Hoxton Ventures’ partners assess Europe’s early-stage landscape

'We’re quirky, but we’re good at what we do'

Hoxton Ventures, a London-based early-stage VC firm best known for backing British unicorns Babylon Health, Darktrace and Deliveroo, announced its second fund last week, coming in at just under $100 million.

The firm’s self-proclaimed strategy is to seek out startups that can scale globally into “large, category-defining leaders” in nascent industries — A strategy that appears to be bearing fruit.

However, although fund two is twice the size of the firm’s $40 million debut fund back in 2013 (when new VC firms in Europe were still seen as a novelty), Hoxton struggled somewhat to close a new fund. Despite having the highest ratio of unicorns to investments in Europe, according to Dealroom, it took more than four years to get fund two over the line, leaving many VC watchers scratching their heads.

To find out exactly what happened and to learn more about Hoxton’s strategy going forward, I put questions to founding partners Rob Kniaz and Hussein Kanji — Fidelity and Accel alums, respectively — and new partner and chief operating officer Rob Ludwig. The conversation that followed was refreshingly candid, providing valuable insights into the state of early-stage venture capital in Europe and what it takes to get funded by an outlier VC like Hoxton.

It’s seven years since you announced your debut fund, which I remember at the time was considerably harder to raise than you had perhaps envisaged. However, despite having three unicorns in fund one, this second fund also appears to have taken a long time to get over the line. Why was that?

Hussein Kanji: I see you’re not taking it easy on us. Good question. Fundraising is our Achilles’ heel.

We did our final closing in November 2014 (not widely reported) and did the majority of this fund’s closing in January/February 2019. That’s a little more than a four-year gap, meaning we’re a year (maybe two) past due. That goes to a combination of two things: we are terrible fundraisers and we had a really awkward experience with the European Investment Fund, which set us back by at least a year.

Rob Kniaz: Yes, sadly EIF denied this publicly but they discontinued new fund relationships in the U.K. after Article 50 triggered, so that cost us a significant amount of time due to the length of their process. By that time we had other commitments that had timed out so we probably had and then lost then reraised nearly half of what we eventually raised.

British Patient Capital was great in the process though and helped ensure we had some continuity as an anchor investor. We’ve been so pleased to work with them.

Hussein Kanji: If you pop up a level, I think the real challenge in European venture is we’re all selling a product that has no buyers. Or if there is a buyer, they don’t have a budget to spend. For anyone who’s spent time in enterprise sales, it’s an interesting sales challenge. If I was a sales manager, I’d qualify most of this pipeline out since it won’t produce results.

The majority of LPs in the industry are in the U.S. Most believe they can get all the European exposure they need by allocating to a handful of established funds. Or they don’t believe Europe is worthwhile to invest in. An even smaller percentage allocate capital to newer funds — what they call emerging managers — and almost always these experimental emerging manager programs are limited to U.S. funds. Only in the past year or so have these institutions become convinced that what’s going on in Europe is here to stay, and they are now building out venture investment programs. That’s a huge step-change, but once again we were a bit too early. We started this fundraise talking to buyers who were researching how to set their budget for the next cycle. This limited pool of LPs is why governments play such a large role in European venture to this day.

Then to the European institutions, we look foreign. We’re a small team. We don’t’ have an army of analysts and associates. We don’t come from wealth or privileged families or the elite boarding schools. We’re not selling impact investing or diversity, or something that’s contemporary.

We’re quirky, but we’re good at what we do. But that doesn’t mean it’s always an easy sell.

You began investing out of the new fund in early 2019 and have already made 20 investments from Hoxton Ventures II, writing cheques between $500,000 and $5 million into pre-seed, seed and Series A stage companies. I could be wrong here, but it looks to me like your strategy has therefore evolved considerably since fund one, where you said you would typically invest between $1 million-$2 million, making between 4-6 investments per year. Is that true and what is the current strategy in terms of ticket size, technologies, sectors and geography?

Hussein Kanji: We were far poorer when we first started. I guess the word would be undercapitalized.

This fund is more than 3x the size of the last one. It gives us the ability to stretch from $500,000-$2 million checks to $500,000-$5 million checks.

The European ecosystem has changed dramatically since 2013. The tech economy has gone from a niche industry to dominating earnings in the S&P. All of this began to change while we still putting together our first fund.

The ecosystem is healthier and more dynamic than ever — meaning round sizes are bigger, even at the seed! By the time we launched Hoxton I, we were already subscale. It’s surprising anyone took our money. We had to convince founders we were way more valuable than our money, because our money was so limited.

This new fund fixes a lot of that and gives us the firepower that we sorely lacked in the first fund.

We’re deliberately anti-thematic strategy just as we were in the first fund. Our job is to back tomorrow’s global tech winners from Europe. We feel most of these come from new market categories that are only now being borne.

I’ve always been puzzled how someone can claim to be able to figure out what the next big thing is going to be. If they were really that smart, why would they fund companies and own 10-15% at exit (sharing this 10-15% with investors) instead of starting the company themselves, and owning 20-50% at exit (with no sharing)? The truth is we — and definitely me — are just not that smart.

I wish all these companies were in the same category. It would make it a lot easier to do business. But the truth is Europe doesn’t produce 10 phenomenal cybersecurity businesses a year, meaning it would be really hard to invest in the same area. We’ve seen funds that are focused on sectors, and it leaves us scratching our heads. It works in the U.S. where competition is fierce and there are a lot more companies, but I’m not so sure about Europe.

Rob Kniaz: We also have a wider check-size range than some funds as we allocate a small portion of the fund to pre-seed companies where we can take some riskier bets where we have particular conviction around the founders themselves or a certain market. It will be years before quantum computing is ready to be commercialized but we think it’s important to have some exposure there to founders we think are exceptional.

Hussein Kanji: Hey, I’m a believer there. It’s improbable — but definitely not impossible — that quantum might happen sooner than we think! And Winnie and Seb (at Universal Quantum) are definitely exceptional. But going into pre-seed at the smaller check size is new for us and something we’re doing more of in this fund.

Rob Kniaz: Geographically, we’re as wide as we’ve ever been. Out of Fund II so far we’ve done deals in Ukraine and Poland as well as the normal “startup hubs” you’d expect. But to me it’s not just London/Paris/Berlin but Warsaw/Minsk/Copenhagen/Lisbon and on and on where VCs need to be hunting. Over the years we’ve cultivated good relationships with local investors in nearly every city so deals often get flagged up to us through them.

Hussein Kanji: We even did Belarus!

Rob Kniaz: As the entry barriers have been lowered, we’ve seen London of course remain the centre of action overall but a large network of feeder cities around either good universities or existing tech company presence. That said, unlike other funds, we don’t focus on Israel as I think it’s quite distinctly a separate geography than Europe. Historically many LPs grouped Europe and Israel together in the same bucket but I think now there’s a total divergence — each market has its own strong local players and strategies.

Hussein Kanji: Back in 2013, our thinking was there were a handful of unicorns founded every year in Europe. Probably closer to one or two than even three or four. We struggled in our first fund presentation to come up with logos to show folks that Europe was producing great companies. There was Skype and then ummm … Back then, we were selling the European tech opportunity as much as selling Hoxton.

This market has come a long way since then. I think it’s only natural as the market scales up you do more in the market.

I want to take you back to something one of you said in 2013:

We’re entirely outlier driven, meaning we want to find companies that will become $1 billion+ companies … If you present a company to us where we are guaranteed to make 3-5x, but there is no potential of being 30-50x, it’s a pass for us.

That sounded pretty outlandish at the time, especially for an early-stage fund in Europe. Yet, with three unicorns in fund one (and an aggregate value of over $7 billion), perhaps not. How would you assess Hoxton against that stated ambition now compared to how it was received at the time?

Rob Kniaz: The ones that get away are the ones that keep you up at night in this business. There are plenty more we could have intersected and we’ve done a lot of work on the data science side to better identify and better track these companies so we see them as early as possible and then most importantly track their progress for growth signals. I’ve written about 10,000 lines of code (during our long fundraise!) to operationalise this and push daily and weekly updates to the team to make sure if we missed something we can then reengage if the company trajectory changes for the better. And likewise to keep an eye on promising folks when they start something new, usually without much fanfare initially. This has worked pretty well so far and flagged quite a few things up to us where we met the founders but it was too early at the time to make a call, or when someone we rated highly quietly leaves their prior gig.

Hussein Kanji: The good news is we were able to back up our statement. We weren’t a total embarrassment. But I think we only did okay. I always tell people we can confidently say we don’t suck, but we still can’t lay claim to being great. Maybe better than average, and certainly respectable enough to stay in business. But far from exceptional.

There’s no reason why we shouldn’t have invested in every great company that came out of Europe. Some of that was out of our control, but a lot of it was and is definitely in our control. We’ve regrettably turned down too many companies that have gone on to be great. And we’re not embarrassed to admit that.

Part of that is being a small fund. Now that we’re a bit bigger, we have less of an excuse. The bar has gone way up.

The scale of our industry has changed. We’re now in an industry that can produce more than just $1 billion+ companies; it can produce $10 billion+ companies. Put aside what you call them, but this is where the bar should be set. And what Europe needs to do more of.

The challenge these days — compared to 2013 — is that the market has matured, which means there is a lot more great stuff being built than ever before. That means we should be more active.

Rob K.’s done some great work building out the infrastructure we need. So let’s see. Our view is the ecosystem is just getting started. The real question for me is what else do we need to do as a fund to get from being good to being exceptional.

Out of fund one, how many companies did you back in total and how many are still in existence today versus deadpooled? And more broadly, what have you learned from those “failures”?

Hussein Kanji: This one is easy. Seventeen companies in Fund I. Three unicorns. Six acquisitions. Two restarts (one good, one bad). Ten are still going, but one of these is walking dead, and don’t even get me started on the bad restart. Of the remaining eight companies, I’d say a handful have a shot at greatness. Behavox raised $100 million before the pandemic, and we’re big fans of what Dylan and his team are doing at SuperAwesome.

Rob Kniaz: We learned that it’s essential to run a process with the founders if things just aren’t quite working as expected, or a market isn’t shaping up as planned. Valley firms do this really well — once a founder hits the wall or decides the product-market fit isn’t quite there, the VCs there use their networks to find a buyer and find a good home for the team, hopefully recovering some capital in the process. This requires a tight network of friends at the big buyers and fortunately we can call on our former colleagues spread across these companies in California to open the door if and when that time comes.

We’re also sticklers to focus as early as possible on the American market. No matter where the company is, with few exceptions the U.S. is the largest customer market for nearly all our companies. I think often it’s easier to dedicate effort to selling in Europe when frankly for marginally more cost and effort you can compete in the U.S. And there’s always American competitors so if you’re going to have a David vs. Goliath scenario in the future with a well-funded American competitor, better to fight Goliath before he grows too big.

Back in 2013, you made a number of assumptions about what the European ecosystem needed in order to grow, including pitching Hoxton as one of only a few new early-stage firms in the region and one what could provide a needed bridge to the U.S./Silicon Valley for customers, partnerships, follow-on funding and future exits. However, these days there is a lot more early-stage capital in Europe and U.S. funds are literally coming to Europe to source deals, while Apple, Amazon, Facebook and Google are now European startup acquirers. Problem fixed, no?

Rob Kniaz: I’m delighted to see the American funds coming over more often, but simply put there just aren’t enough hours in the day to cover the continent properly without a full-time partnership team here. And at the earlier stages, there’s a fast cadence of communication that’s just really hard from 8 or 9 hours away. We get all sorts of founder calls and WhatsApps from 7 a.m. to midnight and all during the day, and you lose momentum in that dialogue if you’re waiting 12 hours for a response. As companies get bigger and more structured this is less an issue but where we play in the market, we think it’s hard to do early stage well if you’re more than a daytrip away from the team. Increasingly though we’re seeing American firms who want to coinvest with us and then lead the subsequent rounds, so we’re happy to be the “guys on the ground” to spend time on the local stuff and use the Valley connectivity of the U.S. firms when it’s useful for the company and as a signal to other follow-on investors.

Hussein Kanji: The problem is never really fixed. Our region is the perpetual global underdog. Back in 2010, the U.S. had $31 billion of venture investing, compared to $7 billion in Europe and $6 billion in China. Everyone has since grown. Last year, when China’s venture economy nosedived, $36 billion was invested in tech startups, compared to $96 billion the year before. Meanwhile, North America put $132 billion to work in 2019. Europe hit all time highs and grew from $7 billion to $36 billion, but you can see that compared to both the U.S. and China, it still has a long way to go.

There is a ton of money now and sometimes it feels like every family office and corporate wants to become a tech investor. But the high-quality money is thin in Europe.

You’re right about the U.S. About 15% of Europe’s funding came from the U.S., and that’s up dramatically from where it was at the beginning part of the decade. Our portfolio’s benefitted from the U.S. interest in European companies. About three-fourths of our companies have raised from U.S. funds.

Probably the two biggest shortcomings we’ve seen in our portfolio is an accumulation of organizational debt, and in enterprise companies, an inability to build the world-class salesforce you need to get to $100 million in revenue. $100 million sounds like a lot, but as this industry has grown, that’s become the new bar. It’s amazing how quickly some companies in the U.S. go from $0-$100 million. Meanwhile, in Europe a lot of companies get stuck going from $10 million-$40 million, sometimes even $10 million-$25 million.

Part of it goes to our hypothesis that a lot of companies in Europe don’t hire for the future; they hire for the present or the past. That accumulates organizational debt because by the time you find someone, he/she ramps up and gets up to speed, you’ve lost 6-12 months of time, at a time when every day and week counts.

A lot of our companies have broken past this stage but it’s been slower going than it should have been. It often helps to get the larger check and a U.S. fund involved, because there is more know-how in building these exceptional teams around the founder. And because our economy has grown so rapidly, great people have become a lot more expensive.

Let’s talk about two of your unicorn investments: Takeout marketplace and delivery platform Deliveroo, and AI-powered health chatbot and remote doctor service Babylon. Both have seen their fair share of controversy, with regards to employment rights and patient safety, respectively. They are also arguably examples of a scale-up getting ahead of existing regulation. How do you think about or “price in” regulation when investing in disruption and do you think Europe’s higher regulatory bar is a competitive strength or weakness for the ecosystem here?

Rob Kniaz: Those are really champagne problems to have about pricing in regulation! You could ask the same of seed investors in Microsoft in ‘83 or in Amazon in ’95 but I’m sure they’d say the same. It’s an honor to be part of these tremendous success stories. Of course there is regulatory risk and things — It’s impossible to price that in at the early stages but the goal is to find these runaway winners early and then ride the wave. As small shareholders we don’t have any say operationally at these later stages but our process means we select for founders who are at the forefront of defining new markets and therefore the regulations that develop around them.

Europe’s regulatory bar cuts two ways. The “single market” is still very fragmented and full of various local roadblocks. But that drives innovation so sometimes anticipating regulation has led to leadership emerging here, as the case was with both Behavox and SuperAwesome in Fund I. We’ll see how GDPR continues to affect company data strategies but in a way the U.S. backlash around the big tech companies has pushed American regulators closer toward European strategies, which European companies adapt to earlier.

Hussein Kanji: I think I tweet a lot about European regulator insecurity. I think it really bothers European institutions that the big tech companies are either U.S. or Chinese. Everyone wants nice things but then it seems like this part of the world shoots itself in the foot.

But our job isn’t to set policy. It’s to find great companies. If those great companies end up attracting regulator attention, I think Rob K. says it right. It probably means they’ve scaled.

You say that approximately one-sixth of the new fund’s investments have been made after the start of the coronavirus crisis. Were these deals done over Zoom and fully remote etc.? Perhaps you can share the process and the challenges or opportunities doing deals this way creates?

Hussein Kanji: That’s a good one for Rob Ludwig to take point on. He joined us in December as our COO and we’ve thrown him in the deep end.

Rob Ludwig: It has certainly been an interesting initial six months; first learning how the guys like to do things and then needing to invent new ways to maintain those processes in a remote environment. First, as you note, since lockdown happened, Fund II has made a significant number of new investments: Three new portfolio investments have been fully signed, we co-led an upround for an existing investment, are in the final stages of legal documentation with a fourth and have nearly agreed to a term sheet with a fifth company. Plus, the funnel of potential opportunities hasn’t seen any material change in size. All this, together with working closely with our existing companies in Fund I, significantly increasing our communications with LPs to give them a “live” understanding as to how COVID was playing out on the portfolio and, not least, carrying out a final close has meant for an extremely busy time in lockdown.

As all of these things are processes, some of them had their roots pre-lockdown (for example, the term sheet for the upround had been offered shortly before lockdown), so there is an element of leveraging prior in-person contacts. However, as the lockdown has lengthened, that has obviously become less relevant and the more recent deals have been done fully under lockdown making full use of all the remote collaboration technology that is out there. I can’t speak for Rob K. or Hussein, but watching it; it doesn’t seem to have caused any real impact on their ability to meet founders and access potential investments.

As for process, internally we are extremely well connected. We are constantly in contact on our main WhatsApp thread, have worked out protocols around always being available to speak quickly and have regularly programmed Zooms to work through where we are in terms of each deal. It certainly helps that the team is so small it has been able to be flexible, historically had already developed good protocols for interacting while one of us was traveling and is also extremely aware and understanding of the different challenges each of us has been dealing with when having to figure out working from home.

Hussein Kanji: A lot of folks don’t know this but we also work with a great coach. Think Wendy Rhoades and “Billions.” It means that we’ve invested heavily in how we stay in sync and perform as a team.

Some folks think we’ve been lucky. But it’s hard work. I’ll never forget during fundraising when a large university endowment told us that they’d concluded that we were lucky with our investment track record. I can understand striking it lucky with one unicorn investment or two, but three in a single small fund?

Where we’ve been really lucky has been in this pandemic. It hasn’t adversely affected our portfolio. We did have a travel company that took it on the chin, going from increasingly beating plan to collapsing to a fraction of its revenue in March. Fortunately, between all the existing investors — Cherry, Endeit and TCV (and with some great support from the Austrian government) we were able to get it enough runway until 2022. We’re hoping that gives them plenty of time to ride out the pandemic.

The consequence is we’ve been blessed with mental bandwidth that allows us to to think about new things. We went into lockdown a few weeks before everyone else so we’ve been fully adjusted to this new normal before the end of March. Rob K. even did some home construction to build himself a new place to work!

We didn’t expect to be so busy in April and May, but we’ve seen some great things come our way (and continue to come our way). The beauty of being a small team is you’re nimble and we’ve more than figured out what it takes to write the check when the right thing comes in the door.

Lastly, how does Hoxton think about diversity and inclusion, both in terms of the investment team you have assembled but also what you expect from founders within your future portfolio and the teams they are building out?

Rob Kniaz: We started putting up these stats on our website. More than a fifth of our companies have a female founder, more than a third are started by minorities and nearly two-thirds are started by immigrants. That’s across both funds. Our website says it best: “Diversity is achieved through actions, not words.”

Rob Ludwig: To me as a new joiner to Hoxton, the most interesting part of the statistics gathering exercise was that it was an actual exercise that we had to go back through and pull the data together. In a different organization, this might have been baked into the process, whereas for Hoxton, the stats, as Rob K. says, speak for themselves, but they have occurred as a result of a process driven by a search for great founders who can build great companies. Now that we have the data, we do need to think hard about what it means for our process and what we can do to make sure our internal heuristics aren’t causing us to miss a great founder building a great company.

Hussein Kanji: As you know, we’re a small team and I don’t think that’s going to change much. We do want to recruit someone in the next year or two, and we’d love to bring a bit more representation into the firm. Diversity helps drive returns. Rob K. has been pushing us to think more and more about this.

We’re largely hands off with our companies, but I think almost all the founders we pick tend to do the right thing and have a broader perspective on society.