Getting to "yes" in a world of "no"…

Posts tagged ‘Vince Cable’

Innovate11, VCs, Lean Startups and design…

Willkommen!

Earlier this week, the Technology Strategy Board’s held its “Innovate11” conference at the Business Design Centre in Islington: but rather than traipse into town and lose a day’s work, I decided to stay working at my PC with the TSB’s live web stream burbling in the background. As you’d hope/expect, there were plenty of familiar faces on show:-

  • The TSB’s Iain “Old Town” Gray as the cabaret host (or am I thinking of Joel Grey?)
  • Amadeus’ Hermann Hauser and my old pal Alex van Someren
  • Deyan Sudjic (director of London’s funky Design Museum)
  • Will Hutton (who was plainly annoyed by the indifferent reception he received)
  • Coalition business ministers David Willetts and Vince Cable.
  • etc

Pretty much everyone on the stage stayed in character, with the notable exception of the wirily energetic Hermann Hauser, who I thought was on particularly fine form talking about the slightly surprising business logic behind Solexa’s success.

I must admit that while Alex van S was going through a fairly sweeping summary of contemporary VC pitching wisdom (e.g. Guy Kawasaki’s famous 10/20/30 maxim, i.e. 10 slides / 20 minutes / 30 point font minimum, la-la-la), I kind of zoned out for a while, musing about the whole challenge of investing in startups.

You see, the whole VC model is to invest in high growth companies early in their curve, so that you stand a chance of getting a few 10x “home runs” in your portfolio, to balance out the (sadly almost inevitable) duds that you’ll also pick up. In the overall business landscape, such high-performing startups are without any shadow of a doubt statistical outliers – so to my eyes, the VC challenge is surely to use nous and experience to search out exceptions to the rule, not companies who slavishly follow the rules. For all the adulatory press that has followed Steve Jobs’ recent death, for me the most telling stories have been the ones that point out how mainstream investment criteria would exclude him rather than reach him.

My point here is really that if VCs need to find exceptions to the rule, why do they now seem to invest so much time in building yet more rules for potential investees to follow? For example, Alex stressed that Amadeus never invests in one-man-bands, while other VCs love to talk about the shamelessly brutal “truck count” metric (= ‘the number of individuals in an organization that could be killed by a truck before that company becomes unable to function’) to emphasize the same point – that small is fragile. Yet I think a typical entrepreneur (a) has to do ten different jobs simultaneously just to get by (and I suspect that’s pretty much always been true), and (b) builds up a network of partners, suppliers, mentors, advisors and indeed customers all helping him/her to get the job done. OK, there’s only one of me, but my network is an army sans frontieres, so what’s the metric for that? Set the [number of employees] field to [1] in Amadeus’ pre-funding application form and you’ll no doubt get filtered out straight away: ‘computer says no*cough*.

Perhaps the bigger issue is whether VCs spend too much effort filtering for excellence when they should be looking for brilliance – there’s a big difference between the two, as my old school housemaster Mr Tarrant used to say.

Anyway, going back to Innovate11, while listening in to the design panel’s protracted noodlings I was struck by how very similar the kind of design-led approach the participants described (customer-focused, iterative, uncertainty-based, etc) was to the whole Lean Startup thing. And the more I’ve thought about it since, the less I can see any obvious differences.

So here’s what I now think: that for Lean Startups, treating everything as if it were a design process is claimed to be the best way of doing business. Furthermore, below this top-level approach there lies an implicit set of (what I personally think are actually fairly corrosive) claims:

  • that design-driven iteration is vastly superior to principle-driven architecture;
  • that what other people (particularly customers) know is vastly more important than what you know;
  • that it is more practical to fix what didn’t work than to predict what should have worked; and
  • ultimately, that it is better to cope fast than to manage well.

For me, the biggest irony of all is that for all Lean’s claims of being a scientific “methodology”, it is built around an inherently anti-science design loop, predicated on what looks eerily like a postmodernist dismissal of Enlightenment knowledge. Why would a Lean Startup need any PhDs or even (*spit*) MBAs, if its development starting point is always going to be one of ignorance?

Pointing this out doesn’t make me a Lean “hater”, it just means that I think I can see Lean for what it really is. Which is to say that, contrary to what is normally claimed, Lean is not about saving money, avoiding process waste or even about learning-focused development, it’s simply the claim that strongly iterative design-based development is the best strategic choice best for all startups. Which isn’t really supportable, IMHO.

As such, I see Lean as arguably just an overreaction to the long-discredited “if you build it they will come” business strategy, which I think overbiased startup discourse in quite the opposite direction (i.e. towards PhDs and MBAs, and towards big science over iterative design). Personally, I try to follow a more blended approach, fusing big science and iterative design within the constraints of a shoestring budget – it may not be fashionable, but it works for me. 🙂

The Enterprise Investment Scheme: stepping stone or millstone?

For many years, a key landmark on the UK startup funding landscape has been the Enterprise Investment Scheme (‘EIS’ for short). This is a wonderful piece of tax legislation wizardry that gives tax breaks to angels investing into qualifying startups both on downside outcomes (i.e. if the company fails) and on upside outcomes (i.e. if the company succeeds). As I recall, the figure I saw quoted for 2009 said that 76% of UK angel investments into UK companies went through EIS, which makes it a pretty popular scheme.

All the same, when I started structuring my own company (Nanodome Ltd) pitch to make it angel-ready, I priced up all kinds of non-obvious corporate structures (options, debt, convertible debt, etc), but honestly – the EIS makes everything else so second-best that it was kind of embarrassing. Hence the EIS is something I’ve long told other entrepreneurs is the only sensible way to go forward: it’s pretty much gold-plated.

However, funding is changing. Paul Graham (of Y Combinator fame) put up an essay last month about what he calls High Resolution Funding, by which he means startups’ selling convertible notes at different prices to different people (and at different times). Convertible notes are a kind of debt equity that can be converted to common stock at a future round (though you have to be careful that you’re not effectively trading insolvently and that you will still have access to overdrafts / factoring / etc). ‘Capped convertible notes’ refine this further (so that seed round angels’ investments don’t get diluted down to nothing on big up rounds). Graham’s finesse on capped convertible notes is that startups can choose to give earlier or particularly-useful angels a better price than later or not-so-useful angels, which makes a lot of sense to me – as he says, few angels nowadays want to lead. But for him, the #1 attraction of this ‘high resolution funding’ is that it means startups don’t have to pre-decide how big a round to raise – instead, you can size it up based on how well angels react.

Of course, you’ve probably already worked out that this is precisely the kind of non-obvious financing trickery the EIS was designed to discourage: to be precise, only common shares held for at least three years in an all-common round qualify (though of course this is not legal advice, read the HMRC guide for yourself), so EIS and Paul Graham’s brave new entrepreneur-centric investment world don’t easily overlap.

And that is where the core problem lies here. While funding is rapidly changing in the US, the EIS supplies a strong disincentive to change in the UK, even though the UK funding picture has changed dramatically over the last few years:-

  • no realistic bank funding (whatever our banker chums say to Vince Cable)
  • hardly any local grants (unless you live in a deprived area)
  • hardly any national grants (unless you happen to be female)
  • unwieldy, overspecialized, glacially slow EU grants (where the size can be exceeded by the bureaucratic effort needed to gain it)
  • regional development funds being dismantled

Hence, R&D tax credits (which are great if your enterprise is just the right size, and with enough PAYE employees) and the EIS are just about the only two bright lights in an otherwise uniformly dark sky. So, it may initially seem somewhat ungrateful of me to say that I think the EIS may currently be turning from a stepping stone into a millstone round startups’ necks. However, it is true insofar as it serves to accentuate the increasing funding gap between the UK angel scene and the US angel scene. In Thomas Homer-Dixon’s phrase, there’s a funding structure “ingenuity gap” here which I think the EIS disincentivizes anyone from filling.

What nobody in the UK government seems to grasp is that things like AngelList (and other routes opening international startup dealflow to US angels) are not ‘high concept theoretical conceits that may possibly become practical in a decade’. They are happening right now, and frankly you don’t have to engage with them for very long to see that they make the UK’s attitude to financing look utterly parochial, utterly dead in its own stagnant water. UK entrepreneurs are now able to jump on a plane and – for much the same cost as, you guessed it, presenting to a single UK angel network – pitch to US angels who they’ve probably already networked with via Twitter, LinkedIn, Facebook, email, etc. And any guesses as to which side of the Atlantic they’d find funding first?

Much as I love the EIS, and much as I understand exactly why the taxman wants to reward equitable investing practices, I can’t help but conclude that the EIS has become one of the things impeding UK startup financing innovation, simply because the startup financing world around it is moving so rapidly. I hate having to say such heresy, but it’s true, every word of it.

Really, if the EIS is the best we can do, what kind of madness would have to take hold of my mind for me to advise a UK entrepreneur in the current climate to pitch to UK angels at all? If you’re building a world-beating company (and you’ve gone just about as far as self-financed bootstrapping will take you), surely your most rational next step would be to hone your pitch until it can slice through a telephone directory at forty paces, network with US angels like crazy, and get on that plane? But then… if the top 10% of UK startups all do this, where next for UK plc?

PS: up until a few days ago, I wondered whether my heresy was just some personal ‘reality distortion field’ affecting my judgment: but chewing the far with other entrepreneurs after Eric Ries’ talk at TechHub helped me realise that no, this is exactly how a lot of other UK startups also read the funding situation. Just so you know!

“Series A, R.I.P.”…?

Doubtless VCs will find some way to disagree (please leave your comments below, I really don’t mind), but I believe that fast growth startupsyou know, the kind VCs are so desperate to get a slice of – should now avoid Series A completely. The Big Things that are So Very Wrong with Series A…

  1. VCs get preference shares, i.e. where everyone who was in before takes a big hit and comes second in any future liquidity event
  2. The process takes so long and costs so much (legals, due diligence, etc) that it has to be for an obscene amount to be worthwhile.
  3. VC funding is hugely expensive, with service charges and top-table directors’ fees to add to your monthly cash outgoings

…have long been believed to be balanced by the sheer weight of the money pile. If your only exposure to business was TechCrunch, you’d be certain that a Series A round sounds like the company has hit a key growth / credibility milestone. But… I think the world has changed so much over recent years that Series A is (almost by definition) redundant. I’ll show you what Wikipedia says about Series A and I think you’ll see why:-

“A typical Series A round is in the range of $2 million to $10 million and is intended to capitalize a company for 6 months to 2 years as it develops its products, performs initial marketing and branding, hires its initial employees, and otherwise undertakes early stage business operations.”

Hence even at the slow end of this model, such startups are looking for (say) $4m to last them 24 months of early stage operations, i.e. burning $167K per month. Circa 2010, the problem with this is that in all but a few cases, product development & customer development are just not that expensive any more.

So on the one hand, thanks to trailblazers such as Steve Blank and Eric Ries, lots of dev people are busy building and bouncing stuff off their customers, pivoting fast to try to fail fast, and persisting down their long-term road to product/market fit nirvana. After all, everyone makes mistakes, but there’s a technical name for people who keep on learning from their mistakes: winners.

While on the other hand, you have an entire VC industry (regardless of whether or not you happen to think it’s moribund etc) dangling big valuations and multi-zero cheques in front of startup execs’ eyes to convince them to build big, go big, stay big: their model of winning is to use money to build a market fortress at speed and get to #1 (or maybe #2 behind Microsoft, if it’s a big enough market and MS is in an acquisitive mood).

So… how can ‘win through learning’ and ‘win through sheer size’ ever be properly reconciled with each other? Personally, I don’t think they can.

I suspect that the new growth path will come from startups building a financial firewall around their IP (specifically their patents) and securitizing it about 18-24 months after their seed round – basically, leveraging a non-VC debt round against market-proven IP. OK, it’s completely true that hardly any Euro bank securitizes intellectual property at the moment: but then again, hardly anybody does IPOs any more either – and both of these are probably just fashions that will change before very long.

Here in Europe, the other big funding angle to watch is what the European Investment Bank is doing, because it is one of those institutions with an awfully big pot of money and a long strategic reach that will probably never scale down to seed level… but mezzanine-level support from it may well be possible.

Finally: here in the UK, unless Vince Cable can quickly devise a way of bribing encouraging more angels to write more (and larger) cheques, there currently seems to be too few active angels to support any substantial UK startup scene (whether seed or early-stage), even with EIS relief (for both downside and upside), and even with Wired going ra-ra-ra about the sector in the current issue. Oh well!