Jeff Lynn, Executive Chairman and Co-founder of Seedrs.
We’re very pleased to be part of the newly-launched ‘Innovation in Finance’ series, produced by BBC StoryWorks. Seedrs is one of the companies featured, along with other notable FinTechs and our alumnus GoodBox. You can see more about this on our blog, and you can watch the excellent (if I do say so myself) Seedrs video here.
We continue to await details on the implementation of the rescue package for startups and scaleups that was announced two weeks ago. I will share them once we have them, but for this week’s note I want to talk about a more conceptual debate that came (back) to life as the rescue package was coming together.
We Must Get Out of the Tower!
In 1906, the German publisher and politician Julius Bachem wrote a seminal article entitled “Wir müssen aus dem Turm heraus!” or “We must get out of the tower!” In it he argued that the Centre Party, which was a prominent force in moderate politics in Imperial (and later Weimar) Germany, needed to move beyond its Catholic roots and open itself to non-Catholics who broadly supported its centre/centre-right views.
Bachem’s article would launch one of the most intense debates in German politics of the first quarter of the 20th century:
- On one side were those who wanted to “stay in the tower”. They viewed the Centre Party as an exclusive and narrowly-focused organisation whose goal was to represent the interests of a particular subset of Catholic Germans, even if that meant never escaping its position as a permanent minority party.
- On the other side were those, like Bachem, who wanted to “leave the tower” by making the Centre Party an open and more broadly-focused organisation. In doing so it would maintain its core political ideology but sacrifice the exclusivity of its base of support in exchange for the opportunity to be the dominant force in German politics.
Given what was to come in German politics from the mid-1920s, the Centre’s “tower” debate is now largely forgotten except by history anoraks like me.* But in my mind it remains one of the most striking examples of the tension between a “closed shop” and an “open shop” approach that beguiles many organisations, communities and ecosystems.
And so it is with the startup and scaleup world, which has long had its own version of the “tower” debate. Those who would stay in the tower see this ecosystem as a fundamentally limited one, where only a certain number of good entrepreneurs exist, meaning that only a certain number of good businesses can be started in a given period. This view in turn says that investment in these businesses is a highly specialised, and should therefore be a highly exclusive, activity. Proponents of this view may come to it from a few different angles, but there are a few common assumptions that most of them hold, including:
- What constitutes a “good” startup is an essentially objective question and is knowable (at least by the professionals) from very early on in the startup’s life.
- A startup is only worthwhile if it has the potential to produce exorbitant, return-the-fund types of returns. Anything less ambitious, even if still targeting a many-multiple return (and possibly doing so with a somewhat lower risk profile) is uninteresting at best or even gets the highly dreaded moniker of a “lifestyle” business.
- There are two types of investors: “smart” ones and “dumb” ones. “Smart” money includes essentially anyone who manages a fund, as well as a slightly amorphous and self-defined group of angels. “Dumb” money is everyone else: family offices; active individual investors who have not dubbed themselves angels; customers of the business; friends and family of the entrepreneur; and so forth. “Smart” money, this thinking goes, is really the only money that should be coming into the ecosystem. “Dumb” money sits outside the tower.
This view was the norm in the UK startup ecosystem until about a decade ago (note that I don’t say “scaleup” ecosystem because, not coincidentally, we didn’t have one back then). But gradually a movement emerged to leave the tower and embrace greater openness and diversity in the space. It came from a number of quarters: certainly the work done by Rohan Silva, Daniel Korski and their colleagues at No. 10, which sought to make Britain the best place in the world to start a high-growth business, was an important part of it; the advent of a younger generation of VCs, who came to see more value in expanding the pie rather than fighting for the biggest piece of the one they already had, helped tremendously; I’d like to think that in opening up the investment landscape, Seedrs and our peer platforms played a small part; and a number of other forces were at work as well.
Those of us who would leave the tower don’t reject the entirety of the other side’s views, but we see the startup and scaleup world as much bigger—and more expandable—than they do. We think that the number of good entrepreneurs and good businesses out there is, if not infinite, far greater than those in the tower assume. And more capital coming into the ecosystem—whether from traditional types of investors or from new ones—simply makes it possible for more people to leave jobs at other organisations and start their own ventures. All of this is based on our own set of assumptions:
- Whether or not a startup will turn out to be a good business is only really knowable once it is well into its life. It may be possible to identify hopeless prospects early on (although even that exercise can be fraught), but there are huge numbers of startups that show strong potential, and distinguishing between those that will realise that potential and those that will not is a highly subjective exercise that looks far more like an art than a science.
- The startup ecosystem is—and should be—made up of businesses at a range of points on the risk/reward spectrum. One of the defining characteristics of a startup is that it has some sort of equity story, meaning that there is a level of growth ambition that would, if achieved, produce strong positive returns for investors. But that is very different from the notion that a business is worthwhile only if it’s on the path to becoming a unicorn. There are many startups, and scaleups, that may be shooting for the moon rather than the stars, and often they are doing so with somewhat less risk. These can be very attractive investments.
- Then there is the way that investors are characterised. Rather than the smart/dumb binary, we see a much more complex picture. There are loads of good investors out there who are not professionals or self-branded angels but nonetheless are able to evaluate ideas and teams effectively and build well-balanced portfolios. There are others who are not necessarily great investors in general, but they understand a particular company or a particular team very well, and they’re able to spot the potential for success in that business when others may not. And then on the other side, there are plenty of “smart” investors who have raised significant funds or made big names for themselves but actually deliver underwhelming returns. So while no one should be investing in startups and scaleups unless they understand and embrace the risk of doing so, closing investment (explicitly or implicitly) to those who do not fit a particular profile is nonsensical.
The Debate Renews
Over the past few years, I had thought this debate was largely won. Even the sorts of people who historically would have stayed in the tower seemed increasingly comfortable with leaving it. And in turn, we have seen the UK startup and scaleup ecosystem expand dramatically, with far more good businesses than some people a decade ago would have predicted could be built, and the inclusion of capital from—and generation of returns by—a wide range of investors who never before would have been welcomed into this world.
So it was with significant disappointment that, during the discussions leading up to the announcement of the Future Fund and additional Innovate UK funding, we heard a non-trivial number of voices calling out from deep inside the tower. Some of the arguments focused on the sanctity of VC funding as the determinant of worthiness. The case was made that additional funding from the government would create “adverse selection” or even “moral hazard” by keeping alive those businesses that did not already have access to deep pockets of VC funding. And some went further, including one person who said that “there is *zero* point in giving armless people armbands and hoping they will swim,” reflecting an assumption that anyone who can’t navigate this crisis with existing connections and resources must be “armless”.
And then there was lots (and lots) of talk about how the most important thing in any package be that it not result in the government propping up “bad” firms. No one seem to proffer an idea about what constituted a “bad” firm (other than that it had not yet raised funds from a VC), and the extent to which failures are an inherent part of any early-stage investment strategy was conveniently overlooked. Part of this focus undoubtedly came from a proper concern that taxpayers’ money be spent effectively, but it fundamentally returns to the theme that there is a clearly and narrowly defined universe of “good” startups, and any business not in that universe is not worth supporting.
The voices from the tower didn’t limit themselves to focusing on the businesses. There was (and continues to be) discussion around what investors should be eligible to provide the match funding required for the co-investment scheme. Again some of this comes from the right place—ensuring that the scheme cannot be manipulated is critical—but it quickly spills into a question of who qualifies as a worthy investor, and there are those arguing that it’s a pretty small group.
In the end, we got to a very good outcome with the Future Fund and Innovate UK funding, which together take a relatively (although not perfectly) open and inclusive view of the ecosystem. And many of the voices from inside the tower have now poked their heads out to welcome the package.
But it is apparent that the tower is far from empty, and that despite the appearances of recent years, there is still plenty of demand to stay inside it. For those of us who have fought so hard to leave the tower, this means that the battle goes on.
* Although the internal debates of the Centre Party a century ago may seem obscure today, they had repercussions that continue to be relevant. One of the most prominent advocates of leaving the tower in the 1910s and 1920s was Centre Party politician Konrad Adenauer. After the war, Adenauer would play an instrumental role in founding the Christian Democratic Union (CDU) as a sort-of successor to the Centre Party, and from the start the CDU has been an inter-denominational party welcoming to those of all faiths and none. Adenauer served as (West) Germany’s first postwar Chancellor, and the CDU has governed the country—some would argue quite successfully—for all but 20 of the past 71 years.
Here are a few resources and articles I’ve found interesting over the past couple of weeks:
- From Small Business comes a long and expanding list of help that is available for small businesses for free during the crisis.
- From Fred Wilson, founding partner of Union Square Ventures, comes a blog post called “In Real Life”. Fred is one of the most prolific bloggers in the VC world, and his short and pithy posts almost always make good reading. This one provides his take on how the pandemic will impact our preferences for remote vs. in-person interaction.
- From Jeremy Liew, partner at Lightspeed Venture Partners, comes an interesting thread that makes a further contribution to the hot topic of whether, and to what extent, VCs remain open for business.
- From Azeem Azhar, entrepreneur and one of the great data-led thinkers in this space, comes a highly informative thread on cash runway. Azeem looks at recently-published survey data on startups’ cash balances but then draws some interesting some interesting comparisons to traditional businesses.
- And from Matthew Syed at The Times (paywall, sorry) comes a compelling piece (albeit not directly related to the sorts of things I usually highlight) on the effects of economic recession on mortality. This touches on the highly charged issue of how preventing deaths and maintaining the economy are balanced, but it does so with the particular perspective of looking at short-term vs. long-term causes of death.
That’s all from me for now. Please share any feedback or contributions, and I hope you all stay well and safe in the week ahead.