Reputational Capital and VC Contracting + Series Update

Reposting my favorite practical essay I have written and sharing an update on my series on European Tech

Hello to you all. As you may or may not have noticed, I have not held my promise of publishing my Trans-Europe Express series weekly until complete. I initially decided to give myself an extra week because I wanted the upcoming third section on culture to be the best one, but then an entire afternoon’s work of bringing the piece from 80% to 99% publishable was lost. And, frankly, I was too busy enjoying New York to look at it again. In fairness as well, I was living a rather itinerant life which makes writing on the side challenging.

Anyyyways, I am now back in Berlin after six weeks in the US and feel inclined to focus yet again on my series. I am setting my strict deadline for two weeks from now, or the 27th of June. Hope to see you again before that.

Now, on to the piece appearing in this installment of Above the Loud. After giving Mattias Ljungman of Moonfire some trouble by challenging yet another non-incisive observation that a lot of money is being invested in Europe currently, I re-read Mr. Alex Danco’s stellar essay from February 2020 where he posits that tech company financing events do not encompass true ‘valuations’ per say, but, rather, more typically a fast-growing firm’s ‘valuation’ represents a signal towards a future promise. In practice, he means to say that tech companies can keep raising money at higher valuations, as long as there is a common belief that there will be a future round that offers a mark up on current pricing.

I have always greatly admired Alex’s thinking, especially when he synthesizes organizational theory and startup finance, but, it turns out, I initially found a rather novel synthesis myself as a young undergraduate, before knowing about Danco.

The following piece is far more academic than any writing I have posted on here. But that is also a virtue, as it is, without doubt, the most structured piece I have ever authored.

To provide a brief synopsis: After a brief literature review, I develop a novel synthesis that contends that the traditional understanding of a VC transaction, which holds that the firm sells equity (or shares) in exchange for cash that can be used to rapidly grow the business, is not comprehensive. Rather, the fundraising event represents the sale of shares to an investor in return for the fund’s reputational capital. The argument here is based on contracting theory, in the sense that the privileges, rights, and obligations of the transacting parties are efficiently aligned using the framework of reputational capital, especially, as I note, when both parties are focused on maximizing the possibility of an IPO-exit.

I’ll let the piece do the talking. I am still proud of this one. This brought my grade up from a C to an A- lol. Hope you enjoy!

The Impact of Reputational Capital on the Flow of Control Rights between Entrepreneurs and Venture Capitalists

This was originally written as a term paper for PPE 471, an Organizational Economics Capstone course given at the University of Pennsylvania in Spring 2019 by Giuseppe Danese. Updated on May 15, 2019.

Introduction

Reputation in venture capital financings is of upmost importance. Names like Sequoia Capital, Kleiner Perkins (in the past), and Andreesen Horowitz project immensely strong signals about the viability of companies they invest in. Their reputation is, naturally, contracted out when VCs issue term sheets to early-stage firms. Writing contracts tailored to the types of contingencies high-risk startups face is a difficult task. What is commonly understood in most VC financings is that the company receives a certain sum of money at a certain valuation from the investment fund and in return agrees to sell a certain portion of the firm at a certain price to the venture capitalist. Alas, it is far more complicated than this.

The first section proceeds as follows: I begin by reviewing the literature written on venture capital contracting theories. I acknowledge that financial contracts are inherently incomplete (Aghion and Bolton 1992) and that the ability to make decisions in situations where contracts do not specify what to do is determined by the holder of control rights (Kaplan and Strömberg 2002). I then mention the various contingencies and control mechanisms used by VCs to guide decision making in non-contractable scenarios (Gompers 1995). I move on to discuss the monitoring incentives in these contracts and how particular circumstances affect the intensity of monitoring (Gompers 1995 and Black and Gilson 1997). I briefly mention how VCs can adjust their contracts depending on the states of their prospective portfolio companies (Sonius et al. 2017). Next, I outline the importance of reputational capital in VC financings, paying particularly close attention to how reputation enhances an early-stage firm’s credibility with third parties (Black and Gilson 1997). I describe a parallel situation in which the VC must also utilize its reputation to gain credibility in its own dealings with third parties (Black and Gilson 1997). I contend that the staging of financings allows VCs to withhold not just financial capital, but reputational as well (Black and Gilson 1997). I end the section by discussing how the value of reputational assistance decreases over the lifespan of the portfolio company and how, in order for the venture capitalist to more efficiently allocate reputational capital, the VC firm must initiate exit opportunities for their portfolio firms so they can recycle both financial and nonfinancial capital back into a new set of early-stage ventures (Black and Gilson 1997).

In the second section of this paper, I introduce David Kreps’ trust game from his important work on corporate culture in order to build a novel framework around the importance of reputation in the allocation of control rights between VCs and entrepreneurs. I contend that entrepreneurs accept venture capital to establish a reputation. I then address potential occasions for opportunism in these arrangements, noting that a contract based on the exchange of reputational capital for control rights works well at mitigating these circumstances. I then move towards defining a principle on which contractual relations between VCs and founders can be built upon. I note that by agreeing to make decisions based on maximizing the viability of an exit through an IPO, entrepreneurs and investors satisfy the requirements for successful contracting outlined by Kreps and others. Finally, I end by outlining how such a principle-based contracting approach allows VCs to tweak the allocation of certain control rights to correct incentive asymmetries arising from different development states in a startup’s lifecycle.

It is my hope that with this work I can address the question of how reputation affects the flow of control rights between entrepreneurs and venture capitalists by conceptualizing of financings as the acquisition of reputational capital for control rights which leads to the most efficient and useful outcomes for all stakeholders.

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Literature Review

Financial contracts are inherently incomplete (Aghion and Bolton 1992). Contracts between venture capitalists and entrepreneurs are no exception to this rule. The ability to implement future decisions in situations not provided for in the contract — unforeseen contingencies — is determined by which party holds control rights in a given state (Kaplan and Strömberg 2002). Contingent control is one of two forms of allocation; the other is unilateral, in which the entrepreneur or investor is the sole owner (Aghion and Bolton 1992). Venture capitalists write contracts in which control rights are contingent on financial performance, nonfinancial performance, and other observable actions (Kaplan and Strömberg 2002). Gompers notes three common control mechanisms VCs use in contracts with startup founders: the use of convertible securities, syndication, and the investment of financial capital in stages (1995). The staging of capital infusions is the most potent control mechanism because it allows VCs to gather information and monitor at multiple stages (Gompers 1995). Further, the need for additional funds gives the entrepreneur a performance incentive in the form of a hard constraint (Black and Gilson 1997). For the VC, the ability to withhold continuation funding provides a monitoring incentive and reduces agency costs between the founder and the venture capitalist (Black and Gilson 1997). The right to withhold funding is given to the VC as a response to adverse selection in early-stage financing, where information asymmetry is greatest (Gompers 1995). This asymmetry arises from the minimal information venture capitalists have about the future success of portfolio companies. VCs weigh potential agency and monitoring costs when determining how frequently they should reevaluate projects and supply capital (Gompers 1995). The duration of a particular round of financing (i.e. the period between Series A and Series B), the size of each investment, the total financing provided, and quantity of rounds are metrics for determining the intensity of VC monitoring of portfolio firms (Gompers 1995). The intensity of monitoring should be negatively related to expected agency costs (Gompers 1995). Agency costs increase as the tangibility of assets declines, the share of growth options in firm value rises, and asset specificity grows (Gompers 1995).

Sonius et al. argue that control rights in VC contracts are determined by the degree of bargaining power and the development state of startups (2017). The venture capitalist adjusts contract design for varying stages of development (Sonius et al. 2017). In addition, capital availability also impacts relative bargaining and contracting power (Sonius et al. 2017). Startups can be classified into four types based on their development state and relative bargaining power in their lifecycle. These types are seedling, for a firm with a low development state and low bargaining power, beacon of hope, for a firm with a low development state and high bargaining power, turtle, for a firm with a high state of development but low bargaining power, and finally, skyscraper, a startup with high states of development and bargaining power (Sonius et al. 2017). These types are adjusted for in contracts with VCs, in which liquidation preference, board rights, vesting clauses, and anti-dilution protection are tweaked according to type (Sonius et al. 2017). As one would expect, skyscraper and beacon of hope firms retain more control rights than turtle and seedling firms (Sonius et al. 2017). This is consistent with Kaplan and Strömberg, who argue that in bad states, VCs are allocated more control rights, and then, as performance improves, the entrepreneur obtains more control rights, although the VC does retain rights to cash flow throughout (2002).

Venture capitalists provide more than just financial capital to entrepreneurs (Black and Gilson 1997). They provide management assistance, mostly by utilizing their networks to help portfolio companies hire talented personnel (Black and Gilson 1997). As discussed earlier, VCs provide intensive monitoring and control, derived from equity ownership and voting rights allocated with convertible preferred stock (Black and Gilson 1997). Black and Gilson argue that VCs are given disproportionate board representation — often an absolute majority — relative to overall voting power (1997). This is contradicted by Kaplan and Strömberg, who find that VCs have majorities on startup boards only 25% of the time, in contrast to outsiders, who are mutually agreed upon by both founder and venture capitalist, who tend to hold majorities on 65% of company boards (2002). However, both papers do concur that VCs hold a significantly higher fraction of votes to cash flow rights compared to the founder (meaning closer to a 1:1 ratio) (Black and Gilson 1997 & Kaplan and Strömberg 2002). Board control allows the VC to remove the entrepreneur as CEO in bad states (Black and Gilson 1997).

Most relevant to this paper is the third type of nonfinancial assistance that Black and Gilson outline, reputational capital. The venture capitalist acts as a reputational intermediary between the firm and the market (Black and Gilson 1997). VC financing enhances a portfolio company’s credibility with third parties. That is: talented managers are more likely to join a firm backed by a respected VC because VC participation provides a credible signal of success, suppliers are more likely to commit capacity and extend trade credit, and customers will take the portfolio company more seriously when the venture capitalist vouches for and monitors it (Black and Gilson 1997). VC reputation is also important in securing a reputable investment bank to underwrite IPOs for portfolio firms (Black and Gilson 1997), which will be important to remember later in this paper. The signal of reputation to third parties is credible because a VC fund is a player in a repeated game and, as it were, must put their money where their mouth is (Black and Gilson 1997). The reputation of the VC fund is also crucial for its dealings with its investors in existing and future limited partnerships, with other VCs in syndicate investments, and in negotiating terms with prospective portfolio companies (Black and Gilson 1997). Adding to the contribution of Gompers, who revealed that the staged investment of financial capital is a common control mechanism used by VCs (1995), Black and Gilson contend that commitments of reputational capital can be staged too (1997). The venture capitalist can withhold management assistance and reputational capital, which reinforces its own incentive and power to monitor (Black and Gilson 1997). The venture capitalist’s role as a reputational intermediary shares an economy of scope with the provision of financial capital (Black and Gilson 1997). Potential employees, suppliers, and customers must evaluate the credibility of the VC’s explicit and implicit reputational commitments to its portfolio companies (Black and Gilson 1997). The combination of financial and nonfinancial contributions enhances the credibility of information provided by venture capitalists to third parties while simultaneously binding the VC to its promise to its portfolio firms of being a reputational intermediary (Black and Gilson 1997). This combination also allows LPs to evaluate the VC’s reputational contribution by measuring its return on overall investment (Black and Gilson 1997).

Reputation, monitoring, and management assistance are especially valuable to early-stage firms (Black and Gilson 1997). As a portfolio company’s management proves itself and establishes its own reputation, the relative value of the venture capitalist’s contribution declines (Black and Gilson 1997). Thus, by the time a portfolio company succeeds, the VC’s nonfinancial capital is best allocated in a new round of early-stage ventures (Black and Gilson 1997). However, due to the economy of scope discussed earlier which bonds financial and nonfinancial contributions, the venture capitalist must also exit from its investment in the firm, in order to recycle its financial capital (as well as its service as a reputational intermediary) from successful portfolio firms to its next batch of early-stage ventures, in which its nonfinancial contributions can be allocated with far greater efficiency and impact (Black and Gilson 1997).

Synthesis and New Ideas

Using the framework of David Kreps’ trust game, the importance of reputation on the flow of control rights between entrepreneurs and venture capitalists can be examined in a novel light.


Ronald Coase (pictured) was a huge influence on David Kreps. Where Coase initially said that a firm stops expanding when internal transaction costs equal market transaction costs, Kreps, in the paper cited, pushes the idea that a firm stops expanding once it is unable to enforce its cultural principles effectively across an org and must instead rely on market best practices.


Let us assign label “A” to the firm seeking financing and label “B” to the VC. In other words, the startup is the agent and the venture capitalist the principal. A firm enters into a hierarchical contract because they do not expect to be abused and seek to make gains impossible without coordination (Kreps 1984). The weak party — or perhaps better stated as the party with a weaker reputation — accepts authority because of the presence of the principal’s reputation (Kreps 1984). Kreps identifies the problem of entity “A” as needing many rounds and vast information in order to establish a reputation (1984). A shortcut to a solution is identified as purchasing access in another organization, in which reputation is given in exchange for some type of asset (Kreps 1984). Using the framework of Black and Gilson, we can understand this transaction in the context of venture capital financing as the exchange of control and cash flow rights, which are given to the VC, in exchange for the fund’s financial and nonfinancial capital, namely its reputational capital (1997). Thus, the company enters the “sacred hall” (Kreps 1984) by becoming a portfolio firm of the venture fund. Kreps notes that entity “B”, or the VC here, compete through their reputation for “A’s” (1984). This is consistent with Black and Gilson, who note that VCs are distinguished by their reputation with portfolio firm success when dealing with limited partners, syndicates, and with new entrepreneurs seeking financing (1997).

When the venture capitalist decides to contract with an early-stage company, they have a responsibility to not act opportunistically and renege on the promise of reputational assistance. Opportunistic behavior leads to a reputation loss, which negatively impacts the future transactions of the VC and excludes funds from the opportunity to invest in the best early-stage firms (Black and Gilson 1997). The circumstances for opportunistic behavior come from the ability of the venture capitalist to withhold continuation funding in subsequent rounds of fundraising (Gompers 1995 & Black and Gilson 1997). As Gompers notes, this is a response to the adverse selection inherent in early-stage financing, in which information asymmetry is significant (1995). Simultaneously, this provides the entrepreneur an incentive to perform (or “A” to trust “B”), the VC an incentive to monitor (or “B” to trust “A”) and reduces agency costs for all parties (Gompers 1995). Kreps notes that through repetition of informal arrangements, such as the agreement between VCs and firms, such trust-honor agreements are self-enforcing (1984). This is certainly the case, though there must be a principle put in place that is an intangible asset of the firm and, if not followed in non-contract specified contingencies, will lead to reputation loss for “B” (Kreps 1984).

This principle, using the framework of Black and Gilson, looks something like this: in the case of uncontracted upon contingencies, the VC (and the company) will make decisions that maximize the viability of an IPO exit. This scenario provides maximum benefit to both parties, because the VC will, more often than not, maximize their residual and their accountability to capital providers (LPs). An IPO triggers the full transfer of control rights from the VC to the entrepreneur, which is “a powerful incentive for the entrepreneur”, whereas a sale transfers cash flow rights but not control rights (1997). For a principle to work, it must satisfy three requirements. First, the VC fund (“B”) must promote its understanding to hierarchical inferiors (Kreps 1984). This is seen in the presence of the reputation market, which facilitates adherence to the principle and signals, to the intelligent entrepreneur, that the aforementioned principle is “how business is done around here”. Second, the firm must apply the principle even when it’s immediately costly (Kreps 1984). Again, through the presence of the reputation market, short-term benefits from opportunism are punished (Black and Gilson 1997), thus the principle will be upheld by the VC to protect its reputation. Third, stakeholders must be judged in their fidelity to the principle and the responsibilities which adherence to it entails (Kreps 1984). Given the repetitive nature of contracting between VCs and founders, neither party benefits by not applying the principle. However, additional safeguards exist, in the form of the control right held by the VC, which can be used to remove the CEO, and the termination of said ability upon IPO, which protects the founder (Black and Gilson 1997). In addition, the staging of capital infusions allows the VC to monitor the entrepreneur for non-adherence to the principle (Gompers 1995), and to a lesser extent, it allows the entrepreneur to hold the venture capitalist to account for non-compliance by seeking funding elsewhere. This presence of monitoring also encourages startup teams to develop their own reputation and expertise, because as Kaplan and Strömberg show, the entrepreneur obtains more control rights in good states (2002), which also aligns with the goals of the venture capitalist who wishes to more efficiently invest their nonfinancial assistance in early-stage firms in order to enhance their overall reputation (Black and Gilson 1997). Finally, this principle is flexible enough to allow VCs the opportunity to adjust contract design for information availability and varying stages of development of prospective portfolio firms (Sonius et al. 2017). This permits venture capitalists to adjust the allocation of certain rights (i.e. board rights and liquidation preferences) to correct asymmetries of incentives in different states of the world to increase the likelihood of the principle being followed. Bringing it all back to Kreps, at some point when the scope is widened, the VC will be unable to adhere to the principle without picking up significant inefficiencies (1984). This is where the venture capitalist passes on a deal because “it’s out of scope”, perhaps the most common reason given when VCs choose not to invest in a startup.

Conclusion

To conclude, I will summarize how the contributions of each of the sources of this paper has formed a greater understanding of the influence of reputation on the flow of control rights. First, Aghion and Bolton showed that financial contracts are inherently incomplete (1992). From there, Kaplan and Strömberg contributed the idea that the ability to make decisions in contingent conditions is held by the owner of the control rights and that the quantity of control rights changes in various states (2002). Thus, in order to protect reputation, VCs are incentivized to hold more control rights in adverse states. Gompers goes into greater detail about the contingencies and control mechanisms used by venture capitalists to retain control rights (1995). Incentives for monitoring and how they impact intensity is then discussed (Gompers 1995 & Black and Gilson 1997). Next, the ability of VCs to design contracts based on the states of prospective firms is mentioned (Sonius et al.). This is important because it allows investors to correct for information asymmetry and potential divergent incentives between entrepreneurs and venture capitalists. From there, how reputation enhances the credibility of early-stage firms is remarked upon (Black and Gilson 1997). Necessarily, the benefit of the VC’s reputation to the portfolio firm decreases over time, until it becomes more efficient to invest that reputation in another venture (Black and Gilson 1997). In parallel, VCs must leverage their own reputations when dealing with third parties, such as their limited partners (Black and Gilson 1997). This pushes the VC towards a principle-driven culture, for it allows the contribution of nonfinancial and financial capital to overall returns to be evaluated holistically. The staging of financing rounds allows venture capitalists to withhold not just financial capital but reputational capital as well (Black and Gilson 1997). This encourages the investor to monitor portfolio companies’ adherence to the principle periodically.

Through this synthesis of ideas and sources, it is my hope that I have explained, using David Kreps’ framework, the significance of reputation on the flow of control rights between entrepreneurs and venture capitalists. Future research on this topic could survey VCs about what their firm’s principles are and then empirically examine how their principles are enforced and the success of their adherence to them.

Bibliography

Aghion, Philippe, and Patrick Bolton. “An Incomplete Contracts Approach to Financial Contracting.” The Review of Economic Studies, vol. 59, no. 3, 1992, pp. 473–494.

Gilson, Ronald J. and Black, Bernard S., Venture Capital and the Structure of Capital Markets: Banks Versus Stock Markets (November 1997). Journal of Financial Economics, Vol. 47, pp. 243–277, 1998.

Gompers, Paul A. “Optimal Investment, Monitoring, and the Staging of Venture Capital.” The Journal of Finance, vol. 50, no. 5, 1995, pp. 1461–1489. JSTOR, www.jstor.org/stable/2329323.

Kaplan, Steven N, and Per Strömberg. “Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts.” Review of Economic Studies, Mar. 2002, pp. 1–35., faculty.chicagobooth.edu/steven.kaplan/research/kaplanstromberg.pdf.

Kreps, David M. “Corporate Culture and Economic Theory.” Second Mitsubishi Bank Foundation Conference on Technology and Business Strategy, 1984, pp. 221–275.

Sonius, David, et al. “VC Contract Design: Development State, Bargaining Power, and the Classification of Early-Cycle Companies.” The Journal of Private Equity, vol. 20, no. 4, 2017, pp. 36–46. JSTORwww.jstor.org/stable/44397535.

All Aboard the Trans-Europe Express! Episode 3: The Structural Perspective

At the structural level, Europe favors commerce companies over enterprise ones

It’s great to see those who have been following along since the start again. For those new, you can catch up with the series by reading the introduction here and last week’s part on focusing on Europe’s startup history here. Very grateful for all the words of support, sharing, and feedback so far!

This week, I explore the structural dynamics at play within (and without) Europe’s ecosystem. I start by telling the story of cloud data provider Snowflake, which has been a runaway success coming out of the American West Coast. Snowflake’s rise was thoroughly influenced by the favorable structural dynamics that underpin the Silicon Valley enterprise software environment. In Europe, the structural dynamics are fundamentally different and favor building technology companies that service consumers and/or focus on the commerce value chain. The data around unicorn outcomes in the last decade support this, as does taking a look at some of the hot sectors seeing strong investor interest of late. I wrap by admitting that Europe has indeed made solid progress towards building more robust enterprise companies but also hint that ultimately trying to beat the Americans at their own game may not be the best path forward, largely due to the social capital dynamics I will get into next week.

I hope you enjoy!

Snowflake and why it’s just easier to build B2B in California

I think American business software dominance comes down to three main structural vectors: human talent, inter-startup sales flywheels, and credibility with investors and employees. Snowflake, the cloud data warehousing darling, is a useful example to illustrate this.

Snowflake was founded by three Europeans in Silicon Valley in 2012. Benoit Dageville and Thierry Cruanes knew each other from roles as data architecture nerds at Larry Ellison’s B2B behemoth Oracle. As with many enterprise software founders in the United States, inspiration for their new venture came from their observations while doing their day jobs at a large incumbent. They were the experts. If anyone was going to build the next-gen cloud data warehousing solution, it would be them.

While expert when it came to the technical aspects of what needed to be built, the men were not necessarily business leader material. Their initial investor, Mike Spieser of Sutter Hill Ventures, led the company’s operations in the beginning. None of the three co-founders have ever served as CEO. Spieser built up the company in the very beginning and successfully hired his replacement, a veteran of Microsoft called Bob Muglia. Muglia presided over tremendous growth but ultimately made way for another European, legendary Silicon Valley CEO Frank Slootman. Slootman developed his bona fides at two other successful California business software firms, Data Domain and ServiceNow, exiting both with strong outcomes for investors and employees.

The abundance of operational and technical leadership talent around Snowflake has been fingered as a large factor in the company’s success. B2B software experts, and the networks that bind them, are simply on another level in California. Best practices and technical understanding that would be considered outstanding in Europe are relatively commonplace on the West Coast. Tight physical, social, and occupational networks have driven the cross-pollination that makes possible such exceptional concentration of human capital. This convergence just does not exist on remotely the same scale in Europe.

In practice, this deficit manifests within middle management of European technology firms. At the executive level, top startups, especially with distinguished investors on their cap table are able to bring exceptional people on board. Over at Choco, we recently hired Vikas Gupta, a veteran of Dropbox, Uber, and Facebook as our CTO. At Gorillas, the hyperscaling grocery delivery platform out of Berlin, Ronny Gottschlich, who was the CEO of Lidl UK for six years, serves as their CCO. Filling out the roster of operational function leads and engineering/product managers is a much different challenge. In contrast to California, where there are hundreds of companies with org charts chock full of experienced heads across many different disciplines, the ecosystem in Europe is too immature to be rich in this way. To compensate, it is common for mid-level startup leaders to come from consulting firms or large corporations. Of course, talented people can come from anywhere but the compounding effects of multiple layers of experience at the functional leadership level should not be underestimated.    

On top of talent advantages, Snowflake, like many peer B2B technology companies based in the Bay Area, also benefited considerably from selling their products to other venture-backed, fast growing businesses. An abundance of capital, operators who are naturally inclined to procure the newest cutting-edge tools, along with relationships facilitated by investor networks (like intra-portfolio sales), make targeting other B2B startups geographically and culturally proximate an enticing proposition. While Snowflake now has thousands of customers across many sectors, including over 1/4 of the Fortune 500, it counts Bay Area B2B firms like Adobe, Hubspot, DocuSign, Okta and Coupa as key accounts. This is not to mention other well-known technology companies based in Northern California like Chime, DoorDash, and Electronic Arts. Snowflake is not even an amazing example here, as it has one of the highest ACVs in SaaS (>$100k/year) so prefers to go after larger prey. I’m thinking of firms like Gusto, Ramp, and Looker, whose value propositions are based on solving problems of fast growing businesses, though there are many examples.

Geographical, and by extension social and cultural, proximity is really important, especially when trying to grease the sales flywheel. Enterprise software companies founded in Europe are simply at a massive disadvantage here. Mr. Newcomer points to UiPath as a success story that has broken this norm, but, in truth, approximately 99.8% of the company’s all time total revenues has been generated in the last three or so years. The company moved its HQ to New York City from Romania in 2017.

Nonetheless, Eastern European companies have effectively replicated the playbook first employed years earlier by Israeli enterprise software entrepreneurs, who have built businesses like SimilarWeb, Melio, and Compass. After building the initial product and generating early traction in the home market, firms move their more commercially minded leaders to America while keeping the engineering setup in the old country. This arbitrage allows companies to enjoy superior access to the most important software market in the solar system while retaining technical expertise at a favorable cost. 

Western European startups are generally less keen on the ‘Israeli Playbook’. With exceptions in the healthcare space (a whole other essay could be written on this), Nordic, British and German companies tend to stay put in Europe and pursue their significant but not massive home markets. It is possible to build a tech company valued between $1-3 billion that focuses only on Western Europe. For those whose ambitions are even greater, it is extremely rare to see such a regional focus on Western Europe. The market fragments in this part of the world are large enough to focus on for 2-3 years (and often indefinitely) while firms coming out of Poland or Bulgaria must go international from day one if they want to build a massive tech business. And, if you must go international, why not head to the US?  

Finally, B2B technology companies enjoy credibility with investors and talented employees alike that most European software firms could only dream of. When an experienced technical founder builds enough conviction to leave their often very well-paid jobs at incumbents to found a promising B2B software company in the United States, investors’ eyes see $$$ and typically line up to invest (now, more than ever). This credibility with investors naturally leads to an easier time attracting top talent, who like to pattern match and see a big round by a well-regarded investor as a strong endorsement of a particular project (Europeans for the most part don’t really think this way; it’s a social capital thing, I’ll explain next week). Hiring talented engineers is usually of greater importance in B2B companies than in B2C, where the technical challenges are more intense, the requirements from buyers more stringent, and competition focuses on technological moats more often than in consumer-facing products. The self re-enforcing credibility B2B ventures enjoy in the United States, as a result of investor conviction, ultimately serves as a moat to challengers from other parts of the world.

Consumer/SMB startups, on the other hand, do not benefit at the same scale as business software firms. Thus, European technology entrepreneurs grasp the comparative advantage they possess in the consumer market, and subsequently target their efforts at ventures in that space more zealously.

Few Recent European Unicorns are Enterprise Companies 

By my count, from data from dealroom.co only 10 of the 24 ‘unicorns’ founded in the UK since 2010 have SaaS business models. Looking deeper, I would say only 3 are really pure play enterprise software companies (Darktrace, checkout.com and Rapyd).

Moving the query to Germany, only 5 companies meeting the same criteria are displayed, though I would again reduce that to 4 pure play (Personio, Mambu, Sennder and Celonis). There are 13 companies total in Germany that have reached unicorn status in the last 11 years. The majority are consumer-facing companies (Auto1, FlixBus, Hello Fresh, N26 and so on).

Finally, looking at the Nordics, there are 4 companies that have made ‘unicorn’ in the equivalent timeframe. None of them are really enterprise software companies, except for Itiviti (which I had never heard of). The four don’t include Spotify, Klarna or iZettle, who were all founded before 2010. Those also don’t offer pure SaaS products but rather technology to facilitate digital commerce, excepting the Spotify anomaly.

Chirag Modi tweeted out a report on Kinnevik, one of Europe’s most successful investors in growth-stage technology firms. 55% of their portfolio value lies within a segment they call “Consumer Services”. This doesn’t even include Zalando, from which the Swedish firm has profited handsomely. The concentration within this segment is rather consistent with the ecosystem at large.


Kinnevik’s best bets have been on consumer companies like Global Fashion Group and Oda


It would of course be easy to fixate only on unicorns and leave you here, but I won’t. Instead, let’s look at a few younger and less highly-valued firms, and the trends they embody, to see where European founders and their investors are seeing the comparative advantage.

The Default Gestalt for European Startups is still Commerce

Commerce is still probably the dominant theme in the Old World, though the businesses funded more recently have significantly different models than their execution-play predecessors.

Headless platforms for building online commerce experiences are a hot category, where there is conviction that European firms can lead. Commerce Layer, a rare Italian startup, is backed by Benchmark, with Eric Vishria sitting on the board. Saleor, a similar company based out of Poland, recently announced a modest seed round, with Chris Schagen, a former executive of headless CMS provider Contentful, itself a sneakily under the radar B2B player out of Berlin, participating. Both companies seek to sell to merchants situated between mom-and-pops and large firms with dozens of in-house developers, a sensible market to address coming out of Europe.

On the other side of the commerce spectrum, investors are excited by ventures that are looking to acquire and consolidate existing ecommerce sellers operating on platforms like Amazon. Heroes, out of London, raised some $60 million in Q4 of last year to bring economies of scale to retail operations enabled by Amazon. SellerX, in Berlin, raised even more to do the same thing, notably from previously mentioned Cherry Ventures’ founding partner Filip Dames, with his pal, Zalando CEO David Schneider participating. Within this vertical, there are a couple other companies that have raised solid rounds as well. 

Another category of interest, much closer to home, is technology for the gastronomy industry, particularly that which has a sustainability focus. Christophe Maire and Atlantic Labs, out of Berlin, are the investors of note here.

They seeded Choco, where I work, which has gone on to raise from notable investors such as Coatue and Bessemer. Choco builds technology that brings the relationship between restaurant and vendor online. This allows each side of the transaction to consolidate their ordering relationships into ‘Chats’ on the app, which ultimately leads to fewer errors and food waste. All three founders were affiliated with Rocket Internet. Rekki, in London, is doing something very similar. They have raised comparable amounts of capital, also from distinguished investors.

Grocery ordering is red-hot, with Berlin based Gorillas reported to be raising their next round seeking a $4b valuation. Zapp, which Mr. Newcomer mentions, is also delivering products with freaky fast SLAs in the UK. The company raised from Lightspeed recently. There are a handful of others too, like Flink out of Berlin and JOKR, which raised from top German fund HV and Tiger.

There have also been enterprise software transactions of note recently. CRM provider Pipedrive, out of Estonia, cut a deal with big time PE shop Vista, valuing the firm at $1.5 billion, a big win for Estonia and early backer Atomico. Another B2B Atomico portco, Aiven out of Finland, raised a round led by IVP, announced in the last weeks, that comfortably grew their valuation past half a billion United States dollars.

Europe is indeed moving past the commerce-dominated era of the late aughts and early 2010s. The Zeitgeist is slowly moving towards building businesses that serve more corporate customers who are willing to pay healthy sums of money and offer more useful unit economics than the costly to acquire and retain consumers of yesteryear. However, for the most part, we see that neither large enterprises nor other startups are the targets of this new wave. Rather, it is SMBs and largely known consumer segments who are being served by this generation of startups.

I’m afraid the significant advantages US firms have when it comes to enterprise software persist because of the ecosystem strengths that have developed on the West Coast for decades. Central to the Californian puissance is its highly developed social capital network. In the next section, I will discuss the deficit Europe faces in this regard, which in my opinion is the single biggest force holding it back.

All Aboard the Trans-Europe Express! Episode 2: The Historical Perspective

Understanding the current state of European tech through the three significant waves of activity in the ecosystem

Welcome back! If you missed last week’s introductory post, I suggest reading it here. I want to give a big thanks to those who shared, commented, and/or supported my comeback article. I appreciate you <3

In this week’s installment, we will look at some key historical narratives that largely define the evolutionary arc of the European ecosystem. I go chronologically, sketching out how the cycles have built on top of each other to form the current state of development. Let’s dive right in!

The First Wave: 1985-2001

Sadly, I don’t think Eric Newcomer got the chance to read what is likely the definitive paper on the European ecosystem from ~1985 to 2004, the year of its publication. Written by a pair of academics and Bessemer Partner Felda Hardymon, who has been with the firm for 40(!!!) years and helped finance Staples, the American office supplies retailer, this HBS case details the 2001 establishment of Accel Partners’ London office. Mr. Newcomer, rightfully so, calls them “European venture capital royalty”, but there is an important history that precedes the California firm’s anchoring down in the British capital.


American Kevin Comolli established Accel’s presence in Europe in 2000-2001


The paper traces the history of the modern technology startup ecosystem in Europe to the mid 1980s. Akin to today, the tech company financing environment was at record levels of froth, especially in the United States. European financial institutions saw this enthusiasm as an opportunity to finance new companies who could then become customers of their business-banking products (mortgages, lines of credit, advisory, etc.). This was not a positive development. Hardymon et al. quote an expert, who recalled:


“The industry was staffed in completely the wrong way…with bankers and accountants. They were fine in terms of structuring the deals, but lacked the expertise to assess trends and technologies and add value.”


Bankers, rather than technologists trained to anticipate the future by seeing the present clearly, executing risky investments into fledgling companies led to bad outcomes, unsurprisingly. Returns were weak and the venture capital industry was soon “annihilated”. Crucially, many investors today hail from financial and advisory backgrounds at a proportion far higher than that in the United States because of historical precedent, LP risk appetite, and social capital signaling.

The annihilation of 1987 saw European LPs allocate their capital to other asset classes, European firms close their doors, and American funds pull out of the continent. Conditions wouldn’t improve for a decade. In European English, venture capital and private equity became synonyms. Late-stage equity investments in private companies were better described as buyouts involving complex financial engineering.

The late 90s, of course a frothy time in California as well, saw a resurgence of early-stage tech investment in Europe. While the proportion of institutional capital invested in the PE/VC asset class was only half of that in the United States, European VC AUM grew 2.5x between 1997 and 2000.

In this resurgence, European investors continued to have predominantly financial backgrounds but there was recognition of the importance of operational expertise. Several technology companies reached successful exits, minting some founders and employees with financial, operational, and social capital. The social capital aspect should not be overlooked, especially in the European context. The authors note that entrepreneurship gained some social cache at this time. Finally, regulation started to become a bit more normalized across markets, leading to tech companies becoming more attractive employers.

American players re-entered the market at this time. As with the previous instance, the reasons for their arrival were to avoid intense competition back home, diversify their portfolios via geographic arbitrage and find deals on the cheap, as salaries (especially for engineers) were far lower in Europe. Some funds brought their people over from California, often to London, while others sought to hire investors from existing European firms. A third model emerged, in which established VCs from America would collaborate with financial institutions in Europe. The paper gives the example of Benchmark Capital and JP Morgan (I guess this is what ended up creating Balderton?). The partnership approach mitigated the Americans’ problem of lacking a local network while providing enough space for US funds’ to flex their superior branding, relationships, and capital to win deals for the most promising European ventures. US-based limited partners were largely supportive of Cali funds’ European vehicles, though some declined to take part in these fund raises, citing a lack of personnel experience in Europe and an over-indexing on telecommunications in the European ecosystem.

While many funds were raised (and deployed) between 1997 and 2000, market conditions brought an end to this period of exuberance. Starting in 2001, firms had lots of difficulty raising second funds and enthusiasm for the European market waned. Another European winter had begun.

American capital allocators did not stop looking at foreign markets in the ‘winter’ between 2001-2007. They looked further eastward, at China, which was experiencing its tremendous growth years that culminated with the Beijing Olympics. Enormous firms like Alibaba, Tencent, Baidu and JD were all founded in the late 90s and experienced wild growth in this period. General Atlantic famously invested in Alibaba in 2009, though there are many other examples of American enthusiasm for The Middle Kingdom.   

The Second Wave: 2007-2015

Rocket Internet was founded in Berlin in 2007 by three lunatics who happen to also be brothers. Their strategy was simple: build B2C companies whose business models’ had been proven in other markets and, crucially, sell them off to unlucky acquirers. They themselves did this in the frothy late 90s, when they copied eBay for the German market and sold it in ~100 days. Rocket built dozens of companies in Europe but also across the world, from Sao Paulo to Singapore. Prominent Rocket companies include Zalando (Berlin’s largest startup employer by some distance), Hello Fresh and Home24. There is no secret sauce nor technological innovation here. Rocket Internet sought to use increased internet penetration in Europe and other emerging markets to build companies that sold physical goods online to consumers. Sometimes, they tried to build businesses not built around delivering stuff to people. Examples include Pinspire and Paymill, clones of Pinterest and Stripe respectively. In the end, regardless of what you think about what they did, it is irrefutable that they were hugely successful in their execution. Without Rocket, Europe would not be where it is today.

Within emerging ecosystems, where best practices governing optimal behavior of capital markets are not yet fully developed, conglomerates have been observed as a common phenomenon. Research on this topic looks, among other things, at corporate governance in the context of conglomerates. In immature markets, conglomerates form because capital holders can expect internal diversification (i.e. finance and operate businesses within the same organization) to triumph over financial diversification (i.e. equity investments in other organizations). This is particularly potent when a region’s financial markets and institutions are “substandard”. In the absence of robust capital markets, conglomerates, like Rocket Internet, are able to bridge the gap and provide financing, without onerous transaction costs, for business opportunities. This can be expected to be effective until transaction/monitoring costs converge between internal and financial diversification. Convergence occurs because conglomerates become bloated (see General Electric, for instance) while successful ventures attract the attention of asset allocators who wish to juice returns. This hastily put-together graph may help to visualize this phenomenon:

In the case of emerging startup ecosystems and Rocket Internet, the “substandard” aspect is not related to ineffectual governmental enforcement of contracts, chaotic accounting standards, or anything like that. Rather, the deficit refers to poor information flow, which is a common trait of developing ecosystems. Essentially, when ecosystems are nascent and best practices are not widely adopted and understood, a firm’s cost of transacting with capital markets swells. In the face of such steep transaction costs, aggregating resources under one roof gains in attractiveness. If local capital markets are inefficient--recall that European investors were (and still are) disproportionately financiers rather than technologists--size can function as a significant advantage when it means increased exposure to international financial markets.

Academic research on the topic of conglomerates and capital markets includes the subject of tunneling. It is described as inter-conglomerate dealing that occurs at the expense of external shareholders. Say Zalando makes a large loan at a tiny interest rate to a less financially robust Rocket sibling. Or, perhaps more perversely, HelloFresh executives exclusively using Nestpick for business trip accommodation AND paying far above market rates. Researchers make quite clear that they see this kind of strategy as malign and fraudulent but, in the context of building fast-growing technology firms in immature markets, such an approach seems prudent and synergistic. It is powerful to utilize a highly aligned system of globally-applicable operating models and centralize key functions like IT. More so, Rocket can credit its success to building an internal capital market where the conglomerate can play both market maker and ‘rule-breaker’. This is a brilliant method to overcome the challenge of servicing high-growth, tech-enabled business opportunities in a region where capital markets have not developed at the same rate as technological or business model innovation.      

In a 2014 Economist article, Oliver Samwer was prompted to respond to allegations that Rocket Internet did not pursue original ideas in its company building (it most certainly did not). He emphasized the importance of implementation and operational excellence in his retort, quipping, “A bridge is a bridge wherever you are. We are a construction company.”

And indeed, the business successes of die Gebrüder Samwer are not what make their contribution to this story of Europe’s startup ecosystem so significant. Rather, it is that they helped build a bridge for the next generation by endowing leaders with money, operational know-how and useful relationships. Rocket Internet is often seen as a school for German founders and I think that’s pretty apt. While ‘the administrators’ of the school had some pretty crazy ideas about best practices, it ended up producing exceptional graduates. 

Rocket Internet hired many hundreds of ambitious and bright young Europeans who would have otherwise worked in finance, consulting or large corporations. They worked hard in difficult conditions, but in return, they received a chance to see the world and, most crucially, invaluable operational training. The innovation of taking the conglomerate model, often present in less mature ecosystems, and applying it to fast-growing technology firms was also significant. Rocket basically willed a robust-enough capital market into existence by reducing transaction costs associated with external financing events. At the same time, the aggregation of internal resources that Rocket is famous for allowed for extraordinary speed, flexibility, and repeatability which crystallized into a real competitive advantage that has proved to be highly influential and impactful. There can be little doubt that those who were initially launched into orbit by Rocket have drawn on observations around the most powerful mechanisms, systems, and processes as they build the current third wave. 

The Third Wave: 2015-Present

Of the investors in continental Europe with operational experience (there aren’t that many actually), a great deal of them cut their teeth at Rocket companies. The founding partners of Cherry Ventures (a firm Mr. Newcomer shouts out), one of the pre-eminent early-stage investment funds in the German-speaking world, were both blooded at Zalando, where they were executives. They then used their ‘winnings’ from that firm’s success to invest as an angel syndicate. After huge early successes seeding businesses like Amorelie, Quandoo and Flixbus (themselves all online commerce plays built by folks in the Rocket Internet orbit), they have raised several institutional funds and are leading the way among DACH-focused Seed stage funds presently.

Prominent pan-European investor Project A Ventures has an even stronger connection to Rocket (disclosure: I used to work there). The entire founding partnership, plus another ~15 people, famously absconded from Rocket in 2011 to found the investment firm. They initially sought to invest in what they knew: B2C commerce. But have subsequently shifted focus to B2B businesses, as the sector has matured in Europe. Third wave companies that Project A has backed include: Kry, Sennder and Dixa.

Admittedly, my main area of expertise is Germany but let’s pop up to the UK. Many know London for the consumer fintechs it has produced. TransferWise (now called Wise), Revolut, Monzo, and Starling (B2B) are the well-known names and have been founded in the last decade. The other big category the UK has shone in is ecommerce/marketplaces, with Deliveroo, Cazoo and GymShark leading the way.

In the Nordics, the big names are Klarna, Spotify and iZettle, companies that don’t really sell into large enterprises nor have high ACVs.

The situation in France is a bit different. Those who are familiar with both the Berlin and Paris scenes have (rightfully) observed that German companies excel at building robust operational models while the French, with their superior aesthetical sense, are more keen on building outstanding user experiences and pretty interfaces. But the divergence goes deeper.

Thanks to effective talent mafia dynamics, Parisian tech firms have bucked the trend and produced some stellar businesses that cater to enterprise customers. Exalead, founded during Y2K, functions as the starting point here. Alums of the search-specialist went on to found two of France’s strongest enterprise players: Dataiku and Algolia. While both of these companies were founded in France by French people and still concentrate their development teams in le pays des Gaulois, their HQs are in New York City and San Francisco, respectively. Ironically, two of the top software firms of German origin mirror this. Contentful, a Benchmark backed developer of headless CMS tools, and Rasa, a maker of conversational AI with a16z on their cap table, have their Chief Executives in SF while retaining developmental teams back in Deutschland. In all of these cases, these firms did a basic calculation and saw that the market opportunity in the United States was orders of magnitude greater.

Dataiku and Algolia do differ from Rasa and Contentful along a key dimension: seed investment participation from domestic funds. Berlin-based Point Nine is an investor in Contentful, though I would argue they are a global fund that happens to be based in Germany. Regarding Rasa, I noted this ten months ago:

Dataiku and Algolia had later growth rounds led by non-domestic funds but were both staked at seed by mature French fund Alven, along with other participants.

You may have begun to understand what I am hinting at with the examples I have chosen. Europe’s historical legacy has largely biased firms with a consumer focus over those building for enterprise. In next week’s installment, where I focus on the structural basis for Europe’s ecosystem, I will dive deeper into why I see things this way. I hope to see you there!

Thank you to Moritz for being such a strong sounding board. Thank you to Alexandre for filling me on some of the dynamics at play in France and to Twitter for connecting us. And thank you to Julian, Eric, and Fred, whose feedback on initial drafts has been key.

All Aboard the Trans Europe Express! Episode 1: The Introduction

In response to Eric Newcomer's three-part series on European VC, I have written a trilogy on the European tech ecosystem's historical, structural and cultural characteristics.

A Re-Introduction

Wow. It’s been such a long time. Over 13 months in fact. To succinctly put it, I started a new job AND Corona reached Germany at exactly the same time. I needed to learn how to do my job and, to be brutally honest, didn’t feel like pontificating in a world of such tremendous uncertainty and chaos.

Anyways, I think I have learned a lot in this period and have become genuinely happier and more fulfilled. Perhaps I’ll expand on this in a later post.

Quick bio for those who are new: I’m a 24 year old American who has been living in Berlin for the last 2 years. In the past, I have attended institutions such as Sciences Po Paris and the University of Pennsylvania. I have spent time working at leading venture capital firms in both New York and Berlin. I currently work at Choco, where I lead the Market Intelligence team.


This is me as a younger, less mustachioed man in Montreal, Summer 2018 (for the thumbnail)


A Comprehensive Overview of What’s to Come in the Series

Eric Newcomer, the long-time Bloomberg tech journalist who has now gone the route of many peers by going Direct-to-Substack, has recently published three pieces on the opportunity in the European technology ecosystem. He takes a highly investor-centric approach, more profiling the select individuals who have grown their net worths from the continent’s startup successes than probing any of the historical, structural, or cultural reasons for why the ecosystem looks the way it does today. 

He adequately identifies many of the most notable firms, funds, and people in the region. He mentions the big contemporary success stories of Hopin and UiPath, along with the investors who have been involved. He spends his entire second installment profiling the top US funds’ engagement with Europe. This part is his weakest, as it amounts to little more than short snippets from interviews with people who are now staking their careers on successful investments in European tech firms. As one would expect, they express bullish sentiments in their conversations with Mr. Newcomer, though, hardly go any deeper than saying they are excited to make future investments and are pleased with those that have already been marked up. The third section profiles Blossom Capital’s Ophelia Brown, who is indeed someone under the radar from the US perspective. Mr. Newcomer’s shortest section (one wonders if he got a bit bored), this deep-dive does little more than reveal the origins of Ms. Brown’s firm and profile a few successful investments.

Ultimately, after reading Mr. Newcomer’s work, I found myself wanting for more, much more. So I decided to put together a trilogy of my own and give the story of European technology the thorough examination it deserves. 

I will look at Europe’s tech ecosystem from three perspectives. My first installment will look at the historical angle. Europe has gone through multiple cycles of startup creation. We currently find ourselves in the third wave of this ecosystem’s history. The first wave (1985-2001) was largely characterized by a lack of sophistication on the side of European capital allocators and a sense that Europe was a bargain bin for Americans to mill around in times of boom but largely forgettable when belts tightened. I see the second wave (2007-2015) defined by the activities of Rocket Internet. The German incubator of largely copycat commerce companies, while rightfully controversial, endowed those in its orbit with critical experience, relationships and capital that would be used as fundaments for the contemporaneous third wave. I also link some academic work on emerging market conglomerates functioning as private capital markets to the Rocket Internet story. The third section deals with the current cycle (2015-onward). I mention some firms and funds that have come from former Rocket Internet associates. I hint that many share a similar DNA: an attraction to businesses building with a consumer/SMB buyer in mind.

The second part of the three-part saga deals with a structural analysis of Europe. Using the example of the data warehousing solution Snowflake, I demonstrate that building an enterprise-facing tech company in California carries three distinct advantages over other locales. B2B software experts are overwhelmingly based there, leading to outstanding concentrations of technical understanding and best practices within founding teams. Selling to peer, venture-backed startups just down the road, who often have many pain points in common, makes for a very well-greased sales flywheel. Finally, B2B software founders in California enjoy credibility with the best investors that is simply unmatched elsewhere. This accrues further as a mechanism for hiring the most talented engineers, who like to pattern-match when considering new opportunities and see the equity investment of a well-regarded investor as providing social capital gains to all of those in the company's orbit. I then move on to proving that Europe’s comparative advantage lies with building consumer-focused companies rather than B2B ones. I look at the data around European unicorns founded in the last decade, noting that the vast majority are consumer-focused with a rather heavy operational focus. I finish it off by looking at some of the hottest sectors today in Europe, suggesting that many hyped companies here share a focus on addressing the commerce stack. 

The final section is probably the most interesting one. Something I quickly noticed after moving to Berlin two years ago was that the social contract that governs the behavior of participants in the European system is rather at odds with that of the US. I lean heavily on Alex Danco’s pioneering work on social capital (no, not the firm). I discuss why startup employees in Europe are not incentivized to care much about the development of the ecosystems they work in. I bring up that the hierarchy of occupations on a social capital basis is nearly reversed between the American West Coast and most of Europe. Risk aversion and fear of uncertainty play a significant role in determining what roles are social capital-optimal and which ones are not. Ultimately, this leads to much weaker inter-mingling between the labor and capital classes of European tech. As a consequence, European innovators do not enjoy the same degree of the useful “Social Capital Fog of War” and thus must waste time posturing and gathering credentials. Ultimately, the system in the Old World is designed to function on transparency, order and certainty, which does not effectively incubate dynamic constituent parts. I conclude the section exploring how this systemic weakness is impacting capital allocators in Europe, borrowing Everett Randle’s excellent framing. I conclude that non-dynamic investors, who have outsized faith in rules, structure, and process will have their lunch eaten in the medium-long term by those who have a big appetite for uncertainty.

In the following three weeks, I will serially publish this series, focusing on the historical, structural, and cultural dynamics at play in Europe. I will then come back one last time, (hopefully) taking advantage of reader feedback, and synthesize the aforementioned currents into a coherent view of where Europe really stands as an ecosystem at this stage.

I hope you will follow along on the ride. See you next week.

Deeply grateful to my friends who have been sparring partners and crucial contributors to this project: Moritz, Julian, Eric and Fred. <3

Transition Complete - Week in Review 05/03

Accel in London, David Sacks on what not to do and a review of High Maintenance's newest installment

As many of you may have seen on Twitter and/or LinkedIn, I have officially begun the next phase of my career. Starting Monday the 9th, I will be working as a Growth Manager at a Berlin-based startup seeking to dramatically alter the food industry. At this time, the firm does not wish to attract attention, so I unfortunately can’t expound on why I’m so excited to join and the opportunities I see for myself and other stakeholders moving forward.

One thing is certain: after spending quite a lot of time on the investment side of things, I’m very ready to build new skills and engage with different areas of my capabilities. I would still like to be a venture investor but right now, building something of significance is far more interesting.

With my new role, you should expect this newsletter to change a bit. I still would like to publish weekly (that could change to bi-monthly) but it will definitely be less long than, say, last week’s. Going forward, I’ll focus on 2 or 3 cool articles I find over the week and write 2-3 paragraphs about my takeaways. More so, I hope to transition the subject matter away from exclusively VC topics to things more relevant to the operational side.

Before I begin, want to deeply thank all the supporters of this newsletter. You all have inspired me to continue when I sometimes lost faith in my mission. Muchas gracias.

Onwards!

Moving to Europe from America

On Accel Partners European Launch - Harvard Business School Case Study

This is truly an awesome case. Written in 2003, it details how Accel expanded to London only a few years before, along with tracing, in my opinion, one of the best articulated and densest histories of VC in Europe from the 1980s to the mid 00s.

What struck me most from this excellent article was this one straightforward paragraph:

"U.S.-style venture capital (VC) had made an appearance in Europe in the mid-1980s, due in part to a hot venture market across the Atlantic. European banks also drove this activity, seeing it as a chance to found new companies that would be customers for their banking services. As a result, one expert commented, “the industry was staffed in completely the wrong way…with bankers and accountants. They were fine in terms of structuring the deals, but lacked the expertise to assess trends and technologies and to add value.”

Few important things to takeaway from this paragraph. First, the oft-cited reasons for why now is the time American funds should turn their gaze towards Europe are, more or less, the exact same justifications used in the past during the big boom times (mid 80s and late 90s before dot-com crash). The article cites “a hot venture market” during the 80s and then for the 90s, “to avoid the competition that was bidding up deal prices at home, or to get a bargain on seed investments” because salaries were lower in Europe than in the US.

No doubt, this time is different. There is way more capital allocated to the asset class in both geographies and Europe has, since the publication of the study, proven that it can produce companies (I’m thinking of Zendesk, Adyen, Elastic,and TransferWise) worth many billions of Euro dollars and relevant on both sides of the Atlantic.

However, the legacy of European tech, originally being driven by financial institutions seeking more customers, not, as was the case with Silicon Valley, by the pursuit of innovative technologies that could then go on to create an entire new class of companies, remains a potent force today. It is still the case that European investors, as a share of the total relative to that of America, are disproportionately likelier to have financial backgrounds rather than operational ones (this gap is only growing by the way as successful operators in California increasingly set up small, single GP vehicles). This has a hard to quantify but significant effect on who and what gets funded and even more crucial, what ideas are initially created. The psychology of this is what’s most important, in my opinion. American investors, with operational backgrounds and “the right mindset” can come to European shores, but they can only invest in what is put in front of them. Cheerily, European seed stage capital is evolving quickly to drive this crucial ideological and psychological ambition.

It appears that Europe is still not quite free from its unfortunate origin story. More time (and a greater embrace of remote work and its enabling technologies) will continue to move the needle but, as an admonishment to American investors, critical mass has not quite been reached, yet, and investment approaches from the US should not be expected to be imported wholesale effectively. I am, nonetheless, extremely optimistic!

David Sacks Droppin’ Knowledge

On Blitzfail: How Not to Go Off the Rails by David Sacks @ Craft Ventures

I personally think David Sacks is one of the most underrated California VCs. A member of the PayPal mafia (he was COO), he went on to found enterprise social network Yammer, which raised $142m in funding before being snapped up by Microsoft for ~$1b in 2012. David, after a well deserved respite, founded Craft Ventures in 2017 and has been building an excellent portfolio ever since.

A few weeks ago, David and team announced a $6m round in a company called Pipe. Pipe is providing a platform for companies with predictable ARR to securitize their revenues and thus receive upfront payments usable for R&D to customer acquisition and everything in between. The timing of the announcement was excellent, as Sir Alex Danco had just published his polemical and brilliant ‘Debt is Coming’ which galvanized a weeks-long Twitter discussion on alternatives to traditional cash-for-equity growth financing (seriously, read Danco’s piece if you haven’t).

Anyways, Sacks’ recent article is a great read for entrepreneurs and investors alike. Particularly impressive is how clearly he articulates how one unhealthy facet of a business (say a shortermist sales strategy or sticking with blended CAC as a metric for too long ) affects other relevant parts of the business. Really a must-read.

Return to Form!

On High Maintenance Season 4 Episode 4: “Backflash”

For many of you who know me well, you know how much I love the HBO series High Maintenance. Originally a web series published on Vimeo, High Maintenance follows an unnamed protagonist known simply as The Guy as he pedals his way around New York City delivering weed to his quirky and eccentric customers.

Image result for high maintenance

The show is structured as an anthology, meaning each episode tends to take on the story (often two) of a whole new set of characters linked thematically and also in the show’s reality by having interacted with The Guy (often as customers). Some hallmarks of the show include an incredible soundtrack, hyper-real surrealistic storytelling (idk what else to call it) and heightened social awareness.

This season, the show’s 4th, had been rather plodding through its initial three episodes. It returned to its original formula of two narratives, cunningly weaved together, after Season 3 saw some innovations by introducing The Guy as an actual character rather than a conduit for the wider narrative (I really enjoyed the spin FWIW). Alas, the initial three installments lacked the characteristic thematic heft of earlier seasons while not bringing anything innovative to the storytelling method. Things changed this week.

For one, with a curt nod to Season 1 Episode 3 “Grandpa”, in which the story is told from two feet high through the eyes of a charismatic dog living with a depressed and overworked millennial man, the characters (and they definitely are characters alright!) we encounter in this week’s episode are in possession of/approximate to a lighter with a Buffy the Vampire Slayer sticker on it. The viewer travels through both time and space as the narrative begins sometime in the early 00s at Christian summer camp and ends in the present back in New York, bookended on both sides by the Christian rock classic “What if God was One of Us”. In between, we are confronted with a young black boy’s heartbreaking natural reaction to a policeman’s benign urging and a bright young girl (off to UChicago on a full ride!) as she readies herself mentally for an abortion, alongside quite a few other quirky participants.

While it’s quite clear there was significant effort put into this particular episode, I’m really pleased to see the show get back what made it great: capturing that incredible diversity that is the true essence of what defines New York City.

See you on the 16th,

Max

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