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The 10 Keys to Investing in European Startups
European Straits #184
Hi, it’s Nicolas from The Family. Today I’m sharing my personal framework for reaching sound investment decisions regarding European startups.
With Capital Call I’ve been curating a lot of writing by fellow European investors over the past two months. It made me realize that I really do have my own vision of what investing is all about, and so I thought I would share it here as a 10-point framework.
Read along for the details and reasoning 👇 But here’s the short version:
There’s not just one framework for investing in tech startups. Beware any advice, including mine.
Have a ‘castle’ in your head; use encounters with founders to keep building and embellishing it.
Be a generalist. We’ve advanced enough in the current paradigm shift so as to see recurring patterns and draw lessons across industries. Still, mind the small differences.
The qualities that make a good founder at this point in the paradigm shift are energy, velocity, rigor, and knowledge—not unlike a jazz musician.
Favor founders that are extremely focused on one niche and then expand outwards—both through new products and onto other national markets.
Make sure to identify if the business is ‘default local’ or ‘default global’, and to assess the founding team accordingly.
The best industry stage when investing in a European startup is ‘Step 2’ of the paradigm shift: when users are waking up, but incumbents are still clueless about new entrants.
Because Europe is fragmented, you have to deal with lesser returns to scale. The key is not more high tech or more impact; it’s cash efficiency (and, in time, positive cash flow).
Never forget that as a ‘tech’ investor, you’re really funding marketing, selling, and scaling up. You want a founding team that’s fit to do just that.
Beware three typically European problems: the country of incorporation; the cap table; and the language(s) the startup speaks.
1/ My firm The Family is part of a trend I’m calling The Diffraction of Venture Capital. Once upon a time, VC was a homogeneous category: firms led by a small group of general partners who did most of the work (fundraising, marketing, dealmaking, portfolio management), aided by a handful PAs, analysts, and lawyers. These days, however, VC is all over the place, and very few individuals who introduce themselves as “an investor in tech startups” fit into the traditional category.
Taking our case at The Family as an example, my cofounder Oussama Ammar and I described what we do in detail in our 11 Notes on Berkshire Hathaway:
It takes that infrastructure to reveal promising founders and build long-term, trusted relationships with them. It doesn’t cost much for each startup because such an infrastructure generates increasing returns. Our obsession is not to have as much capital as possible. Rather, it is to have enough capital to seize the opportunity of investing in early stage companies on which we can have a transformative impact by way of our infrastructure. Providing infrastructure to hedge against a toxic environment triggers a [specific] dynamic: it enables emergence and reveals value. To be good value investors in the digital economy, you need to invest at the earliest stage and operate that kind of infrastructure.
This is all to say that my experience as an investor is not the one found in books or on screen while watching HBO’s Silicon Valley. But again, venture capital no longer exists as a homogeneous industry, and every investor operates differently from the others. So take any advice you read, including mine, with a pinch of salt, and make sure to adapt it to your particular investing context.
Key #1 ✅ There’s not just one framework for investing in tech startups. Beware any advice, including mine.
2/ When I encounter European founders and need to evaluate them, I rarely have the patience to read a deck or listen to a pitch. I’d much rather listen to the founder answering my questions. Because my background is in jazz rather than classical music, I assess founders based on their ability to improvise, not their ability to tell the well-rehearsed story they think I want to hear.
In addition, as an investor, part of my day job is studying the market and knowing it inside out. The great (French) mathematician Laurent Schwartz once said that doing math was about building a castle in one’s head. Maybe math was where I acquired the habit of building my own mental castle—not one that is about algebra, analysis, and geometry, but rather one that’s about our world and how it’s shifting from the old paradigm of the Fordist Age to the new paradigm of the Entrepreneurial Age.
Because I’m always working on that castle in my head (made up of the past and the present, all the industries, all the strategies, all the companies, all the geographies—well, as many as I can at least 😉), whenever I encounter a founder, it only takes a short time (30 seconds?) before I understand what the startup is about and I identify which of my castle’s rooms it fits into.
This is why I don’t need to hear the pitch; instead, I want to ask specific questions to assess how the business relates to my grand narrative. And then I want to see if the founder can help me further furnish and decorate the room to which I think the startup belongs—and if they can, it’s always a good sign 😀
Key #2 ✅ Have a ‘castle’ in your head; use encounters with founders to keep building and embellishing it.
3/ More about that castle. For me, the key to understanding the current paradigm shift is to realize that the transition occurs in every industry—at different speeds, yes, but but more or less following the same rules. (This, I think, is the idea behind Marc Andreessen’s “Software is eating the world”.) That’s why I find it especially useful to use cross-industry comparables—as in, there’s a lot to be learned about the paradigm shift in insurance or real estate if you already know what happened in the music industry.
This is why I really don’t understand investors that are self-proclaimed specialists (“I don’t know anything about consumer startups because I’m focused on enterprise” or “I don’t know anything about FinTech because my specialties are mobile and advertising”). I think that kind of thinking is especially found in people with a background in law or research. But as a pure byproduct of the French school system, I’m as generalist as you can get, and the best approach for me is to turn that trait to my advantage.
There is one caveat: The ability to soundly assess a startup depends on going further and spotting the economic laws that govern its particular industry. Luckily this is where a founder who really knows their industry can help refine your thinking, provided you ask the right questions. In terms of tools, I think along the lines of what I call the ‘Southern Side’ (increasing returns to scale) complementing the ‘Northern Side’ (diminishing returns to scale); then I think ‘flywheels’ (or what Kevin Kwok calls “loops”) are the best approach to analyze an industry and a company.
(By the way, I admit there’s a paradox here: the more software eats the world, the more financiers have to specialize into financing startups in given industries from a financial engineering perspective; however, deciding on an investment requires seeing the bigger picture and being more of a generalist.)
Key #3 ✅ Be a generalist. We’ve advanced enough in the current paradigm shift so as to see recurring patterns and draw lessons across industries. Still, mind the small differences.
4/ What about the founders themselves? Having been a founder in the past, I’ve felt the raw, up-and-down emotions of entrepreneurship. Hence what I’m sharing here won’t work for investors without a founding background (and, no, raising a fund is not the same thing as building a startup 😉).
The short version of what I’m looking for in a founder has been expressed by Paul Graham: “Relentlessly resourceful”. But here are more details:
Energy, I think, is the most important trait in a good entrepreneur. Don’t misunderstand me: this isn’t about talking fast or being loud. It’s more of the internal energy that you can spot through a lot of back and forth with the founders—hence the importance of asking questions and assessing the capacity to improvise. Improvising requires a lot of energy!
Velocity is a necessary complement to energy. It’s more about the hastiness you exhibit while building a startup on a day-to-day basis. Are you in a hurry? Do you reply to emails within 24 hours? Are you willing to run experiments at as fast a pace as possible? This is all good, because tech entrepreneurship is all about “trial, and error, and error, and error”.
Rigor. I know that startups are meant to be messy and that the ‘hacker way’ is the best approach to building a business pre-product/market fit. However, I don’t think that is antithetical to rigor being a founder’s personal trait. A rigorous person finding their way in a messy environment is what I’m looking for here—because at some point, rigor will be required for scaling up.
Knowledge. Paul Graham wrote some beautiful lines about ignorance and thoughtlessness being assets when building a startup—you simply wouldn’t do it if you knew too much. However, I think that’s a thing of the past. Now that startups are entering more difficult industries, knowing one’s industry inside out is more an asset than a liability.
Key #4 ✅ The qualities that make a good founder at this point in the paradigm shift are energy, velocity, rigor, and knowledge—not unlike a jazz musician.
5/ What about assessing the market? I think it’s absolutely critical. It’s not necessarily that you want only large markets. But you need to be clear as to what the market is. Here’s what I wrote last year about Evaluating Markets, With a European perspective,
We must acknowledge that markets are more fragmented in Europe than in the US. One trend is that technology is now impacting more tangible industries, which means that assets are located closer to the customers rather than centralized in one place, as is possible in pure software businesses. Another trend is that technology now impacts markets that are more heavily regulated, and despite the EU’s best efforts, regulations tend to be very different from one country to another. And this is all without accounting for the frictions that exist across Europe in terms of language and culture.
On fragmented markets like in Europe, you don’t really have the benefit of network effects and platform effects before it’s quite late in the game. And so for European entrepreneurs it seems the best approach is definitely to be extremely focused on one niche and then expand outwards—both through new products and onto other national markets. The idea that European early-stage entrepreneurs need to double down on focusing on a niche is what inspired in Oussama and I the idea of “The End of Diversification”, described in our 11 Notes on Berkshire Hathaway (see Note #5).
Key #5 ✅ Favor founders that are extremely focused on one niche and then expand outwards—both through new products and onto other national markets.
Fintech is default local, not default global. Unlike software or a social network that can be “turned on” in any geography, fintech products must receive local regulatory approval, offer local payment methods, and work with local bank partners — all of which takes time, talent, and money, oftentimes a significant, dedicated team. Additionally, over the last 10 years, local fintech players have emerged around the world, posing formidable competition for foreign entrants.
Honestly, I can’t believe we Europeans had to wait for a North American (in this case, Anish, who’s Canadian) to come up with the “default local/default global” framework. Still, let’s put it to good use:
If the startup is ‘default global’, then you need a fearless founding team that is eager to have a diverse team from Day One—and, if possible, to switch everything to English as early as possible. Ideally, the team is already international, they already work in English and (assuming we’re not in the middle of a pandemic), they don’t mind travelling a lot—even relocating elsewhere.
If the startup is ‘default local’, you need a founding team that’s passionate about product and sales, because mid-term success will likely be all about selling and then broadening the scope of the company’s value proposition on a local market rather than expanding on foreign markets. Being international is a plus, but not a necessary condition for success. A provincial team working in the local language can always buy international expansion once they have a firm foothold on the local market—so long as the product is good and the scope is broad enough.
Key #6 ✅ Make sure to identify if the business is ‘default local’ or ‘default global’, and to assess the founding team accordingly.
7/ Another very important aspect is the stage at which you invest—not the stage of the startup, but that of the industry, evaluating just how far into the paradigm shift the industry is.
I wrote about that in At What Stage Should You Invest in European Startups?:
In my framework, you can recognize the stages at which misguided European investors deploy capital. Either it’s Stage 1 (the new technology of the day), and it’s too early: European players don’t have Silicon Valley’s firepower to sustain their investment effort over several generations of (likely failed) startups. Or it’s Stage 3, and then it’s too late: at this point, a potential winner has already positioned itself (think: Amazon, Uber, Netflix), and that position will only be cemented by the incumbents striking back, which usually happens at the expense of lesser, would-be European competitors.
The logical conclusion is that we Europeans must learn to play at Stage 2. That is after software eating a given industry is well understood thanks to a great deal of trial and error (Stage 1). But it's still before incumbents strike back (Stage 3), and so there’s still room for everyone to move at a fast pace: entrepreneurs building new ventures; investors deploying capital; and maybe even governments creating a favorable regulatory environment to prevent incumbents from killing the whole effort before it really gets rolling.
Key #7 ✅ The best industry stage when investing in a European startup is ‘Step 2’ of the paradigm shift: when users are waking up, but incumbents are still clueless about new entrants.
8/ Remember that in any case, Europe’s fragmented nature makes it very hard to achieve very high returns to scale—and it cannot be compared to the scale of operations of tech giants either in the US or in China (or India). Many European founders are eager to acknowledge that fact, but they then try to escape that harsh reality by telling themselves stories about what kind of startup they’re building. As an investor, you really shouldn’t take your eyes off the prize, and it’s best to stay far away in two cases:
Beware the ‘deep’ tech crowd. They’ll try to mislead you with explanations of how cutting-edge their scientific research is, and this is why there’s no traction yet. But I think that more often than not this approach to building ‘deep tech’ startups in Europe is a trap, as I explained here. As Bill Janeway wrote in Doing Capitalism in the Innovation Economy, “at any point in time, there is more technology available than anyone knows what to do with”. Therefore, technology is cheap, and investors shouldn’t succumb to the siren call of ‘deep tech’ founders.
Beware the impact crowd. Another way in which European founders will try to make sense of significant difficulties in scaling up is to retreat into the world of “tech for good”, “impact investing”, or entrepreneurship with a “purpose”. Well, I wrote an entire column in Sifted about it, explaining that “it’s not particularly social to decide to stay small by principle”. But in short: don’t fall for impact entrepreneurs, either.
There’s only one way to accommodate the typically European feature of lesser returns to scale, and it’s cash efficiency. This, by the way, is where we in Europe have a lot to learn from the Chinese. See this very interesting extract from Kai-Fu Lee’s AI Superpowers:
From the outside, venture-funded battles for market share look to be determined solely by who can raise the most capital and thus outlast their opponents. That’s half-true: while the amount of money raised is important, so is the burn rate and the “stickiness” of the customers bought through subsidies. Startups locked in these battles are almost never profitable at the time, but the company that can drive its losses-per-customer-served to the bare minimum can outlast better-funded competitors. Once the bloodshed is over and prices begin to rise, that same ruthless efficiency will be a major asset on the road to profitability...
Wang Xing [the founder of Meituan] embodied a philosophy of conquest tracing back to the fourteenth-century emperor Zhu Yuanshang, the leader of a rebel army who outlasted dozens of competing warlords to found the Ming Dynasty: “Build high walls, store up grain, and bide your time before claiming the throne.” For Wang Xing, venture funding was his grain, a superior product was his wall, and a billion-dollar market would be his throne.
By the way, cash efficiency is why it’s so important to deal with rigorous founders.
Key #8 ✅ Because Europe is fragmented, you have to deal with lesser returns to scale. The key is not more high tech or more impact; it’s cash efficiency (and, in time, positive cash flow).
9/ Apart from cash efficiency, there’s another thing any investor in a European startup has to look at closely: the ability to market, sell, and scale up operations. This can be learned along the way, and any company can improve its ability in those fields by hiring skilled operators (maybe with your help). But you need to assess early on if the founding team is really willing to play that game:
Unlike in the US, marketing and selling—hustling in general—is not something that is encouraged in most European school systems, and it’s even looked down upon by members of the local elites. That explains why so many European founders suck at marketing and selling. Investors, however, should know better.
Bill Janeway wrote about the respective magnitude of the risks taken by tech ventures these days (in this case, writing about enterprise software): “The cost to overcome Technology Risk is far lower...The magnitude of Financing Risk has risen greatly...Business Risk remains the least certain since it remains so dependent on the “soft” skills of entrepreneurs. But it is along the dimension of Market Risk that the most complex process of change has taken place.”
Key #9 ✅ Never forget that as a ‘tech’ investor, you’re really funding marketing, selling, and scaling up. You want a founding team that’s fit to do just that.
10/ Finally, don’t forget that, Europe being Europe and most entrepreneurial ecosystems here being immature and/or toxic, you also need to have a look at the following:
Incorporation. Remember that scene in The Social Network in which everybody laughs because Facebook was initially incorporated in Florida—and then they have to reincorporate in Delaware, involving a lot of lawyers (and disputes)? Well, that happens all the time in Europe. Make sure to have a look at this thread by Elizabeth Yin about the legal challenges when building startups at a global scale. (Specifically, avoid Germany and Spain at all costs.)
The cap table. One of the most toxic things in Europe’s local ecosystems is the dumb money brought forward by angel investors who take too many shares while not bringing much to the table. Have a look at my cofounder Oussama’s Keep your cap table clean: “Lots of things in startups are actually pretty fail-resistant. But if you screw up your cap table, it’s incredibly hard to fix it. That’s because the cap table is linked to two key things: emotions and taxes.”
Languages. It’s the softest of things, but it’s the factor that makes or breaks European startups: fragmentation from a language perspective. I wrote about it at length in The Power of the Tongue (2015) and What Language Should Startups Speak? (2019). In the US, language is not an issue because as a rule of thumb everyone speaks English. In Europe, it’s a big issue because “we’re still lacking a shared culture that makes it easier for people from different countries to work together even if they don’t master the same language”.
Key #10 ✅ Beware three typically European problems: the country of incorporation; the cap table; and the language(s) the startup speaks.
What about you? Are you an investor in European startups? What do you think is uniquely important when assessing an investment opportunity in European tech?
😎 I’m about to adjust the content of European Straits to reflect the widespread summer break that happens in August in Europe:
For those of you who receive only the free editions (every Wednesday), the next ones will be about compiling past content with a particular perspective. I expect your mind is wandering away from reading about doing business in the Entrepreneurial Age, but those of you who still want to keep up will have enough material 😉
As for my dear paying subscribers, you’ll still receive the ‘Monday Note’ and the ‘Friday Reads’, with a lighter curation of what’s going on in tech these days, as well as bits from my building a complete archive of my writings using Notion. This archive is meant to become a centerpiece of the paid version of European Straits from September onward!
From European Startups as an Asset Class (February 2020):
Will these seven favorable trends be enough for European startups to thrive? We can only try to spot the trends and act upon our hunch that the next decade won’t be like the last. Meanwhile, keep in mind Christensen’s theory that if you play by the book and do everything it says, you’re certain to lose in the end. It’s true for incumbents in traditional industries focused on the high end of their market, and it’s true for asset allocators that stick with Silicon Valley and its high returns, not seeing any reason to put more of their cash into the nascent asset class that is European startups.
And in case you missed it:
Cancel Culture: A Systemic Explanation—for subscribers only.
How Fred Terman Turned Stanford Into an Entrepreneurial Powerhouse—for subscribers only.
Anyone Can Build an Entrepreneurial Ecosystem—for everyone.
Privacy & Taxes: It Takes Two to Tango—for subscribers only.
Notes on Revenue-Based Financing (Round 1)—for subscribers only.
The Diffraction of Venture Capital—for everyone.
Country Risk in an Uncertain World—for subscribers only.
Investment Banking Rifts—for subscribers only.
From Normandy, France 🇫🇷