Venture Capital

The danger of over-funding and herd investing

By | Venture Capital | No Comments

I’ve just found time to read Bill Gurley’s On The Road To Recap. I won’t add to the volume of good posts saying that he’s right to point out that the unicorn financing market is entering a dangerous period where all manner of pressures and biases will cause people to behave badly and mistakenly put off adjusting to the new reality in late stage funding.

Instead I’m going to highlight his warning about what happens when markets get over-funded:

Loose capital allows the less qualified to participate in each market. This less qualified player brings more reckless execution which drags even the best entrepreneur onto an especially sloppy playing field. This threatens returns for all involved.

In 2014-2015 the unicorn market was over-funded, sparking intense competition, high burn rates, and as we are starting to see now, ultimately damaging returns.

This is a movie we’ve seen many times before, although it is usually an industry sector that gets over-funded rather than a stage of investing.

I first noticed it in late 2000 when the fund I was working for was invested in one of six high profile and highly funded enterprise portal businesses. It seems crazy now to think that software for enterprises to build intranets (remember them) was such a big deal, but we all piled into these companies giving acquirers multiple options to acquire similar businesses and driving M&A valuations down for everyone. I think one of the companies made it to IPO but even they struggled when IBM and other large tech players bought their competitors.

Other examples include mobile games, DVD rentals, and cloud storage. It’s likely to happen in bots and AR/VR next.

The most commonly repeated pattern is for VCs to over-invest in sectors that are obviously going to be big. It’s most egregious when there’s a long period of elapsed time between when it’s obvious a market will be big and the market actually takes off. Most everything that moved from the internet to mobile looked like this, and was hard to make money from as a result.

The lesson here is to not invest in the obvious stuff, either by investing before it’s obvious (but remember that being too early is as bad as being too late) or by giving it a miss altogether. Instead it’s better to look for less popular areas that you understand well, that are growing, and where the fundamentals are strong. That takes the courage to be different and the confidence to hold your nerve, but if you’re short in these areas maybe investing isn’t the best career for you anyway.

The decline in venture is bottoming out

By | Venture Capital | No Comments

Screen Shot 2016-04-15 at 16.09.37

Reading the tea leaves to predict where the venture capital market is heading seems to be everyone’s favourite hobby at the moment, and I’m no exception. Last week we had data from which showed that venture investment in Europe is roughly flat quarter on quarter (excluding Spotify’s $1bn raise). Now we have Mattermark and PWC data on Q1 in the US and, surprisingly, the picture there is similar. As you can see from the chart above there was a precipitous decline from Q3 to Q4, but the rot stopped in Q1. Moreover, we are still at a high level of investment when compared with any period except the last couple of years and the 1998-2000 bubble.

It will be very interesting to see where this goes next quarter. I’ve been saying that I think the underlying growth in venture and startup activity here in Europe will balance out the correction and my best guess is that investment levels for the next few quarters will be roughly flat on where they are today at €3.5-4bn, but that I expected the US to keep falling. Now I’m wondering if I should revise my expectations upwards.

The other interesting thing to emerge is that investment in the Bay Area is falling faster than everywhere else – Q1 2016 is 20% down on Q1 2015. The capital overhang is greater in the Valley than anywhere else whilst at the same time it’s getting easier to start and finance your business in multiple other places (including London) so I would expect this trend to continue. That would be good news for startup ecosystems all around the world.

European tech investment is holding up

By | Venture Capital | 3 Comments just published stats for European VC investment in Q1. We used to wait months for this kind of data and it’s great that it’s coming through in the first week of the new quarter. Faster data enables better decision making.


As you can see, if we ignore the $1bn debt round in Spotify, the value of investments in Q1 was roughly the same as in Q4 at €3.5bn. However, the number of deals continued to rise sharply, and hence, as you might have figured out, the average round size was lower – falling from €5.8m in Q4 to €4.6m in Q1 (ex Spotify).

The increase in deals came, therefore, at lower round sizes:


This data matches with what we’ve seen in our portfolio. Some of our companies have found it takes longer to raise, but they are all still getting their rounds away.

I think the big picture is that whilst it might be decreasing sharply in the US investment by value is holding flat in Europe. That’s what the first chart shows (ex Spotify). There are two related reasons:

  • The 2015 and H1 2016 exuberance in the US only came across the Atlantic to a limited extent
  • The supply and demand of capital vs startup opportunities in Europe here still favours capital

Because of these reasons the European market was less inflated than in the US and any correction effect is being balanced by natural growth in the market.

It’s also interesting to note that over the last three quarters the numbers of €0-1m deals and €1-5m deals has been roughly the same, implying that most companies raising a seed round are successfully raising their next, larger, round. The big drop off, and implied failure point, comes between raising €1-5m and €5-10m.

UK venture deal volume surpasses 2000 peak

By | Venture Capital | No Comments

Screen Shot 2016-03-10 at 14.43.41

Yesterday Stuart McKnight/Ascendant Corporate Finance published their regular report on activity in the UK venture market. As you can see from the chart above, 534 investments were made in the UK (above £0.5m) beating the previous high of 463, which was set back in 2000 at the height of the dotcom bubble madness. As you can see, our ecosystem has been growing fast since 2011, giving more credence to the notion that we we are finally reaching critical mass.

Whilst deal volume broke records last year, deal value did not. By Ascendant’s numbers, in 2016 £2.6bn was invested in the UK and Ireland, up 76% on the £1.5bn invested in 2014, but still well below the 2000 peak of £3.5bn.

London saw more of the action than other cities with 207 of the 534 deals. Edinburgh was the next biggest city with 25.

It’s also interesting to note that only 19% of the deals were in fintech (21% by value).

Critical mass and the London startup ecosystem

By | Startup general interest, Venture Capital | No Comments

Often results are not linear. You get a little bit more mass, and you get a lollapalooza result.

Charlie Munger

Critical mass is a term that gets bandied around a lot in the startup world. A common use case is to describe the point when a company reaches sufficient scale that it achieves profitability. Another is the point where a network or ecosystem has sufficient supply and demand that the user experience starts to work. Most networks crack this chicken and egg problem by using a hack of some kind to get either supply or demand in place. AirBnB famously scraped Craigslist to get their business started and here in London Hailo built a social networking app for cabbies as a way to get drivers on the platform before they had any users.

Without hacks like these networks and ecosystems grow slowly, and that’s what’s happened with the startup ecosystem here in London. There have been many successful government and Brussels sponsored initiatives to help get us towards critical mass, but there’s no getting away from the fact that it takes time to build a startup ecosystem. Silicon Valley got properly started in the 1950s and 1960s whereas we have only been going since the late 1990s.

Inevitably we have been sub-critical mass for much of that time, and it’s been painful. Many of our best entrepreneurs have taken the difficult decision to leave their home country and go to Silicon Valley because the startup ecosystem is stronger (most importantly, because there’s more finance) and the companies that remain have, on average, found it more difficult to raise capital, often resulting in smaller raises, less ambitious plans, and slower growth.

Over the last year or two I’ve felt that changing. It’s not possible to define critical mass and therefore to pinpoint the moment it’s been achieved, but the recent proliferation of new startups and new funds (including ours) feels like Munger’s lollapalooza result. High failure rates are part of the model, so it should never be easy to create a company or build a fund, and that remains the case, but it has definitely got a lot easier recently, at least in part because the volume of investors and high quality founders reached a point where there was lots of opportunity for everybody and confidence spiralled.

The other reason financing companies got easier recently is because the markets were hot last year. They are less hot now. It will be interesting to see if our ecosystem has the depth and resilience to stay at or above critical mass, or whether we will dip back below.



Unicorn deals – not that heavily structured

By | Venture Capital | One Comment

Last May law firm Fenwick and West published an analysis of the 37 US unicorn deals that happened in the twelve months ending 31st March 2015. It’s an old post which I saw for the first time this morning.

Here’s the headline data on the deals:

  • Mean valuation: $4.4bn
  • Median valuation: $1.6bn
  • 35% of companies had valuations in the $1.0-1.1bn range, indicating many companies negotiated specifically to get unicorn status

The headline finding was that the unicorn investors had significantly more downside protection than public market investors. All of the deals had a liquidation preference of 1x or more. This goes some way to explaining why we went through a period when late stage private companies were valued higher than their listed peers. However, whilst I haven’t seen a full analysis, I doubt this additional downside protection would be enough to explain all the difference in valuation. I think a bigger part of the explanation lies in deal dynamics – it’s easier for companies maximise valuation in private financing auctions than it is in IPOs.

However, few of the deals went beyond a simple 1x non-participating preference share. I always wondered if companies were accepting multiple liquidation preferences in exchange for high valuations, but that was only the case in 3% of the deals analysed. Similarly, only 5% of the deals had a participating preference share (in a participating preference share the investor gets their money back first and then participates pro-rata with other shareholders in any remaining proceeds).

Other protections were not that significant in number either. Only 30% of the deals had protection against a downround IPO, and protection against private downrounds was inline with venture industry standards (weighted average anti-dilution protection).

In summary, structuring and other fun and games was limited and the high valuations were pretty much what they appeared to be.

One other interesting titbit is that 75% of the rounds were led by hedge funds, mutual funds, sovereign wealth funds, corporates or other non-traditional investors in private companies. Money from these sources flows quickly in and out of markets and is now chasing other opportunities. It’s that more than anything which has been bringing the market down for the last six months.

New money into venture explains ups and downs in the market

By | Venture Capital | 9 Comments

There’s been a lot of talk recently about what will happen to startup financing in 2016, including here on this blog. The consensus is definitely negative, but one thing that has buoyed my optimism about the prospects for our portfolio is the number of new funds raised in London recently. A lot of them are focused on Series A investing and favour the ecommerce and marketplace sectors that Forward Partners focuses on. Moreover, most of them are only a small way into their funds and under most scenarios will want to maintain a steady investment rate through 2016.

I just saw a great presentation from Mark Suster/Upfront Ventures on the State of the Venture Capital in 2016 which explains the discrepancy between the sentiment in the market and the observation that there are lots of funds out there which need to deploy capital.

Screen Shot 2016-02-09 at 12.30.17

With this slide he’s explaining that in 2006-2007 investments into startups were equal to the funds raised by VCs, implying that only minimal amounts of non VC cash was invested in startups, but by 2014/2015 the situation had changed dramatically. In the last couple of years the ratio of money into startups to funds raised by VCs was 2.5 implying that an awful lot of non-VC money flowed into the ecosystem (the column headings in the charts are a little ambiguous, but the explanation I’ve given matches what Mark wrote here).

Mark also notes that startup valuations went up 3x from 2006-2015, and simple supply and demand logic suggests the non-VC cash in the market was important in driving prices up. He also surveyed 72 institutional investors in VC funds who said they think they will maintain their rate of commitments to new funds this year.

Pulling all this together it seems to me that any correction in the market we see this year won’t be because VC funds are investing less but because non-VC sources of capital are pulling back. That makes sense given that a lot of the froth was in big late stage deals where hedge funds and big fund managers like Fidelity were playing, and that is the sector of the market most closely affected by the downticks in public markets we have seen this year.

There will be a trickle effect down to earlier stages of investment, but most of our portfolio is still very young and the Series A market that’s most important to us in the short term is almost entirely comprised of VCs, and with a bit of luck will be less hit by any downturn than the later stages of investment. That fits with my observation about the number of funds in the London market and tallies with our experience in the first 5-6 weeks of this year, which is that our companies aren’t finding it noticeably harder to raise capital than they were last year.

Corporate innovation will harness the power of entrepreneurs

By | Exits, Venture Capital | No Comments

Jon Bradford, founder of Techstars UK, once said to me that corporate innovation budgets dwarf venture capital. This tweet from Benedict Evans gives an insight into how much. The excess cash from Apple from 2006-2015 was greater than US VC funding in total.

That got me thinking, so I took a look at corporate R&D spend and it turns out that 2014 spend in the US was over $250bn and in Europe it was over $200bn. That compares with $86.7bn in global venture capital investment in the same year.

The interesting thing is that large companies are increasingly looking to the startup world to help achieve their innovation objectives. They, run accelerator programmes, and open ‘labs’ in startup hotspots and make acqui-hires.

These activities are interesting, but small scale. Over the next few years I expect we will see a lot more experiments as large companies work out how to harness the power of entrepreneurs. They have to. New markets are spinning up much faster than they can plan for and exploiting those opportunities requires a tolerance for failure and risk-reward balance that I don’t believe can exist inside large company structures.

I think truly innovative companies will get more sophisticated in the way they monitor the startup-ecosystem, get close to interesting companies, partner with them when appropriate, and know when they can acquire them effectively.

When they do that I predict a sizeable percentage of that R&D spend will flow into the startup ecosystem.

Big markets are spinning up and disappearing faster and faster

By | Venture Capital | One Comment

The idea for this post came this morning when I saw these two tweets from Benedict Evans. One shows the newspaper industry growing steadily for fifty years and then declining for ten and the other shows the Japanese fixed lens digital camera market growing from nothing to 120m unit sales in ten years and then dropping by 80% in the seven years after that.

The market for the Japanese cameras spun up and disappeared more quickly than for newspapers. There’s a hypothesis that’s a phenomenon we are seeing over and over again. New markets, especially digital markets, grow big very fast, but don’t have legs. Other examples I can think of include

  • Word processing software – the market took off in the 1980s and is now in substantial decline due to Google Docs and Evernote. Evernote (arguably itself a new market) grew very fast but is now threatened by Quip.
  • Video cassette recorders took off in the 1980s, were replaced by DVD players in the 2000s, which are now being replaced by streaming services
  • Vinyl records were around for decades before being replaced by CDs in the 1980s, which were replaced by music downloads in the 2000s which are now being replaced by streaming services
  • Walkmans were replaced by MP3 Players which were then usurped by phones on a similar timetable
  • PDAs and satnavs were usurped by mobile phones in about 15 years
  • Blogging got going in about 2005 before Twitter and a collection of other sites took the wind out of it’s sales over the last three years or so

A few too many of these examples are linked to smartphones for my liking, but I do think there’s something in the idea that new markets have shorter and shorter durations. It fits with my worldview that the pace of change is accelerating. If the duration of markets is shortening it has implications for venture capital, because if companies take 7+ years to reach a big exit then increasingly their markets will have started to decline before they get big enough to sell or IPO and the model will break.

[Apologies for not posting the images from the two Benedict Evans tweets. WordPress won’t let me upload anything today…]

Venture investment was down in Q4 but may have further to go

By | Venture Capital | No Comments

Screen Shot 2016-01-15 at 14.33.21

Yesterday I wrote that there are clouds on the horizon in the world of startup finance, but it was unclear whether valuations will continue to drop, level off, or even go back up. Today the new data from PWC shows that investment dropped sharply in Q4 but is still at historically high levels. As you can see from the chart above even though the $11.3bn invested in Q4 was 32% less than the $16.6bn invested in Q3 it was still higher than all bar five quarters since the 2000 bubble burst.

Moreover, the shape of the decline in venture investment after the NASDAQ peaked in Q1 2000 suggests that the current decline will go on for more than the 1-2 quarters we’ve seen so far. As I said yesterday, private markets react slowly.

However, on Mattermark this morning we had a post from Calacanis arguing that market deflation is almost complete and a post from Tunguz which concluded by saying he thought it likely that VCs will continue to pay high valuations for premium SaaS startups. For me the jury is still out on which way the markets will move next, although I do think that a further downwards move is likely at some point in the next year or so.