mentioned in the Schedule. Details of individual derivatives transactions are included in Confirmations entered into by the parties to the ISDA Master Agreement. Each Confirmation relates to a specific Transaction and sets out the agreed commercial terms of that trade. Confirmations are generally quite short as they will normally incorporate one or more of the definition booklets published by ISDA. Each of these definition booklets relates to a specific type of derivatives transaction and, in addition to defining terms, they include mechanical provisions (e.g., Articles 5 and 6 of the 2000 ISDA Definitions set out how to calculate the Fixed and Floating Amounts payable under an interest rate swap) which do not then have to be laboriously reproduced in the Confirmation.
A plethora of groups left empty-handed by the Budget are queuing up in Whitehall to lobby the government over the £750m cash pot allocated towards the vaguely defined strategic investment fund.
Well since I don’t know Lord Mandelson and I’m admittedly a neophyte when it comes to navigating public sector bureaucracies, I thought that rather than go stand in line of what is certainly a very longish queue, I’d make our case from this little soapbox in case one of my readers has the Minister’s ear! (That way I’ll have no regrets, you never know until you ask and all that…) So here goes:
Over the next decade and beyond, a tremendous opportunity exists to profit from the emergence of a new paradigm in financial services and markets. Disruptive business models, products and services – enabled by exponential improvements in technology – will fundamentally challenge incumbent firms and market structures. These new approaches will drive a reconfiguration of the financial industry and the structure of many markets within the wider economy.
Nauiokas Park was created in order to take advantage of this opportunity. Marrying patient long-term growth capital with expert operational and strategic advice, we seek to create wealth for all of our stakeholders by anticipating and catalyzing change through investments in entrepreneurs and companies that will lead and shape the new industry paradigm.
Given the importance of the financial services sector to the UK economy, the relative dearth of venture capital focused on supporting and developing innovative start-ups in this sector threatens the long term health and competitiveness of the UK financial industry. The lack of a vibrant ecosystem of entrepreneurs in financial services*, hobbles the forces of competition and creative destruction and will ultimately undermine the long term competitiveness of the UK as a modern 21st century financial centre. Nauiokas Park is ideally positioned to address this and as such is an obvious partner for the UK’s Strategic Investment Fund.
Of course, one would also have to carefully consider what constraints such an investor would bring but at least to begin with, we’d come into any discussions with an open mind.
[Waiting for the phone to ring.]
* I have excluded hedge funds from this definition – not because they are not entrepreneurs, they most certainly are, but because their talents are focused on novel and unique strategies for investing and trading and not on developing new, innovative and disruptive business models or approaches to providing services.
AMEE announced today that they had closed a new round of financing. I think this is a fascinating company and compelling opportunity. Given the chance, would I have for certain chosen to invest? Based on what I know of the company and its management, I would like to say yes. Probably. I’m forced to hedge my opinion because I just don’t know enough, especially with respect to the financials and the attractiveness of the valuation given the opportunity. But given what I do know, I would have loved to have them in our portfolio. And I’m certainly more than a little disappointed that we weren’t in a position to throw our hat in the ring, do our homework and at least make an offer…![Reblog this post [with Zemanta]](http://img.zemanta.com/reblog_c.png?x-id=5e0035c5-b888-49bb-b8b8-a15574c6097c)
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? – felt great and so I asked him to send me a couple pairs of skis to test. I had them for 2 or 3 weeks and not only did I test them, but I let a number of my ‘local’ friends try them out too, including a teenage ex-racer, a ski instructor and a ski shop owner. Everyone, including me was blown away. Not only that, except perhaps for the teenager, we were all pretty skeptical in an old reactionary kind of way to these ‘newfangled’ funny looking “skis” (if you could call them that.) All of the sudden, I rediscovered the joys of off-piste skiing – powder, crud, bowls, glades – it was so easy and fun. And I’ve never seen skis turn so many heads in a lift-line. The final confirmation that these guys at Faction were on to something is when the teenager didn’t want to give back the skis and kept insisting he would buy them off me! I decided I better dust off the IM and take a closer look…
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