What's the best startup model for Europe?

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I recently met with Yoav Andrew Leitersdorf, managing partner with YL Ventures. YL is a VC with offices in the Netherlands, Israel and Silicon Valley. Leitersdorf thinks his business model of ‘flipping’ tech companies faster is better applied in Europe than trying to create a massive startup in the way US firms do.

Here’s how the idea goes: YL looks for tech companies with seed investment, say a million euros, and which show growth. They then put in a Series A funding round – say around two million euros – but then soon after look to sell the company, often to a Silicon Valley player. They don’t try to carry on pumping in cash but to enable the founders to exit quickly for a good price. So, no Series B. The idea then is to create lots of successful entrepreneurs who can then go on to their next startup, which might in turn be bigger the second time around. “Most funds want big exits but this contradicts what most European entrepreneurs want,” he says. His catch phrase is “Series A then M&A”.

His view contrasts markedly with Nic Brisbourne, partner at DFJEsprit, who says on his blog recently that “Adopting a home-run mentality is the best way forward”. He bases this view on figures from the latest Go4Venture report which said that the market is increasingly driven by larger deals, with 22 transactions of more than EUR 20mn in 2007, compared to 15 in 2006 and 2005, and only 5 in 2004. Go4Venture says this reflects European VCs growing taste for high risk/high reward transactions, which is closer to the behavior of their Silicon Valley brethren.

So who is right? Should European startups set their sights lower but try and create some early wins so we can really kick-start the market? Or should people aim to become the next Facebook/Google etc?

  • http://www.clearmymail.com Dan Field

    Its an interesting suggestion… get out whilst you can.

    It comes back to the big issue of raising serious funding for a startup in Europe, and I guess Yoav is accepting that it just isn’t possible (At the moment in Europe) to raise the right amount of money.

    I do think this is slowly changing though, people like Niklas with Atomico seem to have the right idea… having come from the startup side himself gives him great insight into what we need.

    Another downside to the investment market here in Europe is the way that European startups have to try and monetize their businesses before the critical mass is achieved… no money = we have to charge to keep the services and development going.

    So maybe selling out early (ish) in your first start-up is great advice.. you’ll certainly learn allot the first time round which will help with your second and third startup!

  • http://www.thoughtsintime.com Sean Glass

    I certainly don’t have the experience as a venture investor (only done the angel side), however wouldn’t the appropriate answer be – “it depends”? I know that sounds like a non-answer, but different companies are in different industries, different situations, etc. so wouldn’t it be better for both the investor and entrepreneurs to have clear conversations up front about how they expect to grow the company, how they plan to gain liquidity for investors, and then to continue the conversation as the business grows? Some companies may do better for both through a quick sale, while in other cases, a quick sale may cause the entrepreneur and investor to lose out on a ton of future value. I guess I’m proposing that the correct investment model is to ensure that investor and entrepreneur expectations are alligned prior to investment, that open communication between these partners occur once investment has happened, and that together, they make decisions to maximize expected returns given the agreed upon shared view on risk / return and future plans for the company and leadership.

  • http://www.hubdub.com Nigel Eccles

    Does this approach not feel slightly depressing and unambitious?

    If this is the right model for Europe then what we are saying is people in Europe lack the skills and ambition to build world changing companies. I just can’t believe that is true. Yes, Skype and Last.fm were sold when the time was right but I very much doubt that their founders put in the long hours so they could one day ‘flip’ it.

    And are Silicon Valley firms really excited about buying the next ‘built-to-flip’ European start-up? I doubt it.

  • http://www.fiftybyfifty.com/lifeoffarhan/ Farhan lalji

    Why not do both? VCs can’t turn down the companies that they can see being flipped while waiting for the home run. Surely they’re likely to have 8-10 companies in the portfolio, believing all are home runs is not likely. More like focus on the 2 or 3 that have the potential to be home runs, pay enough attention to the other 2 or 3 that are likely to give the fund a good sized return and let the living dead companies take care of themselves.

  • http://www.YLVentures.com Yoav Andrew Leitersdorf

    Nice note Mike, you captured quite a bit of the strategy.

    However, I wouldn’t really say ‘flipping’ because significant work, energy and networking goes into developing these companies to the point that they are attractive to Silicon Valley corporations – the process can take up to 2 years.

    Our specialty, if you will, is our ‘value-add’ which entails improving product, promotion and access to customers – maximizing valuation while still keeping a low burn-rate. The concept is: rapid progression along the product and customer axes in order to open up exit opportunities early on.

    And to Sean’s point: we certainly do remain open to situations whereby both entrepreneurs and investors agree that there’s more value to be had and therefore a longer ‘holding period’ may make sense.

    In summary, we look for high-growth capital-efficient tech companies that, together with our ‘value-add’, have a much wider exit window than normal: from a couple dozen million Euros all the way to a ‘home-run’. The ability to exit early (vs. having to force a company to get to significant scale) is an element that sets us apart, and one which will hopefully enable more than 1-2 companies per portfolio to exit successfully (thereby enriching more entrepreneurs per portfolio, thereby helping to create the European ecosystem, etc).

  • http://www.nixonmcinnes.co.uk Will McInnes

    Mike – is the model proven though? What’s the track record as a firm with this ‘new model’? I can’t find anything on their site: did you get anything from them when you spoke?

  • http://www.mobiya.com Sacha Vekeman

    Yoav, Mike: Isn’t every VC looking for “high-growth capital-efficient tech companies that have a much wider exit window than normal?”

    More importantly, some seasoned VC’s told met that the professional – and global – M&A market starts with companies capitalized at €10M. Anything below €10M is simply not interesting (commission wise) and is not on their radar (sector knowledge – too specialised).

    Exits of companies below €10M are very regional, and do certainly not get the attention of Silicon Valley. They are done by smaller corporate financing houses by smart finance people, who have no network or experience in the Valley. Yoav, you might have the network, but you don’t scale as a person to do this on a European basis.

    Coming back to numbers, maybe it is a math trick, but could you explain how you get to a €10M capitalization with a Seed funding round of €1M (which is very high in Europe), followed by an A-round of €2M? With some leverage and goodwill, but certainly pre-revenue, I simply don’t see how this ‘startup model’ could deliver a €10M capitalization, unless valuations are back in the clouds, which is definitively not the case?

  • http://www.friendent.com Sean

    Yoav – I wonder if you will run into a selection problem if you focus on entrepreneurs who want a quick exit. If it doesn’t look like that’s going to happen, rather than grinding it out for perhaps a decent exit later on, they may split early causing you to be more likely lose the principal that was invested than if they were committed to fight to the end. The issue I see is that maybe an entrepreneur who says up front that they want a quick exit (2 years is pretty quick), might jump to the next thing at the first sign of trouble – and there’s always trouble as one’s ironing out a plan and building a new business :-). I’d be interested in your experiences with regards to this. I personally am interested in whether evaluating the psychology of the entrepreneurial team can help investors improve returns. It seems as though your approach will attract a certain profile and thus the results could be interesting from that perspective. Good luck and perhaps we’ll meet up in greet space to discuss more in the future.

  • D

    I personally wouldn’t look to get funded by the many invest and flip VC firms that are starting to emerge.

    They look to take a very large amount of equity and control in your company.

    I say concentrate on building a great initial product/demo to where investors start approaching you.

  • http://putplace.com Joe Drumgoole

    YL is a resonable model that ackknowledges the reality that most European exits are trade sales (even Skype went that way!). However I wonder what happens to YL is the situation where a stellar success requires series B and C rounds to capitalise on growth. I don’t know YL’s capital base, but can it follow its money into series B and C rounds for companies that require it? Or does its limited capital force and exit strategy on companies that might benefit from subseequent investment rounds?

    I would advocate going for the fund that matches your ambitions (and who here doesn’t want to be the next Skype or last.fm?). A large fund will happily procure an early exit if the multiples are right.

    Can a small fund take you to your 100m+ valuation?

  • http://www.raum-fuer-notizen.de Lars Pohlmann

    From a developers point of view. I wouldn’t want to work for a company which is just looking for a quick exit. That’s not satisfying work.
    I guess many developers think that way, so how would those companies get better than average, passionate employees?

  • http://www.theequitykicker.com Nic Brisbourne

    Mike – interesting post. I’m a strong believer that there is no right answer for companies – it all depends on the situation and what the founders/shareholders want.

    When I say the home run strategy makes sense, that is for big VC funds like DFJ Esprit.

    Hence YL will be right for companies seeking a quick exit and we will be right for companies looking for the home run.

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