Thanks to all of you who attended the Tortoise Digital Thinkin we did the Friday before last. We had a lively discussion about government support for startups and scaleups during the crisis, and it was great to have participation from a number of familiar faces. Our next ThinkIn will be tomorrow, where I will join former Unilever CEO Paul Polman and others to talk about how the pandemic may breed innovation. You can register for free here.
We’re also very pleased to be
part of the newly-launched ‘Innovation in Finance’ series, produced by BBC
StoryWorks. Seedrs is one of the companies featured, along with other
notable FinTechs and our alumnus GoodBox. You can see more about this on our
blog, and you can watch the excellent (if I do say so myself) Seedrs video here.
We continue to await details on the implementation
of the rescue package for startups and scaleups that was announced two weeks ago. I will
share them once we have them, but for this week’s note I want to talk about a
more conceptual debate that came (back) to life as the rescue package was
coming together.
We
Must Get Out of the Tower!
In
1906, the German publisher and politician Julius Bachem wrote a seminal article entitled “Wir
müssen aus dem Turm heraus!” or “We must get out of the tower!” In it he argued
that the Centre Party, which was a prominent force in moderate politics in
Imperial (and later Weimar) Germany, needed to move beyond its Catholic roots
and open itself to non-Catholics who broadly supported its centre/centre-right
views.
Bachem’s
article would launch one of the most intense debates in German politics of the
first quarter of the 20th century:
- On one side were
those who wanted to “stay in the tower”. They viewed the Centre Party as an
exclusive and narrowly-focused organisation whose goal was to represent the
interests of a particular subset of Catholic Germans, even if that meant never
escaping its position as a permanent minority party.
- On the other side were those, like Bachem, who wanted to “leave the tower” by making the Centre Party an open and more broadly-focused organisation. In doing so it would maintain its core political ideology but sacrifice the exclusivity of its base of support in exchange for the opportunity to be the dominant force in German politics.
Given what was to come in German politics from the mid-1920s, the Centre’s “tower” debate is now largely forgotten except by history anoraks like me.* But in my mind it remains one of the most striking examples of the tension between a “closed shop” and an “open shop” approach that beguiles many organisations, communities and ecosystems.
Startup Towers
And so it is with the startup and scaleup world, which has long had its own version of the “tower” debate. Those who would stay in the tower see this ecosystem as a fundamentally limited one, where only a certain number of good entrepreneurs exist, meaning that only a certain number of good businesses can be started in a given period. This view in turn says that investment in these businesses is a highly specialised, and should therefore be a highly exclusive, activity. Proponents of this view may come to it from a few different angles, but there are a few common assumptions that most of them hold, including:
- What constitutes a
“good” startup is an essentially objective question and is knowable (at least
by the professionals) from very early on in the startup’s life.
- A startup is only
worthwhile if it has the potential to produce exorbitant, return-the-fund types
of returns. Anything less ambitious, even if still targeting a many-multiple
return (and possibly doing so with a somewhat lower risk profile) is
uninteresting at best or even gets the highly dreaded moniker of a “lifestyle”
business.
- There are two types of investors: “smart” ones and “dumb” ones. “Smart” money includes essentially anyone who manages a fund, as well as a slightly amorphous and self-defined group of angels. “Dumb” money is everyone else: family offices; active individual investors who have not dubbed themselves angels; customers of the business; friends and family of the entrepreneur; and so forth. “Smart” money, this thinking goes, is really the only money that should be coming into the ecosystem. “Dumb” money sits outside the tower.
This view was the norm in the UK startup ecosystem until about a decade ago (note that I don’t say “scaleup” ecosystem because, not coincidentally, we didn’t have one back then). But gradually a movement emerged to leave the tower and embrace greater openness and diversity in the space. It came from a number of quarters: certainly the work done by Rohan Silva, Daniel Korski and their colleagues at No. 10, which sought to make Britain the best place in the world to start a high-growth business, was an important part of it; the advent of a younger generation of VCs, who came to see more value in expanding the pie rather than fighting for the biggest piece of the one they already had, helped tremendously; I’d like to think that in opening up the investment landscape, Seedrs and our peer platforms played a small part; and a number of other forces were at work as well.
Those
of us who would leave the tower don’t reject the entirety of the other side’s
views, but we see the startup and scaleup world as much bigger—and more
expandable—than they do. We think that the number of good entrepreneurs and
good businesses out there is, if not infinite, far greater than those in the tower
assume. And more capital coming into the ecosystem—whether from traditional
types of investors or from new ones—simply makes it possible for more people to
leave jobs at other organisations and start their own ventures. All of this is
based on our own set of assumptions:
- Whether or not a
startup will turn out to be a good business is only really knowable once it is
well into its life. It may be possible to identify hopeless prospects early on
(although even that exercise can be fraught), but there are huge numbers of
startups that show strong potential, and distinguishing between those that will
realise that potential and those that will not is a highly subjective exercise
that looks far more like an art than a science.
- The startup
ecosystem is—and should be—made up of businesses at a range of points on the
risk/reward spectrum. One of the defining characteristics of a startup is that
it has some sort of equity story, meaning that there is a level of growth
ambition that would, if achieved, produce strong positive returns for
investors. But that is very different from the notion that a business is
worthwhile only if it’s on the path to becoming a unicorn. There are many
startups, and scaleups, that may be shooting for the moon rather than the
stars, and often they are doing so with somewhat less risk. These can be very
attractive investments.
- Then there is the
way that investors are characterised. Rather than the smart/dumb binary, we see
a much more complex picture. There are loads of good investors out there who
are not professionals or self-branded angels but nonetheless are able to
evaluate ideas and teams effectively and build well-balanced portfolios. There
are others who are not necessarily great investors in general, but they
understand a particular company or a particular team very well, and they’re
able to spot the potential for success in that business when others may not.
And then on the other side, there are plenty of “smart” investors who have
raised significant funds or made big names for themselves but actually deliver
underwhelming returns. So while no one should be investing in startups and
scaleups unless they understand and embrace the risk of doing so, closing
investment (explicitly or implicitly) to those who do not fit a particular
profile is nonsensical.
The Debate Renews
Over
the past few years, I had thought this debate was largely won. Even the sorts
of people who historically would have stayed in the tower seemed increasingly
comfortable with leaving it. And in turn, we have seen the UK startup and
scaleup ecosystem expand dramatically, with far more good businesses than some
people a decade ago would have predicted could be built, and the inclusion of
capital from—and generation of returns by—a wide range of investors who never
before would have been welcomed into this world.
So
it was with significant disappointment that, during the discussions leading up
to the announcement of the Future Fund and additional Innovate UK funding, we
heard a non-trivial number of voices calling out from deep inside the tower.
Some of the arguments focused on the sanctity of VC funding as the determinant
of worthiness. The case was made that additional funding from the government
would create “adverse selection” or even “moral hazard” by keeping alive those
businesses that did not already have access to deep pockets of VC funding. And
some went further, including one person who said that “there is *zero* point in
giving armless people armbands and hoping they will swim,” reflecting an
assumption that anyone who can’t navigate this crisis with existing connections
and resources must be “armless”.
And
then there was lots (and lots) of talk about how the most important thing in
any package be that it not result in the government propping up “bad” firms. No
one seem to proffer an idea about what constituted a “bad” firm (other than
that it had not yet raised funds from a VC), and the extent to which failures
are an inherent part of any early-stage investment strategy was conveniently
overlooked. Part of this focus undoubtedly came from a proper concern that
taxpayers’ money be spent effectively, but it fundamentally returns to the
theme that there is a clearly and narrowly defined universe of “good” startups,
and any business not in that universe is not worth supporting.
The
voices from the tower didn’t limit themselves to focusing on the businesses.
There was (and continues to be) discussion around what investors should be
eligible to provide the match funding required for the co-investment scheme.
Again some of this comes from the right place—ensuring that the scheme cannot
be manipulated is critical—but it quickly spills into a question of who
qualifies as a worthy investor, and there are those arguing that it’s a pretty
small group.
In
the end, we got to a very good outcome with the Future Fund and Innovate UK
funding, which together take a relatively (although not perfectly) open and
inclusive view of the ecosystem. And many of the voices from inside the tower
have now poked their heads out to welcome the package.
But
it is apparent that the tower is far from empty, and that despite the
appearances of recent years, there is still plenty of demand to stay inside it.
For those of us who have fought so hard to leave the tower, this means that the
battle goes on.
A Footnote
* Although the internal debates of the
Centre Party a century ago may seem obscure today, they had repercussions that
continue to be relevant. One of the most prominent advocates of leaving the
tower in the 1910s and 1920s was Centre Party politician Konrad Adenauer. After
the war, Adenauer would play an instrumental role in founding the Christian Democratic
Union (CDU) as a sort-of successor to the Centre Party, and from the start the
CDU has been an inter-denominational party welcoming to those of all faiths and
none. Adenauer served as (West) Germany’s first postwar Chancellor, and the CDU
has governed the country—some would argue quite successfully—for all but 20 of
the past 71 years.
Resources
Here
are a few resources and articles I’ve found interesting over the past couple of
weeks:
- From Small
Business comes a long and expanding
list
of help that is available for small businesses for free during the crisis.
- From Fred
Wilson, founding partner of Union Square Ventures, comes a blog post called “In Real
Life”. Fred is one of the most prolific bloggers in the VC world, and his short
and pithy posts almost always make good reading. This one provides his take on
how the pandemic will impact our preferences for remote vs. in-person
interaction.
- From Jeremy
Liew, partner at Lightspeed Venture Partners, comes an interesting thread that makes a
further contribution to the hot topic of whether, and to what extent, VCs
remain open for business.
- From Azeem
Azhar, entrepreneur and one of the great data-led thinkers in this space,
comes a highly informative
thread
on cash runway. Azeem looks at recently-published survey data on startups’ cash
balances but then draws some interesting some interesting comparisons to
traditional businesses.
- And from Matthew
Syed at The Times (paywall, sorry) comes a compelling piece (albeit not
directly related to the sorts of things I usually highlight) on the effects of
economic recession on mortality. This touches on the highly charged issue of
how preventing deaths and maintaining the economy are balanced, but it does so
with the particular perspective of looking at short-term vs. long-term causes
of death.
***
That’s all from me for now. Please share
any feedback or contributions, and I hope you all stay well and safe in the
week ahead.
Jeff Lynn
I’m Executive Chairman and Co-Founder of Seedrs.
Source: https://www.seedrs.com/learn/blog/leaving-the-tower-thoughts-from-the-chairman-5
