Dear all,
š®š¹ This week Iām writing from Italy, where Iām travelling with my colleague Pietro Invernizzi to talk about my book Hedge and expand The Familyās network in a country in which weāre still in the process of discovering the local startup communities.
On Monday we were in Milan, where I discussed Hedge with Francesco Cancellato (moderator), Marta Ghiglioni of Italia Fintech and Andrea Garnero, an economist at the OECD. Yesterday was Rome, where I talked at the ClubHouse Barberini with Roberto Basso (moderator), Licia Ottavi Fabbrianesi of ANGI, and Stefano Firpo of the Italian ministry of economic development. Today weāre on our way to Naples, where Iāll be speaking about Hedge as part of the NAStartUpDay.
And all of this has been made possible thanks to the incredible support of our friends Raffaele Russo, Roberta Laudazi, and Fabrizio Pagani ā¤ļø.
When venture capital goes mainstream
A recent New York Times article on startups shunning venture capital has caught the attention of many in the tech world. It suggests that startup founders have become addicted to raising venture funds when in fact itās often a mistake to do so. In reaction, more founders are turning down the opportunity to raise venture capital and instead opt for bootstrapping their venture. Meanwhile, some investors, such as OATVās Bryce Roberts, are exploring a new way of financing innovative ventures, one in which founders raise less money and thus retain the majority of the returns in case of success. The wave of āsmall is beautifulā seems to have taken over the conversation of what startups are about.
What I donāt like in this discussion is that in Europe it enables all the toxic people who bring out their āI-told-you-soā spirit and tell European founders that itās time for them to renounce venture capital, too. This is a pattern that we at The Family know all too well. First US entrepreneurs do something (like raising a lot of VC money) and get rewarded with great successes; then they do too much of it, which triggers a backlash; then itās āOh no, we shouldnāt have done that, shame on usā; and finally, just as Europe is catching up (because Europeās always late to the game), the backlash provides toxic people here with arguments and European founders are yet again deprived of the successes that their US counterparts enjoyed a few years before.
So instead of bragging about āSee, even the Americans are turning against venture capital now!ā, itās time to put this discussion in perspective. Let me share three ideas to that effect.
First of all, the backlash against venture capital is only the later stage of founders gaining more power over investors. Steve Blank published a great piece in 2017, in which he explained that ā21st century VCs have been relegated to passive investors/board observersā. For me, itās all but predictable that founders having the upper hand in general has led some of them to raise too much money. And because raising too much money inevitably leads to problems, like a cat eating the entire box of treats, one seemingly logical reaction is to promote frugality.
Itās not that renouncing venture capital is right for everyone. Rather, itās just that a new moral standard has to exist that pushes the most addicted ones away from their self-destructive behavior. In other words, the fact that some people are addicted to alcohol doesnāt mean that we should all refrain from having a glass of excellent Bordeaux. It means that moderation has to be touted as virtuous if only to make people think twice before downing the whole bottle and then chasing it with a shot of cognac.
My second idea is that relying less on venture capital is more logical as tech entrepreneurs explore more tangible industries and more regulated markets. Venture capital was the ideal tool for financing businesses when tech entrepreneurship was all about intangible assets, such as distributing music and advertising brands on lightly regulated markets (as opposed to, say, healthcare and real estate). Today, building a tech company comes with what I call the āNorthern Sideāāthat is, everything in a business that is tangible and regulated and thus comes with diminishing returns to scale.
Youāll find a Northern Side in every tech company: think about Amazonās world-class logistics, Googleās massive salesforce, Uberās compliance with regulations that differ in every city. But all of them can still be called tech companies because their āSouthern Sideā, the one that is built with computing and networks and thus generates increasing returns to scale, accounts for a larger part of their value chain.
But as software is eating new parts of the world, tech companies are entering new territories in which the tangible Northern Side tends to weigh more and more on the business returnsādegrading their capacity to grow at scale and making these new tech companies more closely resemble traditional companies.
Should it be a surprise that this kind of tech company is less prone to raise venture capital? No. Venture capital perfectly fits a company whose returns increase exponentially as it scales. Itās less relevant, however, when the company raising funds has to deal with a more prominent Northern Side and sees its capacity to generate increasing returns flounder as a result. For such companies, traditional ways of financing, starting with bank loans and, later, raising money on the bond market, are more relevant; after all, they have the tangible assets and the regulatory moats to reassure traditional investors that are far removed from the world of venture capital.
And so this is how we should interpret this revolt of the founders against venture capital. Itās not that their mindset has changed as compared with the previous generations. Itās more that this new generation of founders is tackling different entrepreneurial challenges in sectors in which the difficulty to generate increasing returns to scale makes venture capital less relevant.
Finally, let me conclude with a third idea: we in Europe didnāt wait for the Americans to relapse to realize that you need to generate revenue before you raise more capital. Let me simply quote my co-founder Oussama Ammar on that:
āBootstrapping is absolutely difficult. But as hard as it is, itās also very rewarding, mentally and financially. Thereās no pleasure for an entrepreneur like having a satisfied customer. In terms of development, having a company that shows growing revenues makes everyone happy. It gives you leverage when the day comes to fundraise, and youāve put the power on your side.ā
Off to Barcelona, and then Menlo Park
šŖšøThe Hedge tour continues! Next week Iāll spend two days in Barcelona, by invitation of my old friend and classmate Cyril Piquemal, whoās the French Consul gĆ©nĆ©ral there. Iāll be participating in a panel, probably in French, as part of La nuit des idĆ©es, about which you can find more details here.
My colleague Lorenzo Castro and I donāt have a full schedule yet, so if youāre in Barcelona and would like to meet, please reply to this email! Also donāt forget to buy your copy of Hedge by visiting the relevant Amazon website depending on where you are: šŗšøUS, š¬š§UK, š«š·FR, š©šŖDE, š®š¹IT, šŖšøES.
šŗšø Right after that, Iāll board a plane to San Francisco to spend two days on the Facebook campus in Menlo Park as part of Tim OāReillyās Social Science Foo Camp. Then Iāll have a full day in San Francisco (Monday, February 4) where I still have a bit of time: so if youāre around, letās grab a coffee!
Also have a look at those two articles:
Anthemisās David Galbraith published an incredible thread on Twitter: A brief history of the world since 1995.
Check the latest issue in The Familyās Scaling Strategy series: What Makes Tech Companies Different.
More readings about venture capital as technology goes mainstream
Bootstrapping Like a Boss (Oussama Ammar, The Family, a few years back)
The Digital World Is Not a Flat Circle (me, The Family Papers, October 2015)
Low Risk, High Reward: Why Venture Capital Thrives in the Digital World (me, The Family Papers, November 2015)
The New Berkshire Hathaway You Havenāt Noticed (Yet) (Oussama Ammar and me, The Family Papers, July 2016)
A Brief History of the World (of Venture Capital) (me, The Family Papers, May 2016)
Why Uber is The Revenge of the Founders (Steve Blank, November 2017)
Why Seed Scaled (Bryce Roberts, October 2018)
Sticking Our Neck Out (Bryce Roberts, December 2018)
More Start-Ups Have an Unfamiliar Message for Venture Capitalists: Get Lost (Errin Griffith, The New York Times, January 2019)
Why do VCs insist on only investing in high-risk, high-return companies? (Jerry Neumann, Reaction Wheel, January 2019)
Warm regards (from Rome, Italy),
Nicolas