This is a guest post by Fred Destin, a Partner at Atlas Venture based out of Boston. Previously Destin was, for years, an active VC in Europe, working on DailyMotion, Seatwave, Zoopla and a number of other high profile European startup investments.
Nick Halstead at Datasift seems to have ticked people off the wrong way with a candid assessment of his experience fundraising in Europe. He might might not return emails but he’s also raised money from one of the smartest dudes around (Roger Ehrenberg and his Big Data Band) so if you allow me I’ll pay some attention to his opinion, and in fact expand on it.
Nick’s video interview with Mike Butcher starts exactly as I would like to start my article: I’ve always been a huge advocate of Europe, and a believer that we can blaze our own trail. I would not have invested the amount of time I have in, say, Seedcamp since its founding by being an investor, board member, mentor and contributor (my Prezi slides and a little plug) if I did not believe we could build great things, and thankfully, occasionally, we do.
Since the excellent Jos White at Notion Capital has stated the motion for the house, I will state, Oxford style, the motion against and focus on what I think is broken in our industry. Jos essentially states that whilst the European venture industry is lacking in some respects, it is a great place to make money given macro indicators that suggest there is a shortage of venture capital, a track record of generating exits on less capital invested, and great opportunities in the market at reasonable prices. I don’t actually disagree with his points, but wonder whether we can seize our moment.
My motion is simple: the European venture capital industry deserves a B- at best, and is unlikely as a whole to capitalize on the opportunities presented above.
It is generally very average, sometimes downright ugly and only sporadically brilliant. Rather than go macro, I am going to go micro and focus on the quality of our ecosystem at a grassroots level to illustrate this statement.
Entrepreneurs are pissed off
Great entrepreneurs talk amongst themselves about their experience with venture capitalists, and I never miss an occasion to listen hard. Unfortunately, the feedback is almost universally negative; entrepreneurs typically have had a bad experience with Euro VC’s and are generally wary of taking their money.
There are usually three types of issues at work:
• Too many VC’s look at everything though the lens of the budget and are unable to go deep on product, tech or strategy. A few examples: the CEO of a social gaming startup laments the fact that none of his five investors uses twitter or facebook and none has ever tried one of his games, yet the success of his companies relies entirely on gameplay and social distribution. A senior VC tells the CEO of a company in an insanely fast moving segment: “I am not here to talk strategy, and no one else around this table has any clue about strategy, I am here to check what you do with my money every month”.
• There’s very little empathy with the management team and in the end boards become threatening or cumbersome reporting environments which are formulaic and useless instead of being a work session where the future of the company is being discussed and honed in a collaborative manner. I wrote a long evidence-based post about this a while back entitled “the Arrogant VC” if you want more depth.
• Too many VC’s are, simply put, afraid of failure. It makes it very difficult for the entrepreneur to discuss openly when the model is struggling and a significant pivot or strategy shift is required. I have been involved with one company a while back where the lead VC response to a fundamental go-to-market and single customer dependency issue was to review every line of spending at every board, one-by-one. Including travel, IT, and so on. Unfortunately, I am neither kidding nor exaggerating. I also had a case with Zoopla where in the early days we used to run ourselves lean on fast iteration 3-months budgets and roadmaps. We were raising money and had few alternatives, and ended up with one investor insisting on a 2-year budget being appended to the legal docs. In the end, Alex and I had the appetite for neither building that budget nor dealing with that investor and turned them off, even though that meant we had to fund Zoopla internally: the incoming VC was just barking up the wrong tree, asking for security and comfort where they could be none, since the numbers were clearly not worth the paper they were written on. I have written on the need to embrace ignorance before, though now of course you could think of that as being Lean.
In general, VC’s are not considered evil by euro entrepreneurs; they’re just the least-worst form of capital, perceived to be a necessary burden that comes with reporting obligations, oversight and very little value-add. It is too rare to hear an entrepreneur praise a VC he’s worked with for great help and insight, even though this is a common occurrence stateside.
I could of course write a companion post about how many Euro entrepreneurs need to toughen up, stop looking at VC as the root of all their failings, and generally think more ambitiously too, but that will be for another day. And on balance, I have to say I find the VC ecosystem is letting even our best hopes down too often, and that’s that.
Limited Partners are pissed off
The reason why I think we’re well past the complacency stage is that the situation within the LP community (“Limited Partners” or LP’s are the institutions who give money to venture capitalists) are even more dispirited than the entrepreneurs are. Seriously. Many top tier LP’s have written off Europe and don’t even have a “Europe venture allocation” anymore. Those that do are either focused on their top 5 funds list or are looking for (very few) emerging managers. All of them are concentrating money in the hands of fewer managers.
Why do you think every national venture capital association is reviving the debate around the “funding gap” and the need for the government or the EIF to get involved? Solace lies close to home and thanks to a network of government agencies, local banks and funds and so on many funds are managing to stay alive. The point is, we’ve managed to piss off our funding base, or at the very least make them extremely wary of backing us.
What’s wrong with us?
What I stated before is based on tens of conversations with investors and entrepreneurs. What I am going to be stating now is my personal opinion of what we do wrong, my diagnosis of why, on average, we suck.
• For some, wrong incentives: there are too many guys out there who have no incentive to either lose or make real money. To them being a venture capitalist is a job. Allow me for a second to paint a different picture of that VC you were very impressed by at the cocktail drinks. He talked a good talk but he’s actually employed by a regional financial institution that gives him money to invest every year. He does not make that much, he enjoys the perks and the feeling of importance and the Beamer but he really has no incentive to do things that are too great, rather make sure he doesn’t drop the ball on any of his investments. He really enjoys when his boss tells him he negotiated great, harsh terms. He’ll never go against his partnership for a company he believes in but that’s in serious trouble. He does not invest in his own fund, or very little. He does not really care that much as long as you get him cash back, because that’s probably enough for him to survive inside his organisation.
• For too many, wrong DNA: following up on the above, I am convinced that many folks involved in Euro VC are just in the wrong industry. They’re not entrepreneur champions and they never will be. They’re not risk takers, willing to embrace failure as the unavoidable counterpoint of attempting to be great. This is partly why I think we need new entrants, a revolution rather than an evolution, as so much of what we have currently is just wrong and non fixable. One company I was involved with was on the wrong track, because the investment thesis was turning out to be flawed. I remember the reaction of my co-investors to what was obviously an extremely hard to solve product/market fit problem, and here is what they told the CEO: “fight for as many years as you need to bring us money back, any money back”. A perverted form of “earn your stripes by salvaging a wreck” that was going to cost the CEO years and not allow a talented guy to move on to the next project. I resigned from the board after we hired a banker and told the CEO to take 12 months to try and sell and otherwise do an orderly shut down. The company somehow survived two more years after that but failed anyway; I bet the CEO did not get as much as a thank you for trying.
• Lack of depth: I cannot count the number of times I have heard entrepreneurs lament the fact that they cannot go into any level of detail on product or tech. Of course we have grandiose exceptions (most of the hardware investors in the UK would qualify) but boy, I have certainly witnessed first hand my share of shallow commentary. It’s extremely difficult to be subtle about say, pricing levels and go-to-market strategy where you have no real insights into the underlying products you are selling. Funny anecdote: this other VC sits next to me at dinner and comments on a product the CEO is demo’ing: “neat, is that from google ?”. CEO responds: “huh no, we’ve had it for two years”. No comment.
• Lack of accessibility: ever wondered why every single deal seems to come with a banker attached these days? Again, ask the entrepreneurs. The pain and friction in running a European fundraising process is such that hiring a fundraising agent is considered not only prudent but also necessary. Too many VC’s are hard to get to, non-responsive, too slow. Again there are glorious exceptions of course: Errol at Wonga had at least 4 term-sheets on the table in a matter of a few weeks from starting to fundraise for his series B, and that’s before they took off. But this is where the delta with the Americans is so huge. When Shafqat at Newscred got sponsored onto Angellist, his endless and soul-sucking European fundraising process turned into a 2 week whirlwind of investor interest and a brisk move to New York.
• Still treating legal terms as an upside mechanism: I could go on for hours here. Yes, major progress has been made, including with the Seedsummit terms that Seedcamp, Tina Baker and co. designed. But whereas legals should really be considered an insurance policy against bad behaviour, they are often used as a way to juice returns, applying what are mostly private equity techniques to young companies that should really be free to iterate fast in search of the perfect way to scale. For example:
– taking founder shares into escrow and having confusing good / leaver bad leaver language inserted (Yee Lee comes to mind more often that you’d think !), or severely restricting exercise periods for employee options.
– putting performance ratchets in place for a Series A or B company that only have a few million in revenues (including EBIT targets, as if you could know at that stage whether you should be gunning for profitability or growth ?)
– Participating preferred of course, which although they are a legitimate way to trade-off price/returns profiles when you “get” finance, are rarely well understood by founders … with VC’s obligingly leaving them in the dark
– And of course full ratchet and multiple liquidation preferences, which are not yet a thing of the past. The equivalent of the Iron Maiden for entrepreneurs I suppose, delivered at a VC shop near you.
Who are you again ?
I may piss some people off coming for a first guest post on TC with a broad brush critique of the venture community. Yes, I am a Belgian who recently deserted Europe, and whose fund was a good example of raising too much in 2000 and trying to expand too far, and I am far from perfect. Yes, I have pulled from a deal after a signed term-sheet once (sorry G), yes I failed to tell an entrepreneur for weeks I was not investing in him even though I was pursuing a business in the same field (sorry R), and yes I have been involved in two founders being removed from the post of CEO, though both times I fought hard to make them successful first.
If you come out of reading this thinking I’m a lesson giver who’s left the building, you’re missing the point. If we want to fix ourselves, we first need a harsh and intellectually honest look at how we are operating, and what our key constituents think of us. You cannot fix what you do not accept is broken.
I have frankly seen my share of odd or bad behavior directly. Whilst the blackberry obsessed distracted board member with the gorgeous soft leather daybag is by no means a European invention, we’ve added our own garden variety of venture gnome that only wakes up for the last ten minutes of the board when the monthly financials are being reviewed.
The Times They Are A-changin’
The good news is of course that our ecosystem is changing fast (and has been improving since the dawn of venture). We know strong ecosystems take time and consistency to build, and we have more and more of the ingredients coming into place:
First and foremost are great entrepreneurs building awesome successes. Skype transformed Estonia (ASI, ERPLY, Grabcad and many others), gave us a great new VC firm (Atomico) and a bunch of awesome offshoots (Spotify). And we have many more brewing, such as Wonga, Soundcloud, Gameforge etc. Every success spawns smart angels, repeat entrepreneurs, and more importantly a sense of confidence.
We’ve always had some strong VC’s (a minority in my book), we’ve had one homegrown tier I brand name with Index Ventures, a bunch of strong ones in the making often with a US heritage (Accel, Balderton, Northzone, Wellington etc), a number of exciting emerging managers (Mangrove, ISAI Notion, Passion etc, see Rise of The SuperAngel), at least one super-optionality fund (Kima) and, finally, initiatives that are truly focused on technical founders (Seedcamp, hackfwd etc)
A Revolution in mindset required, still
Whilst change is happening, I am still thinking we need a bit more of a revolution than Jos’ more gentle evolution. I would not want to suggest all VC’s are dinosaurs like my anything-but-boring friend Dave McClure, but I do hope the LP community funds the VC marsupials selectively and aggressively stops funding the VC dinosaurs.
It’s OK to shrink ourselves back to health … and we do NOT need some mis-allocated Government money introducing bias into VC selection. The government should focus on giving tax breaks to angels and lowering operating costs and red tape for startups.
On the current model, European VC’s too often think of a “deal” as an agreement with an entrepreneur about hitting a set number of milestones and financial objectives, i.e. what they perfectly rationally think of as “building a business”.
Whilst it sounds reasonable, are you more excited about doing the above or “backing exceptional people to go do exceptional things” even if that means investing with a much higher level of risk and accepting a very uncertain path to success?
If we want to avoid seeing too many of our entrepreneurs sucked by the Valley Vortex or funded by travelling Yankee fans, we better get our act together and improve the quality of our offering to the best entrepreneurs out there. They’re a finite population! Yes, the US market may be frothy and delusional, but let’s not take that as a comfortable excuse to not raise our game yet again. Onward.