Venice Project

Pitch investors at the right level of abstraction

By | Startup general interest, Venice Project | No Comments

I’ve just read the a truly excellent guide to fundraising from First Round Capital. It’s a long read, but packed full of goodness and I highly recommend reading the whole article.

I’m going to pick out and expand on one point – it’s critical that founders pitch investors at the right level of abstraction. The two common mistakes are:

  • Pitching too much in the weeds, leaving investors unexcited about the big picture
  • Pitching at too high a level, preventing investors from really feeling the opportunity – you’re looking to create a visceral connection

As First Round put it:

The fundraising founder has to operate at the right oxygen level between the soil and the stratosphere. Not in the trenches, but not in rarified air.

Founders who are pitching too much in the weeds focus too much on operations, short term progress, and the mechanics of the business. If investors are worried about market size or exit potential, or if they are simply looking bored, you may be making this mistake.

Conversely, founders who are pitching at too high a level talk too much about market trends (often using poorly defined buzzwords) and don’t properly connect their story with their business. If investors are asking lots of questions about what you actually do or struggle to understand your story, then think about whether you are making this mistake.

The best pitches paint a picture of the future which is easy to understand and grounded in reality. Then they describe the path that will get them there, starting from where they are today.

Sustainable startup growth and venture capital

By | Venice Project | 2 Comments

On Friday it seemed like everyone in the venture capital industry was again reading about market turmoil, this time the news is that angel investors are pulling back and valuations taking a hit. I read it too, because it’s a big deal. Startups everywhere will need to adjust their fundraising strategies and good investors will be helping them to adjust quickly – it’s much less painful that way.

However severe our current situation is, I’m sure there will be plenty of short term negatives, including more job losses, company failures and down rounds. However, every cloud has a silver lining and this time I hope it’s that out of the current correction/crash (wherever we end up) comes a more sustainable model for startup growth.

In his post The end of the big venture formula Danny Crichton put it like this:

What’s needed is a sustainable approach to startup growth and venture capital. That means much less blitzscaling (whatever the heck that ever was), and lots more heads-down quality thinking to build products that customers actually want and will eventually pay for. We need a new disruptive capitalism that is designed for a much more mature internet market, one that can bring founders, investors, and employees together.

I would summarise that as getting the fundamentals right – from great product, through unit economics to stakeholder alignment.

Crichton went on to highlight three myths that are preventing founders and investors from focusing on fundamentals:

  1. Growth is limitless in a world where 3bn people are connected to the internet and the other 4bn will be online soon
  2. The best startups capture all the returns so focusing too much on entry valuation is a mistake
  3. Scale is everything, and all else should be sacrificed for it

I would say there is some truth in all three myths but not enough to make them useful rules of thumb. In the ecommerce and marketplace markets Forward Partners operates in growth is limited because business has to scale country by country. It’s easier than ever before to do that (we have a 4 month old ecommerce company experimenting with US expansion) but still hard work. Secondly, there is definitely a power law in venture returns, but in the now huge global markets the winner takes all dynamic is weakening, and only chasing unicorns misses the huge opportunity in companies with $100-1bn exit potential. Thirdly, in early stage startups, scale, or more precisely growth/momentum, is hugely important but if the unit economics are never going to add up then you don’t have a business.

It’s worth remembering that there’s some game theory at work here. If the markets are only focused on scale then focusing on fundamentals risks seeing a competitor raise more than you, grow faster, and make it much tougher for you to raise more money and grow customers yourself. And so long as there’s a bigger fool  out there focusing exclusively on scale often works out just fine.

Most long term venture industry insiders prefer operating in a steady climate where companies don’t have to follow highly risky strategies just to stay competitive. I think that’s why you see people like Bill Gurley, Fred Wilson and Mark Suster publicly talking markets down. They are hoping the ‘bigger fools’ will step out and we can all get back to focusing on fundamentals.

I’ve written a lot on this blog about two aspects of fundamentals – great product and strong unit economics – but less about stakeholder alignment. I will look into redressing that balance, but my first thought is that because of current practices/trends towards non-participating preference shares and early founder/employee/angel investor liquidity this is the one front on which we’re not doing too badly.


Valuation trickle down

By | Startup general interest, Venice Project | 4 Comments
I’m back to the bubble question this morning.
First up we had an interesting post from Fred Wilson arguing that frothy activity is restrictred to Series B rounds and later in private companies, whilst Seed and Series A and public markets are still rational. He used this chart as evidence:
Second, I read Josh Kopelman’s/First Round Capital’s Open Letter to Investors from May this year which says that seed valuations are up 3x from 2007-2015 without a corresponding increase in exits. Note that we can see a similar increase in Series A valuations in Fred’s chart above.
Third, I was talking with a potential investor in our fund yesterday about market conditions here in the UK. He was asking whether with all the new funds in town valuations are rising and returns are likely to suffer. My view is that the market here is the healthiest I’ve seen it. When I joined the VC industry in 1999 there was too much money in the market, and then over the course of 2000 that flipped to too little money a position from which we are only just recovering now.
Whilst the odd deal is getting done that looks a little bubbly there isn’t much of that at idea and seed stage here. The valuations Forward Partners is paying haven’t moved in the last couple of years and nor are deals getting done in dangerously short timescales. I sat down with our investment team this morning and talked through some of the hotter deals that have been done in our sectors lately and how investors are responding to the deals we bring to them and we aren’t seeing anything other than isolated pockets of investors getting irrational.
Pulling it all together, I think that unless there is a correction in late stage private investing the frothy activity will trickle down to earlier and earlier stage rounds. Fred Wilson’s chart shows that US B and C rounds have already caught the bug and Josh Kopelman’s letter shows that seed markets are also getting hot. The trickle has two dimensions – down to smaller and smaller rounds, and across to other geographies. The trickle down happens faster than the trickle across, but absent a correction in the US valuations will start to rise here at some point in the next couple of years.
If the public markets maintain their discipline I think a late stage correction is more likely than irrational activity trickling all the way down to UK seed investing. If not, not.


Comparing valuations between rounds

By | Venice Project | 2 Comments

We’ve just been writing an update for investors about the progress our partner companies have been making. A few of them have done good up rounds and the easiest way to describe the magnitude is to talk about the valuation multiple.

From the perspective of existing investors the right way to calculate the valuation multiple is to compare the pre-money valuation of the new round with the post-money valuation of the last round, which is the same as the increase in share price. (As a refresher, the post-money valuation is calculated as the pre-money valuation plus the amount of money invested.)

Investors and entrepreneurs alike want to present the progress in the best light by showing the biggest multiple they can and they often default to comparing the post-money valuation of the new round with the post-money valuation of the last round. At first glance that seems to be a fair representation of how far things have moved forward, but it doesn’t account for the impact of the new money.

This is best explained with a fictitious example.

  • ACME Hot Food co first raises a round of £2m at £6m pre-money and hence £8m post-money
  • Twelve months later the company raises a further £8m at £8m pre-money and hence £16m post-money
  • The share price and valuation of the company hasn’t moved forwards because the new investor valued the company at £8m, the same as the post-money valuation of the previous round – the share price won’t have changed
  • Comparing the pre-money valuation of the new round with post-money valuation of the old round shows this clearly – £8m to £8m – ACME Hot Food co has achieved something in raising more money, but there has been no uplift in valuation
  • However, comparing the post-money of the new round with the post-money of the old round gives the illusion that the valuation has doubled – £8m to £16m

Note: if the option pool has been increased between rounds this will have the effect of reducing the increase in share price and should be factored into the analysis.

Some lessons on startup financing from Tren Griffin and Nassim Taleb

By | Exits, Startup general interest, Venice Project | No Comments

Nassim Taleb is one of the most visionary thinkers in modern finance. His books Black Swan and Fooled by Randomness are must reads for anyone in the investment business. Tren Griffin writes a good blog about investing, and this post is inspired by his article A dozen things I’ve learned from Nassim Taleb about optionality/investing. Thanks to Josh March for the pointer.

Griffin and Taleb’s main point is that we should all seek investments which offer high optionality. He explains why in his first bullet:

1. ”Optionality is the property of asymmetric upside (preferably unlimited) with correspondingly limited downside (preferably tiny).”  Venture capital, when practiced properly by a top tier firm, is a classic example of a business that benefits from optionality. All you can lose financially in venture capital is what you invest and your upside can be more than 1000X of what you invested.  Another example of optionality is cash held by a disciplined patient value investor with the temperament to not buy until Mr. Market is fearful.  As just one example, Warren Buffett did exactly this during the recent financial panic and earned $10 Billion by putting his cash to work.  Seth Klarman, Howard Marks and other value investors use dry powder in the form of cash to harvest optionality since Mr. Market is bi-polar.

He later explains why venture capitalists build portfolios of risky options:

Warren Buffett believes:  “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments.  Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted  for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but  unrelated opportunities.  Most venture capitalists employ this strategy.”

The corollary of this is that when valuations get too high, or the amount of cash raised gets too high then the asymmetry between the upside and the downside disappears. The optionality is therefore lost and the investment becomes less attractive. This is all from the perspective of the venture investor.

Interestingly though, I think things end up looking pretty similar for the entrepreneur. In this case the investment is largely in the form of time committed to the startup, and hence the downside is the time lost to other opportunities. Most entrepreneurs work as hard as they can to grow their businesses quickly and for the good ones the limits to growth are generally exogenous – i.e. they come from outside the startup, usually in the form of market readiness for a solution or the availability of enabling technologies – so there isn’t much that can be done to change the investment or limit the downside. There are however many important decisions to be made that change the probability profile of the upside, and following the Munger/Taleb logic they should be made to maximise optionality.

The most important of these decisions is how much money to raise. Many entrepreneurs seek to raise the maximum amount of money they can at the highest valuation possible at the earliest possible time, but that locks the company on the path of seeking a very high exit and looking through the lens of maximising optionality it’s clear that from the point of view of maximising founder returns it isn’t always the right thing to do. The examples are pretty obvious to think through. If after a $5m Series A a founder holds 30% of her company and then goes on to raise a $20m Series B at $60m pre-money her stake will drop to 22.5% but she will most likely now be sitting behind a $25m liquidation preference and have taken on new investors who want to exit the company for at least $240m (to get 3x on their investment). The probability of getting to a big exit will have increased but the commitments to new investors will have reduced the chances of getting a smaller exit and the amount of cash the founder gets from those smaller exits will have reduced, particularly at sub $50m exits when the lions share of proceeds will go to the preference holders.

The upshot of this is that in the situation where it’s too early to have real confidence in the big upside opportunity AND there is a viable go slower option raising the maximum amount of money at the highest valuation isn’t the smartest strategy.

Griffin puts it this way:

7. “[Avoid] companies that have negative optionality.” Companies (1) focused on a niche market,  (2) have employees with limited technical skills, (3) which raised too much money at an inflated early valuation or(4)  are highly leveraged are examples of companies with negative optionality.

8. “[Avoid[ A rigid business plan gets one locked into a preset invariant policy, like a highway without exits —hence devoid of optionality.”

Locking into arrangements that demand a high exit is a form of rigid business plan.

Raise enough money to get you 6-9 months past the next milestone

By | 50 Questions, Venice Project | 4 Comments

Fred Wilson wrote a post on Sunday with the following advice for entrepreneurs raising money:

raise 12-18 months of cash each time you raise money. Less than a year is too little. You’ll be raising money again before you know it. Longer than 18 months means you may well be sitting on cash that you raised when your company was worth a lot less.

My advice is usually a little more conservative than that.  For me the best way to figure out how much money to raise is to work back from your next funding round, with the objective of making sure there is a decent appreciation in value.  The first step in this approach is to estimate the time and money it will take to get to the next value appreciation milestone (and remember startup valuations move in step functions) and then add another 6-9 months burn on top of that.  That way you can begin the fundraising process with the good news in the bag and have six to nine months to raise the money.

I was a little hesitant in writing this post, for fear of falling into the stereotype of the over-conservative European VC.  I think the point is important though, and in Europe at least raising twelve months money is a dangerous if you then miss a beat on execution.  My differences with Fred maybe reflect the different depths of the US and European VC markets and the fact that it still takes longer to raise money over here (unfortunately).  Additionally, Fred starts his post with the caveat that his advice is for companies that are ‘growing really fast’, whereas my advice is more general and applies equally to startups that have yet to hit their rapid growth phase.

For an alternative perspective on how much money to raise check out Nicholas Lovell’s 50 Questions: How much money should I raise?

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Understanding Venture Capital – slides for my Cass Business School talk

By | Venice Project | 9 Comments

Thanks everyone who chipped in with suggestions for the talk I’m giving to a CASS Business School MBA class in a couple of hours.  One of the reasons I write this blog is to help shed some light on the often murky world of venture capital and it has been helpful to hear which areas are the murkiest.

I’ve embedded the slides below and they will hopefully answer most of the questions raised, although as ever there will be more in the voice over than the Powerpoint.  There are a couple of points that bear repeating in the body text of this post, although they won’t be surprising to many of you:

  • Taking money from a VC usually locks a company into shooting for a big exit, and rules out the possibility of a lucrative low level exit or running a lifestyle business
  • Venture capital is rarely for starting companies, but rather for accelerating the success of those that have gotten off to a good start

Finally – Ben Holmes, if you are reading I have copied a couple of slides from your Glasshouse presentation.  Thanks and I hope you don’t mind!

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Joost’s B2C strategy failed due to lack of focus

By | Google, Startup general interest, TV, Venice Project | 6 Comments

Om Malik has a great post up today on GigaOM reporting on Joost’s announcement that it will now offer a white-label video hosting platform whilst at the same time letting some people go and closing its Netherlands office.  The reason for this shift in strategy is clear in the chart below – they haven’t got enough traction.


As well as covering the change in strategy (which he describes as a strategy of last resort) OM does a bit of post mortem analysis on the the consumer play.  He lists the many things they had going for them at the start (many of us were very excited by their prospects at the time) and then the reasons they went awry.

According to OM these are the top three reasons things went wrong at Joost:

  • Too Big, Too Fast: Joost hired too many people, too quickly. It never behaved like a startup but instead always felt like a grown-up company with too many bureaucratic layers.
  • Too Geographically Spread Out: The company was based in multiple geographic locations — New York, London and The Netherlands — and as a result, each location became somewhat of a silo.
  • Not Enough Focus: Remember what your mom used to say when you took too big of a bite? If you’re not careful, you’re going to choke. Startups are just like that. Unless you focus, you’re going to choke. Joost couldn’t focus on one single market — and startups need to focus on one market at a time in order to win.

The reason I am bringing these out is that I think they apply to just about all startups anywhere.  I actually think they all boil down to the same thing, which is focus. 

In my experience companies which think of themselves as big companies from day one rarely succeed because they start doing too much.  Instead the great ones focus obsessively on doing one thing brilliantly.  That can be a single product that works globally (Skype, Google) or it can be a service that you perfect in a single country before going international – and most media and advertising businesses fall into this second category.  Just look at Hulu, which has made itself successful by focusing on the US (much to my irritation as I’d love to be able to use it here..).

Once you have success in one area it becomes much easier to grow either geographically (which is where Hulu is going) or by adding new products.

The other great virtue of this approach of course is capital efficiency.

I think these arguments have much more weight than the opposing one of wanting to get everything done super-quickly for fear of ‘missing the window’.

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Joost and Babelgum struggling for content

By | IPTV, PCTV, Venice Project | 2 Comments

In a development that is perhaps not too surprising Joost and Babelgum are struggling with content acquisition.

Their responses are quite different though. Babelgum has created a €10m commissioning fund for original content and made it’s first investment, whilst Joost is retrenching from it’s global ambitions to focus on the US.

I have talked to a lot of people about how the TV value chain might look in the future and for me the most obvious structure to migrate to has just two players (at the highest level) – the content owners and aggregators who provide search and navigation functionality.

Note the absence of broadcasters. As per Anderson’s Long Tail argument I think these guys are products of a bygone era where limited distribution capacity shaped the industry.

That said, as well as managing distribution capacity broadcasters play a critical role in predicting demand and managing the customer relationship on behalf of content owners. I suspect that in the future the larger content owners will do that for themselves and the smaller guys will need to use local sales representatives in each geography.

This matches the way the web works today, and indeed I’m persuaded by the idea that TV programmes will one day be delivered in much the same way as websites. They are both forms of digital content, after all.

Seedcamp – judges day

By | Entrepreneurs, Equity gap, Seedcamp, Venice Project | 8 Comments

If you follow the Seedcamp Blog you will know that applications to participate in startup-school-cum-incubator-cum-fund’ Seedcamp closed twelve days ago and yesterday was Judges Day where the 268 applications was whittled down to the 20 that will be invited to Seedcamp week.

The number of great companies was awesome to see.  By definition they were all early stage, but there were a lot of really high potential businesses amongst the 268 (which came from 40 countries by the way).
One of the reasons I have gotten involved with Seedcamp is to do my bit to help the London/European startup ecosystem to develop.  What I saw yesterday tells me we are already in pretty good shape.  Of course there is more to do, and I would encourage everyone to chit in, but it was great to see such a high quality set of companies.

I am really looking forward to Seedcamp week.  With this level of company everyone should get a lot out of it, mentors and companies alike.