VC Perspectives

Isn’t it ironic. One on hand, VCs stress the importance of building great companies and on the other hand they want to discuss potential exit paths even before they have invested.

This slightly schizophrenic situation is according to my experience pretty correct and I’ll try to explain why:

At Creandum we don’t believe in building hype companies or quick flips. We will only invest if we really really think that we can help build a great company.

And great companies are bought, not sold. This means building a company that has a sustainable business model and can control its own destiny and thus preferably choose the timing for either an IPO or a trade sale.

This takes time. In our study of 300 Nordic technology exits, the average time from when the company was founded until there was an exit was close to 10 years and increasing over the last 5 years.

So why are we talking exit scenarios with entrepreneurs even before we have invested?

It is important that the entrepreneur is aware of that eventually we need to sell our shares (usually this means a trade sale of the company). It is sort of an acid test that the founders are at least thinking through what it means to bring on a VC.

Another aspect is that talking about potential exit paths actually is a really good way to understand the market dynamic and the value chain. It also helps us to learn if the entrepreneurs have a good grasp of what value they can add to the value chain and if we have the same view.

Specific questions could be:

• What position is strategically most important in the value chain and why
• Where will existing players move and what will this mean
• Is there a risk that we’re heading towards a position where there will be fewer exit possibilities
• How could our business model or sales strategy affect the value of the company (e.g. licensing out technology vs product sales; perpetual license vs monthly subscription)

Some of the above questions relate more to competitors but often entrepreneurs omit the long-term competitors that lure in the background (e.g. Google, Microsoft etc) or get stuck in discussions about what the competition can do today rather than what they will do tomorrow. As these companies however often are thought of as exit candidates it is sometimes easier to have meaningful discussions from the exit perspective to understand the drivers that can make them competitors as well as acquirers.

Finally, we believe strongly in establishing a joint ownership plan between all owners (founders as well as investors). As such, it becomes inevitable to talk through various exit scenarios. Are we aiming for an IPO? What’s the time frame, what needs to be achieved? What strategic decisions might affect the company value? What capital requirement do we think we will have in building the business? All these questions are tightly connected to questions about exit expectations and are very useful to talk through already during the investment period.

We have just finalized an investment in the Norwegian software company It’s Learning. This is the first investment we’ve done since the summer of 2009 so we’re really excited about finally getting the deal in place.

It’s Learning is one of Europe’s fastest-growing software companies and a leader in the LMS (Learning Management Systems) sector for the educational sector with millions of users in Europe and the US.

There are several reasons why we decided to make this investment.

First of all, they have a very strong team led by a Arne Bergby who’s a serial entrepreneur and an experienced company builder.

There’s a lot happening in the educational sector and the transformation to web-based tools for digital learning is accelerating. The Nordic region together with UK & US are the leaders but many other countries are starting to jump on board as well. It’s a pretty fragmented market with a few large leaders with international presence and lots of small local vendors. However, as with many software companies, you need scale to be able to keep up with the heavy investments in product development so consolidation is already ongoing and will continue to take place.

We also really liked their product and product vision. It’s Learning has focused hard on building a great product that is easy to use and supports the learning process of students instead of only focusing on administrative tasks. What is also very clever is that they have built a very open system which allows users to easily plug in 3rd-party products like social media tools, Microsoft & Google products, and external educational applications.

It’s Learning has a very attractive business model. It’s a Software as a Service model with a subscription per user which enables high level of recurrent revenues and great scalability combined with pre-payment contracts.

The investment was done together with Norwegian venture capital firm Viking Ventures.

Tomorrow I am joining a panel discussing where Nordic venture capital will be in 25 years. The reason for this is not by any means that I would hold the answers, but rather that at least there is chance that I would actually still be around in 25 years. And although the time frame of course is ridiculously long (especially considering how young the Nordic venture industry really is) I have put together some thoughts on the topic.

On a very high level, I think there are a few general areas that will determine how successful venture capital will be in the next 25 years:

Good entrepreneurs & companies to invest in

Most important area and I think this will improve in the next 25 years. The situation today is better than 10-15 years ago. More people are interested in entrepreneurship. Founders are the new rock stars. There are more serial entrepreneurs with experience & capital to build new companies. People have more international experience & exposure. Eventually regulation will improve (even politicians will realize that we cannot rely on old, large companies or public sector for growth & job creation).

Exit market

There will always be good and bad times but I think the landscape will change. The default exit route for larger exits of Nordic companies have by default been to US or maybe a local IPO, but given time India and China will become more active acquirers also of tech companies (they’re already active in traditional industries). But it will still take time, companies in these countries don’t have the experience of US firms to acquire innovative, fast-growing companies and initially there will be lots of failures.

I also think that there will be a diversification of exits. Unless a company is riding the hype-curve optimally, it will be difficult to get large exits (> €100M) without significant revenues. This will most likely mean that it will take longer to get to a big exit. On the other hand, there will continue to be plenty of tech exits w/o significant revenue picked up for their technology or products with good multiples for investors if they didn’t invest too much. This is something investors must adapt to.

Financial markets

Usually there’s financing for good companies as well as top-performing VCs. But general access to and the price of financing will go up & down. Maybe we won’t see capital ever being as cheap again, but I still don’t think that there will be long-term major changes in the coming years.

Better VCs

It takes time to build good companies but also to build good venture investor teams. We need to learn from mistakes and also find the right mix of senior, experienced investors and young, hungry go-getters. With venture capital being out of fashion, there is plenty of risk that the venture capital industry is being hacked before it has really matured.

Threats

For Nordic venture capital, I see a few threats:

• Increased regulation - politicians seem to have a hard time to understand the difference between valuation arbitrage and value-creation and are now on a rampage to regulate anything involving risk & investing thus pushing hedge fund-related regulation on to venture capital.
• Lack of critical mass - the Nordics is a small market and there are definitely areas within the eco-system where there are just too few professional investors. Also, the gaps between various type of investors are sometimes too wide meaning that companies get stuck or die on the way.

My bet is that there short-term will be a continued shake-out of institutional, classic VC-firms with the Nordic region as an important focus. However, the ones that survive will mid-to-long term have improved performance. I also think that there will emerge other types of investors to cater for the needs of a complete eco-system.

Finally, a note on what I would like to happen within the next 25 years.

Firstly, I am convinced that the best way to create a good venture capital industry is to provide the best possible framework to build great companies. This means more favorable regulations for startups & founders, promotion of success and acceptance of failure, and tax-incentives for angel investments. This is more important than the regulation / conditions for venture capital companies.

Secondly, I hope that VCs can really prove their worth for good companies. The role of the VC is not only to provide financing for companies that otherwise would die or never get off the ground, but more importantly to be considered a natural choice as part of creating great companies.

Tech Tour Nordic is an event that tries to bring out the best and most exciting Nordic technology (defined as pretty much everything except life science & bio tech) companies to an audience of local and international investors. Our experience is that it is definitely one of the best opportunities to present your company wether you’re looking for money now or in the future.

To register, please visit the Tech Tour website

We’re really happy to announce that Johan Brenner has joined our team. Johan is an experienced entrepreneur and investor in technology and growth companies.

Recently, he worked as a General Partner at Balderton Capital (previously Benchmark Europe) and was involved with Nordic and European investments such as LiveBookings, Habbo Hotel, Rebtel, Zopa and others. Prior to joining Balderton, Johan has been involved in building several successful companies as an entrepreneur, investor and board member, such as Jobline, E*Trade Nordic, DIBS and Tradera.

A few week backs I spent some time in Boston and New York with fellow Nordic VC colleagues meeting US investors, VCs, entrepreneurs and academia. It as a great week and here are some thoughts and remarks from the trip.

The state of VC

In general, the views on VC is pretty pessimistic. As in Europe, US investors and VCs are debating the poor returns from VC during the last 10 years: on average, VC returns have been zero or worse.

There are several explanations to the situation, the most common one being that there’s just been too much money injected into the VC market. Many VC firms grew in fund size and many average VC firms received lots of capital as well (the total amount of yearly VC investing doubled or tripled from mid-90s to mid-00), while at the same time the IPO-market has been much worse compared to the boom years.

Most agree on that what will happen is a healthy readjustment with fewer, smaller funds & teams and total VC investment levels down to what they used to be before the millennium.

There’s also self-criticism on behalf of how the VCs have been investing, throwing money at companies to grow (too quickly) and get a quick exit. Now, the VCs are now even talking about finding capital efficient companies.

Capital efficiency

Maybe not something you would expect to hear from US VCs; it is often said that European VCs are not providing enough capital for the companies early enough but there’s definitely much more focus on investing in capital efficient companies. Or as Axel Bichara at Atlas Ventures put it: Prove-Build-Scale.

The LP (VC investor) perspective

The classic VC approach is to have a few home runs providing the returns and cover for the bad ones. However, this approach has meant high volatility (how much the returns fluctuate) with a few good exits creating almost all positive returns. So when the exits weren’t as many and as big as before and the failures increased, it became difficult to get consistent, good returns. From an investor perspective, this creates a problem because they want consistent, good returns. As a result, LPs are more and more appreciating stable returns and fewer failures which few VC firms have provided, alas LPs’ appetite for VC has gone down.

Dare to invest early

I was surprised to find that most of the VC firms we met (large, top-tier funds) still are doing early-stage investments, even seed investments. The problem is normally that when you have a billion dollar fund, it is hard to justify small, early investments because of time and resource aspects - it is more efficient to invest large pools of money at the same time. So it was very encouraging that the VCs are still regarding it important to continue to do early deals as well.

Terms

A typical A-round is 1x participating liquidation preference where the VC invests x dollars on x pre-money valuation. This means that the VC owns 50% after the investment, the founders 30% and 20% is usually allocated for options. This is quite different to the Nordics where VCs typically would own less after the first financing round and where much lower amounts of shares are allocated to options (partly due to tax issues of course).

Here’s a good article about what’s wrong with the venture capital.

The Seedcamp season is in full swing with events happening around the world. For the Nordics, this year’s event is held in Copenhagen May 27.

One of the mentors at the New York event was Jonathan Klein, co-founder of Getty Images who presented 10 tips on how to build a great business. And one of the participants was Emi Gal, CEO of Brainient, who wrote about Jonathan’s presentation here.

There are plenty of very good advise from Jonathan; from a Nordic perspective I would particularly like to emphasize point 3 & 9 as these are oftentimes much more important than one might think and really critical when scaling up an organization.

Here’s the list as noted by Emi:

1. Raise more money than you think you need. If you’re on to build a large business, dilution doesn’t matter anyway. You’re in the business of minimizing risk.

2. Cash is the only thing that matters. That should be your focus. Create an automated, scalable business model that will generate cash.

3. Invest in your company’s culture. It works as a filter for making small, easy or complex and tough decisions.

4. The two most important things in your company are: your employees and your customers.

5. Be honest, transparent & realistic. Especially with yourself.

6. Decide fast. It’s better to be wrong and fix it than sit around for 3 months and miss on opportunities.

7. Wrong decisions are OK. As long as you’re wrong really fast!

8. Focus, focus, focus. Say NO to stuff. Constantly.

9. LEAD. People are crying out for leadership. Know where you’re going, and they’ll follow. You can find Jonathan’s leadership principles here.

10. Have fun every day. “Sometimes it’s even black humor“, he said.

If you’re interesting in getting some data points on European and US venture capital for 2009, it could be a good idea to attend FutureMoney in Helsinki on February 18. The event will be chaired by Mikko Suonenlahti from Growth Management Ltd.

VCs usually use various forms of preference shares when investing. As an entrepreneur, it is important to know what this means since it will affect things such as how proceeds from an exit will be distributed.

Through Fred Wilson, I found this good link to a description of how VC terms affect the proceed distribution in various cases. Here it is.

Larry Cheng at Volition Capital keeps a VC blog registry sorted by popularity. Good source for adding new blogs to follow.