2008: VCs and startups get real across Europe

Over the last few weeks I have been going around talking to venture capitalists, mainly in London, with a view to trying to get some kind of forward visibility about the technology and startup market next year, especially the role of the VC in all this. A few themes emerged during these conversations, as well as some learning about the VC mindset. (Please note, this is mainly about VC issues, not seed or angel investing, which has different issues I’ll address later).

It seems that the VCs that will be successful going forward in the next year will have to be pretty nimble-footed. A few VC firms are starting to realise they have boards packed with people who don’t contribute anything to the bottom line of the firm and aren’t actually able to keep up with the fast pace of developments in the market today. If you are a startup looking for VC backing, look into who is on the board. If the board has people on it who reflect the right kind of knowledge about the broad issues of entrepreneurship and the tech market then this is a good sign. If it is stuffed with a lot of old suits who did well in the 80s but barely understood Fax machines when they launched, think again. Perhaps that sounds harsh but these are the people your personal VC contact may have to convince about your startup.

In addition VCs without some kind of connection to Silicon Valley – either a business development person or some kind of footprint – are not going to be as appealing as those without. This is not a statement saying that European VCs are bad – It is quite simply a statement of Realpolitik. If you want to know why Silicon Valley remains important to tech startups ask a French entrepreneur who just threw a massive European startup conference, Loic Le Meur. His new startup? Silicon valley-based Seesmic. (Disclosure: TechCrunch’s founder Mike Arrington is an investor).

It is also an acknowledgment that Europe still requires a few more years of great tech VCs (and entrepreneurs for that matter) to come through the system before it quite has the “compost” to create a truly amazing startup culture. [Yes, I know all about Skype being European but let’s leave that to one side for a second]. But this point applies less to London-based VCs than it does to continental Europe. Chatting to some frustrated startups in Barcelona and Berlin recently, one still got the impression that VC firms, even in some major European hubs, tend to think not in global, US or broad European terms, but in local terms. Will this startup be big in Catalonia, they might ask? Will we get traction in Greece? The VCs who seem to me to be less constrained by parochialism are in London and Scandinavia (Sweden and Finland specifically – what can I say, they just think that way). That is clearly a totally subjective viewpoint and quite possibly wrong on several counts, and I’m happy to be corrected – but it’s my impression all the same.

Please note at this point that I am on the side of people like Saul Klein and Ryan Carson who are passionate advocates of staying in Europe to do your startup. I agree with them. Quite obviously I think you can startup in the UK and Europe. But it is also smart thinking to put down feelers in Silicon Valley, that’s all I’m saying. I doubt anyone would disagree with that point.

If you are a startup, you will also want to ask questions of a VC firm about the structure of the firm. If you really want to put the wind up them, ask them what their “succession” policy is. Put simply, in the past some VC firms have become top heavy with older management who have yet to leave. The young bucks who know the market are champing at the bit to make smart investments and see their startups through to exit, but without a career path (or succession ) up the ladder they will gravitate toward other firms that offer them this trajectory. If you as a startup encounter a VC that you feel you can work with, just think about whether they will still be there in a year or so to plead your case for more funding.

Another way to make the sweat break out on a VC’s brow is to ask them if they think they are “Tier One” or not. This will either produce a clipped answer (“Yes, of course we are”) or a long winded one (“Well it depends on what you mean by Tier One…”) Either way it’s a useful exercise to get the cut of their jib.

Now, some of the issues VCs are going to be focusing on in the new year relevant to “2.0” startups are…

Advertising, despite many nay-sayers, is going to be a deeply interesting business model for some time to come. The simply fact is that there remains billions of dollars which have not been spent online, but which economic issues like the credit crunch will start to push online. Why? Because online is measurable, off-line it is not. Exactly the same thing happened in the last nuclear winter after 2001/2, it just wasn’t noticed as much. Two key aspects of online advertising relevant to startups will be video ads. The second will be targeted advertising, particularly niche advertising based on location, but which can be served across a large reach of eyeballs, often via social networks. Yes, I know this sounds like DotCom Bubble talk, but believe me when I say, I have looked into the whites of the eye of these VCs and many are utterly convinced that there remains a deep vein of advertising revenues waiting to be mined by smart startups. And if you don’t believe me just go read Paul Fisher’s blog (he of Advent Venture Partners), which has recently become obsessed with advertising.

A further theme amongst VCs next year will be Eastern Europe. There remains a deep core of technology talent in the former Eastern Bloc nations. Plenty of UK startups have made use of the great developers to be had there, and there are at least three outsourcing Web development companies in Kiev, Ukraine, for starters. And then there is Sofia (Bulgaria), Warsaw (Poland), Prague (Czech Republic), Tallinn (Estonia) etc etc. All of these nations have great people, even if the entrepreneurial culture remains at an early stage. [Note that I have not included Russia in this list. The VCs I talked to consider Russia, with 142 million people, to be its own, inward-looking market. Startups there do not need to build and scale beyond Russia, so the opportunities are different].

But the smart ‘western’ startups are finding ways of working in a pan-European manner. I have lost count of the startups I have met in continental Europe who say things like “Our head offiice is in Copenhagen, but our developers are in Warsaw, our VCs are in London and we have a biz-dev office in San Francisco”. Outside of the US, all of these people are an hour or so away on a plane (remember to carbon offset your flight though!). It is precisely this “Think Europe” attitude which I personally would like to see more UK startups take on board (I will not bother lecturing my Irish friends about this – by and large they already do it). My resolution for next year is to punch the next startup CEO who comes up to me at some event and whines about how he “can’t find any coders in Farringdon”. Get out of London for starters, and find some talent in the rest of the UK, and in Ireland (Dublin and Cork are great). And after that go East my friend, go East. (Yes, I may get punched in turn by UK Geeks who want job security, but I am afraid this is the reality of globalisation. We need to “get with the programme”). In fact, there is probably a startup waiting to be done which actually helps other tech startups who want to go pan-European…

However, if you are based in the UK, then fear not. All European companies and – predictably – all US firms come through London eventually (I will leave the arguments about the London-centric nature of VC-land for another fight) so there remains plenty of opportunity in the UK. In addition to which labour remains most flexible in the UK. Hire someone in some European countries as a full time employee and you might find yourself still paying their wages for a year when they turn out to be crap. Watch out for that.

But, the really cool thing about Europe in the broadest sense is just how much opportunity there is. It remains a deeply complex market for US companies to enter. They tend to get to the UK and then balk at going further. That means European firms have a lot of scope to be smart about building here and following whatever strategy that makes sense. Plenty of European startups have rolled out across Europe only to be acquired by a wealthy US web giant, simply because our American friends – coming from one big market – are unfamiliar with the complexity involved. And let’s not ignore the particular advantage in language UK startups have for facing in the other direction and growing fast in the US first. Always an option.

As far as the talent pool is concerned, there is also room for optimism. We are starting to see second and third time entrepreneurs coming through the eco-system now and the experience is deepening.

But let’s be in no doubt that the era of turning up to an OpenCoffee event in a loud shirt, talking loudly about “Web2” and your social networking startup for owners of three-legged dogs is pretty much over. The same goes for the guys who have a great idea marketing to Gap year students who want to blog their trip…

Luckily, the real hard-nosed people in this space don’t fall away when times gets tough, and they are about to get tougher.

As Fred Destin, VC with Atlas Ventures, says “brace yourselves for a tough 2008“. His view is that investors have done a lot of deals in the last two years and now what faces them is a period of uncertainty. That means entrepreneurs need to get tough and “make their cash work even harder.” We are not talking about a huge crash or an ‘end to the bubble’ (there never was a financial one, other than of hype), just a harder-edged reality. It’s likely that many startups which won funding at the start of this year will either get real traction in their market or start to run out of funds. Plenty of mergers and acquisitions are predicted in this case.

Destin says startups will need to pay particular attention to their milestones and align themselves with VCs who can hold their nerve when times get tricky. And there will be a lot of emphasis on revenues (as in, do you have any?). If your startup underperforms expect to get your funding starved in favour of better performing startups in the VC’s portfolio. Gulp! But there is a way out: “do fewer things better and buy yourself runway”, Destin says.

I would also tend to agree with Destin about not slamming your VCs if it all goes wrong. Yes, there are some terrible investors out there, but the best VCs know when to call time on a startup and the startup needs to recognise that as well.

But let’s not be too down beat. The great thing about the wider European economy taking a hit next year is that a lot of the chaff will fall away. In the last bubble we called these guys “B2B” entrepreneurs. In other words they go “Back to Banking” because they previously left their safe banking job to join a startup. Their departure creates space for smart people to move in and do something exciting. A little recession is no bad thing for the internet entrepreneur. Less able to fritter their time and money away in the real world, more people arrive online to swell the ranks of the potential audience. Plus office rental gets cheaper. And Europe’s base of angels and investors is likely to grow exponentially, as pointed out by Nic Brisborne of DFJ Esprit.

So to conclude: Tougher conditions, but more “real”. Still loads of opportunity, even still in the right kind of social networking applications (web and mobile) and advertising. Great things to be achieved in a pan-European sense.

So get out more, and start building those connections across Europe…