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The Future of Silicon Valley
European Straits #160
Hi, it’s Nicolas from The Family. Today, I’m sharing a few thoughts inspired by my recent trip to the Bay Area.
I’m back from the Bay Area, where I spent about 10 days. The core reason for the trip was attending Social Science Foo Camp, which was great, full of interesting people. But then most of my time was spent meeting local players and hearing their assessment of where Silicon Valley is at the moment and what direction it might be headed toward in the future. Read along 👇
1/ My last piece of writing about Silicon Valley had a rather pessimistic tone. The title was Silicon Valley Nearing the Breaking Point, and it looked at how distributed work would make it easier for entrepreneurs and employees to skip settling in Silicon Valley, avoiding the skyrocketing housing prices. I also wrote a bit more about the rise of remote work in Sifted a few weeks ago.
2/ Right now, though, my question for every Silicon Valley-based venture capitalist I meet is: Do you invest in startups in Europe? I’ve asked powerful and well-connected people for introductions to discuss that matter. But they all came back empty-handed. Venture capitalists in the Bay Area are not interested in Europe in a systematic way. A few firms now have outposts in Europe, but the reasoning seems to be as random as “One of our partners wanted to spend some time in London with his wife, so we figured we should have a look at some startups there.” More often than not, those who have invested in European startups did so because founders came to the Bay Area to pitch them.
3/ There seems to be a kind of an adverse selection due to the nature of the VC business. On one hand, there are established firms with a track record so impeccable and a brand so powerful that partners can simply sit on their couches on Sand Hill Road and wait for the entrepreneurs to show up. They have access to infinite money and could expand in Europe, but they’re not interested in hopping on a plane and criss-crossing the Old Continent. After all, those firms already have the best deals and the best returns out there while staying in the Bay Area. Why bother with jetlag, competition with European VCs, being away from their family, overcoming cultural and linguistic barriers?
4/ On the other hand, there are some upstart VC firms that might be interested in differentiating themselves and adding Europe as a significant segment in their deal flow. Alas those firms simply don’t have the means to invest in Europe in a systematic way. For a firm based in the Bay Area, being in Europe incurs large costs both financially and physically, costs that these firms and their partners simply can’t cover. First they need to score a few wins at home to establish their brand and a good track record. Then they can go out and raise more money, and then cash in more management fees. Only then, maybe, can they add Europe to their roster. But will they? At that point, it is likely that they’ll instead opt to sit back on their own new couches (though in South Park rather than Sand Hill Road).
5/ This clearly puts European entrepreneurs at a disadvantage. Most can’t access the capital and expertise that VC firms in the Bay Area can bring to the table. For those who try to get ahead by spending some time there, they will likely slip up within the unspoken social order of the place and fail to tick the boxes that prompt investors to move forward.
This is in sharp contrast to how Israel jumpstarted their startup ecosystem back in the 1990s. A key feature of the Yozma program was attracting US VC firms and having them open a local office to invest in local startups. Israel wanted more than capital; they also wanted an education in how to grow successful ventures. By expanding to Israel and establishing a strong local presence, Silicon Valley venture capitalists contributed to that education. In turn, that made it easier for Israeli entrepreneurs to use Silicon Valley as their preferred base for fundraising.
6/ Does ignoring Europe represent a threat to Silicon Valley? With Clayton Christensen passing away recently, I’ve been watching or rewatching several videos of his, and I discovered this one where he discusses the disruption of VC with the case of his friend Mitt Romney building Bain Capital in the 1980s:
At first, the firm was very much about doing VC deals, that is, investing small amounts of money in risky early-stage businesses. Staples was their most famous success during that phase. According to Christensen, Bain Capital invested $1M in what later became a leading department store for office supplies. The Staples deal [in fact, $4.5M] put Bain Capital on the map.
Then one day, Christensen introduced an entrepreneur to Romney, expecting him to consider another $1M investment, this time in his friend’s company—an investment similar to that which Bain Capital had made in Staples a few years before. But Romney flatly turned him down, explaining that Bain Capital had outgrown its initial VC business and had stopped looking at deals that were less than $10M. Their early scores had begotten success, and now they’d expanded to become more of a private equity firm: larger funds, more management fees, and diminishing returns to scale that were forcing them to pass on small, early-stage deals.
The conclusion, according to Christensen, was that Bain Capital had fallen victim to the mighty laws of disruption. By pursuing larger, more lucrative deals, they were missing out on early-stage opportunities. They were now in the position of not being able to connect with the most successful founders when long-term relationships are formed, that is, at the earliest stage.
Not all VC firms get lost in disruption like Bain Capital in Christensen’s story. Union Square Ventures and Benchmark are exceptions, highly successful firms that keep on raising relatively small funds and staying lean despite their potential access to unlimited money. But you can see a pattern in which having too much money on hand could lead financiers in the Bay Area to miss out at the early stage, in turn leading Silicon Valley to lose its position as the preferred place to start a company. If you don’t need to raise $10M+ at a high valuation, why even go there?
7/ Another thing that makes Silicon Valley prone to disruption is the acceleration of the investment cycle. Disruption doesn’t come only when you have more capital to deploy and focus exclusively on large deals. It also looms when you expect faster returns:
The fact that returns are faster in Silicon Valley reveals its strength as an entrepreneurial ecosystem: founders are more ambitious; they can access as much capital and talent as they need to grow fast; there’s a deep and efficient secondary market that provides liquidity at any stage. All of this makes it easier for investors to cash out big in a rather short timeframe.
However, problems arise when you start to get used to these fast-paced returns. It creates expectations that lead investors to overlook opportunities in markets where building a successful startup takes more time. And with software now eating more tangible industries on more regulated markets, the best bets are now in those markets where things go slow.
In a previous issue, I explained how some US investors are willing to make early small bets on startups tackling new, difficult challenges. Even if the probability of short-term success is low, making those early bets contributes to paving the way for deploying more capital later. You can afford to waste money with the first generation if their many trials and errors help the second generation to succeed and generate faster returns—and if those early bets signal to the best founders that in time they should raise with you rather than the competition. But such strategies, which can be seen in crypto, for instance (take the examples of Andreessen Horowitz and Union Square Ventures), are the exception rather than the norm.
This all speaks to how Europe could position itself. It’s difficult for European investors to implement this two-step strategy, because we can’t afford to waste that much money on the first generation tackling a new challenge. On the other hand, the fact that Silicon Valley tends to neglect businesses that take time to take off creates a clear opportunity to disrupt Silicon Valley. Europe can focus on those industries in which returns are large but take longer to generate.
8/ There’s definitely a scenario in which Silicon Valley becomes more of a financial hub rather than a startup ecosystem per se—a kind of Wall Street for the Entrepreneurial Age:
Not all companies founded in the 20th century were located or even originated in New York, far from it. But it became the hub for financing them all (with places such as Chicago and Dallas as secondary hubs). Silicon Valley could become that: not the place where you start your company or locate your employees, but rather the place where you go to access the big-time financiers.
While more and more resources, notably talent, are now redistributed outside of Silicon Valley, capital is prone to remain concentrated there. It’s the resource for which liquidity is the most critical. And the numbers of those working in finance are quite low, with those lucky few clearly being the most tolerant when it comes to the cost of living going through the roof.
9/ Becoming a financial hub, however, takes a willingness to innovate when it comes to financing businesses. Just as I was reflecting on that, Alex Danco published a compelling article on the growing diversification in financing entrepreneurial ventures:
There used to be a time when any tech startup had but one way of raising capital: pitching a VC, getting them to agree, and then having them in the company’s cap table. But now there are many segments of the market (from SaaS to consumer goods) that lend themselves to debt financing rather than equity financing. Because revenue is easier to predict and therefore securitize, we’re witnessing the rise of non-dilutive ways of financing tech-driven businesses.
Thus the question becomes: will Silicon Valley make the switch from venture capital and venture debt to more diverse ways of financing businesses? It seems like a necessary step if it wants to secure its position as the global financial hub for the Entrepreneurial Age. But then again, this kind of innovation could happen elsewhere, from New York to Salt Lake City to...Europe?
10/ Finally, there’s one more wrinkle to consider, showing adverse selection at work: it may be that startups that stay away from Silicon Valley and raise less capital will best succeed in the long run. There are two angles:
As tech companies are more and more hybrid, the average returns to scale are likely to slow down in comparison to pure software businesses. It will make it impossible for most startups to generate the returns that VCs expect when they throw a lot of money at them. And once they understand that, the best founders may well decide to skip Silicon Valley altogether and to deal with financiers who better understand their particular needs.
The other angle was recently discussed by venture capitalist Elizabeth Yin. There are some founders whose background, personality, behavior, or lack of network make it more difficult for them to raise money from Silicon Valley-based VC firms. At first, those founders seem to be at a disadvantage. But the fact that it’s hard to raise venture capital forces them to be more cash-efficient and, in the long run, more innovative. Kai-Fu Lee has described this pattern in his masterful AI Superpowers: In China, the winners are not those who raise the most money, but rather those who manage to be the most cash-efficient. Likewise in Europe, we tend to lament our lack of the financial hub that Silicon Valley has been becoming. But maybe, as once remarked by my former colleague Emilie Maret, this is a European founder’s strength: it feels harder at first to grow a startup here than in Silicon Valley; over the long run, however, cash efficiency is rewarded and thrift gets its revenge.
Are these opportunities more Silicon Valley-based VCs are willing to seize? Some are already experimenting, as documented here and here. It won’t be easy, as I wrote here while suggesting a few tips. But it would only be logical: if Silicon Valley becomes the world’s financial hub for the Entrepreneurial Age, then it needs to not miss out on financing Europe-based ventures.
Please scroll down for a comprehensive reading list on the future of Silicon Valley.
👩 My colleague Salomé Taieb joined us a few months ago to take care of our community of investors and to make smart introductions that benefit everyone involved. It's not surprising, though, that she noticed something quite quickly about the angel investing world: its lack of women. With my cofounder Alice Zagury, CEO of The Family, she launched Madrinas, a community of women wanting to come together to learn from one another and invest in startups. She wrote about their first workshop here: Actually, there are women ready to invest in startups.
🧠 One of my cofounder Oussama Ammar's favorite topics is the brain's relationship to learning, especially how to do it better, how to do it faster. He wrote about a few of his favorite techniques here: Yes, You Can Train Your Brain.
📕 The release of the French version of my book Hedge, titled Un contrat social pour l’âge entrepreneurial, is imminent: you’ll be able to buy it from every French or online bookstore starting on February 19 🎉 Also, you shouldn’t miss the second edition of the related Les Jours heureux seminar that we’ll have at our Paris office on Tuesday, February 25, where I’ll discuss the challenge of building a new social contract in Europe while the US and China are racing (way) ahead. Is there a European way of accomplishing this? Or will we have to comply with either the US version or the Chinese version of a social contract for the Entrepreneurial Age? Click here to register 👉Entre les Etats-Unis et la Chine, quelle place pour un modèle européen à l’âge entrepreneurial ?
Here are more readings about the future of Silicon Valley:
Peak California (Byrne Hobart, Medium, March 2019)
Some More Reflections On Silicon Valley (Sarthak Haribhakti, SarHaribhakti’s Newsletter, April 2019)
Reinventing Financial Services (me, European Straits, May 2019)
At What Stage Should You Invest in European Startups? (me, European Straits, June 2019)
Can you build a unicorn business outside the Silicon Valley? (Elizabeth Yin, August 2019)
The Founding Murder and the Final Boss (Alex Danco, Two Truths and a Take, September 2019)
US venture capitalists: here are 10 tips if you want to make it in Europe (me, Sifted, December 2019)
The Social Subsidy of Angel Investing (Alex Danco, Two Truths and a Take, December 2019)
The next silicon valley won’t be in the US (Joe Schorge, Quartz, December 2019)
The Circadian Rhythms of Silicon Valley (Eugene Wei, Remains of the Day, January 2020)
Silicon Valley Abandons the Culture That Made It the Envy of the World (Alexis C. Madrigal, The Atlantic, January 2020)
Social Capital in Silicon Valley (Alex Danco, Two Truths and a Take, January 2020)
Wall Street Battles Upstarts in Hunt for Silicon Valley Rich (Sophie Alexander and Cristiane Lucchesi, Bloomberg, January 2020)
The fragmentation of venture capital (me, Sifted, January 2020)
It's an interesting time of bifurcation and money (Elizabeth Yin, Twitter, January 2020)
Debt Is Coming (Alex Danco, Two Truths and a Take, February 2020)
The US VCs are coming to Europe (Amy Lewin and Sam Shead, Sifted, February 2020)
From London, UK 🇬🇧