A few weeks ago Sorosh Tavakoli, chief executive (CEO) of Videoplaza, one of my portfolio companies, and I visited Silicon Valley.
The purpose of the trip was mostly market intelligence, but we took a few meetings with some venture capitalists (VCs) as well.
One of those meetings was with James Slavet, of Greylock Ventures, investor in social networking companies Linkedin and Facebook and, most recently, discount coupon provider Groupon.
While the meeting was short and cursory, both Tavakoli and I were struck by how friendly Slavet was, particularly to us as a start-up. He offered us office space while we were in the Valley, made sure Tavakoli had some vitamin C to ward off a cold he was catching and indicated a willingness to reconnect and chat at any time about the market and landscape.
He seemed eager to open doors and help in any way he could. What struck me most from this experience – in addition to the casual clothing and laid-back atmosphere of Sand Hill Road – was the absolute focus on the entrepreneur as the "talent".
Whatever Greylock’s interest in investing, their hospitality was impeccable – the result of years of learning that a happy entrepreneur is a great source of both direct and indirect dealflow in the future. Moreover, their willingness to give space, network capacity, food and conference facilities all stood in marked opposition to the modus operandi I have seen in the European venture community.
Contrast Slavet’s approach to that of the unnamed VC in a pin-striped suit, braces and tie, sitting across a massive wooden desk from Lastminute.com co-founder Martha Lane Fox, asking her: "So what happens when you get pregnant?"
Ignoring the obvious and ridiculous sexism, there is something else at work here. It is that much of the European VC scene is finance-foused, whereas in the Valley the firms are entrepreneur-focused.
This is not to say there are zero finance folks in the Valley, nor entrepreneurs in Europe (Saul Klein at Index Ventures and Pär-Jörgen Pärson at Northzone are high-profile exceptions). But in general this is a common theme. In Silicon Valley, entrepreneurs, particularly serial ones, are the talent, to be courted, coddled and seduced.
The industry is all about enabling them, building long-term relationships with them and, yes, making them rich. In Europe, finance sits at the top of the mountain, where entrepreneurs climb up to beg for scraps of cash both initially and through other governance mechanisms later.
I have heard tale after tale of VCs in Europe preventing start-up CEOs of successful companies from taking any money off the table, criticising their need for reasonable cash salaries, and often resisting any early liquidity, whereas in the US an entire industry (second markets) has been built to facilitate this.
The average VC-entrepreneur relationship lasts much longer than the average marriage, but often neither side invests nearly enough time evaluating nor building that relationship.
This entrepreneurial versus finance focus is a theme of the second challenge in our market – where VCs place their portfolio management emphasis. In conversations with VCs based in Silicon Valley, I have been struck by how few of them pay any real attention to profit and loss or, more specificall, profit.
In some cases there is actually an aversion to profit. For most Valley-based VCs, if a firmis generating profits it is a sign it is not growing fast enough – and often this is viewed as a signal to engage in mergers and acquisitions (M&As) to exit, often to private equity, a competitor or a larger corporate.
Valley VCs want growth – double-digit, quarter-on-quarter growth – with a view to this growth leading to a bigger customer base, a bigger market and a stronger, defensible competitive advantage, which almost but not always leads to a bigger exit.
Often these exits, both flotationsand to bigger corporates, are pre-profit if not pre-revenue. Contrast this to firms in Europe. I have heard board members tell businesses of less than two years of age with double-digit growth to "slow down that growth and make us some money" – a strange instruction when you contrast the internal rate of return (a measure of annual performance) of a dividend with the exponential returns of double-digit growth.
This is particularly true among consumer internet companies, where scale is really the goal before you can monetise effectively. Some will call this evidence of a risk aversion in the European start-up scene, but I would also say it is a lack of understanding of operational metrics.
Too early a focus on profit will restrain growth, as will a misunderstanding of the complexity around setting proper management metrics, key performance indicators and targets to motivate people, including compensation. Another challenge facing European VC is the distinct lack of follow-on investment.
Europe as a whole is severely undercapitalised. Since much of this capital is chasing either seed deals or late-stage growth equity, there is a shortage of follow-on capital, which forces VCs to manage their business to metrics more attractive to private equity, stunting the growth and often future of the business, just to get that much-needed capital on board.
The number of great businesses I have seen wither while searching for follow-on investors for the series B (or even A if the seed round was big) is depressing, to say the least. In many cases, these businesses simply move to Silicon Valley, like Loic Le Meur, founder of Seesmic and LeWeb.
Better syndication of follow-on rounds between regional VCs could help manage this risk and build a better VC community in Europe – something the US has already started to do.
Do a back-of-the-napkin analysis of European versus US portfolios. Count the number of earlier exits in the portfolio and count the number of shuttered businesses. You will find interesting anecdotal evidence of another secret of Valley VCs – they use M&A as a key tool to manage out the middle-performing assets in their portfolios, whereas European VCs often hold these sometimes profitable businesses long past their shelf life, to the point where they shrivel and die.
M&As early and often in a portfolio can help reduce underperforming assets, balance a possibly incomplete management team or, in some cases, create a market victor (such as film rental company LoveFilm) from a few smaller players who alone will eventually cede market to a larger, likely foreign, competitor. While we’ve seen a notable recent uptick in M&A (DailyMotion, Citydeals and LoveFilm) I would say we’re oddly still significantly underperforming on this key measure.
M&A also presents another challenge for the European VC. Victory for many European start-ups is to be acquired, most likely, given the landscape of buyers, by an American. Microsoft, Google, Facebook and Yahoo have stacks of cash on the sidelines, so there is a clear opportunity, and frankly a need, for more transactions between the US and Europe.
While there is a healthy debate around whether this is a good or bad thing, it is the reality today. As a VC and a serial entrepreneur, you need exits at the highest valuation possible to refill your coffers and allow you to continue contributing to the ecosystem. This means one of your key customers is a potential buyer in the US, probably in Silicon Valley.
Yet I can count on one hand the number of European VCs with deep relationships in Silicon Valley. The firms with strong ties almost always outperform their counterparts, fund after fund. Only time builds trust, and some of that time needs to be spent face to face.
I suspect this is one of the reasons Index Ventures’ Danny Rimer is moving to Silicon Valley, and that DN Capital has Steve Schlenker there full time. It is also why I live in both cities.
A possible response to my last point is that M&A is the responsibility of the company, not the VC – which leads to my next observation, regarding governance. In many start-ups (though notably not Scandinavian leaders Northzone or Creandum, investors in Videoplaza), I have been astonished at the passive, back-seat approach to business oversight from the boards.
Consisting of a regular meeting and the occasional phone calls, they did not, as a rule, get involved in the businesses day to day unless it began to fail. I suspect there are many reasons for this, including a lack of resources – VCs in Europe have much smaller funds, meaning much lower headcounts, making such activism difficult.
But, to speak plainly, many hedge fund managers I know are more active than some of the VCs I have engaged with here. Perhaps that is down to a lack of operational experience. In Silicon Valley, the vast majority of VCs have some degree of operational experience – most firms pull a mini-mum of one, if not more than half, of their partners from the ranks of entrepreneurs and operators.
In Europe, you are hard pressed (with clear exceptions, including Atomico and Profounders) to find significant entrepreneurial or start-up operational experience among the general partners or associates at these funds.
Even stranger is the almost complete lack of that Silicon Valley standard EIR – entrepreneur in residence – role. For a small cash stipend, plus housekeeping – office,internet and maybe a bit of secretarial assistance – most VCs could easily augment their limited operational pool of talent. Yet very few have a significant number of EIRs, in many cases not at all. You have to wonder whether the sector’s under-performance is related to this imbalance. I am not suggesting VCs should begin micromanagement, rather just a bit more engaged offering coaching and mentoring.
As an angel investor, I don’t want to bite the hand that often feeds me. I have been very tough on European VC here, but I want to make one thing clear. I moved to Europe five years ago with a specific mission – to identify how to build successful consumer internet businesses in a market with greater geographic, political and linguistic complexity.
I have chosen to make Europe my home because I want it to be the best place in the world to found a consumer internet business. In this next age of global digital business, we have many advantages, so let us address some of our weaknesses, play to some of our strengths and build the next generation of great companies here.
This article was firstpublished as a guest column in the Tele graph’s Tech Start-Up 100 debate series.