In 2006, the majority of London’s tech startup scene could fit into a “Internet Peeps” dinner and the closest thing we had to Campus London was Adam Street library. Nine years later though things have changed completely. Little seedlings like Huddle and Skimlinks have grown into full blown companies and both the quality and quantity of entrepreneurs has exploded. But one thing that’s barely altered though is the number of entrepreneurs that have exited or companies that have been acquired.
There are now many quality companies and many excellent teams but for various reasons the exits aren’t happening. This is not a sustainable situation. Each company is a roll of the dice, each one an experiment, you have to experiment a lot of times to be right and exits are the funding that pays for that experimentation.
Exits are not gifts for doing well though, they have to be fought for and they are an essential ingredient in a startup ecology. Entrepreneurs don’t get them as a reward for being in the top graduates of their incubator. London’s “Tech City” will not be giving them as a reward for being a top hub in Europe. Acquisitions are the moment when, with five people holding your back and your face in the muck, you get the ball across the line anyway. They are points not prizes. Acquisitions will not be awarded, they need to be taken and if London doesn’t start taking them soon it’s tech renaissance will be extremely temporary.
The Tech City initiative, the government’s SEIS scheme and the £440M-funded Technology Strategy Board have angled themselves to help with this.They have helped incubate young companies and de-risk small investments. They’ve helped put players on the pitch. Now, though, the game is in play and startups need to start scoring.
Some games are harder to score in than others and for UK startups it is not going to be easy. Silicon Valley is built on many strata of technology-focussed acquirers. The M&A teams that do such acquisitions often include entrepreneurs who were themselves once acquired. The cycle of startup life is buried deep in their psyche. Those teams don’t travel far to spend their cash and they tend to buy people they know. In short, Google’s and Facebook’s M&A teams won’t be dropping many $30M or $100M cheques on UK startups; for that we need to look closer to home.
Our startups and their potential acquirers are not as well acquainted as those in San Francisco though. Our technology companies were built in a different era, in different industries by people of different generations. Our technology acquirers are places like Vodafone, ARM and Autonomy. The people in those companies don’t mix with the startups of Shoreditch or Hoxton and I have never heard of a single startup with angel funding from their executives. If they are going to start buying our companies we’re going to need to close that gap.
The government’s current efforts have been well-meaning but need a change of gear in order to have any impact. Enticing Californian companies to put sales offices in Tech City creates about as much long term growth as call-centres do in Bangalore – even if some of those offices will have engineers. The SEIS scheme is well-intentioned but with its £150k cap it has the ironic effect of undercapitalising many of the startups who qualify. And while the Technology Strategy Board has a vast annual budget of £440M, that money is so inaccessible that I know of people who make their entire living consulting on how to apply.
In short, the efforts to-date are well intentioned but are more superficial than meaningfully effective. Tech City could genuinely grow into a billion dollar, fifty-thousand job, technology centre but that’s not going to happen via tax relief on £150k investments. It’s acquisitions (and ultimately IPOs) that will inspire investors and entrepreneurs and which will graduate Tech City from being an temporary press event into to an actual industry.
How could the government help make acquisitions happen? One simple way is literally to match-make startups with acquirers. Meet and mingle entrepreneurs with M&A teams and CEOs. Tech acquisitions are extremely people-focussed: companies are buying teams and it’s hard to spend $30M or $100M on a team you don’t know. The first step of an acquisition is to build a relationship with the acquirer and to find out what they even want. In San Francisco you might meet the M&A guys from Google or Facebook at parties or conferences. That’s not true in London though. I’ve been here on and off for seven years and never once met anyone from an M&A team. Simply matchmaking founders with the people who could buy them would be a huge leap forward.
Dating helps grease the wheels but you also need to push the train forward. Tax breaks for acquisitions could be one way to get things rolling. The UK government puts £440M of funding into the TSB each year. If even a fraction of that were used to incentivise UK PLCs to start buying it would massively accelerate the growth process. £150M of acquisitions would have the most incredible impact you could imagine on the startup scene. Spread that across five acquisitions and you would would create more new entrepreneurs, startups and investors than a decade of SEIS grants.
Such an accelerated market would be undoubtedly frothy and some of the acquisitions would be misjudged; some would even be a complete waste of cash but such is the nature of Silicon Valley M&A too. I’ve got a friend who sold his company to Google for $10M; the project was shut down immediately and the entire team left, fully-vested a year later. It was strategically pointless for Google but he’s a better entrepreneur for it and has since made several angel investments.
Focussing on exits may seem like little more than handouts to hipsters but nothing could be further from the truth. It is entirely self-interested. The risks and returns in startups are totally different to those of normal businesses. Startups will burn millions of dollars and there are are little or no assets left when they go wrong. Startups will dissolve the war-chests of investors and those of the LPs that fund them. Only a fool would fund such ventures without proportional returns. If those returns aren’t there then only fools will remain. If you want great companies you need acquisitions.
Make acquisitions happen and the investors will follow, the jobs will follow and in eight to ten years the IPOs will follow too. This is exactly what I saw happen in the years since selling my company after it was invested in by YCombinator.
The photo above was taken after our YC demo day in 2007. The young people you see in it are all first-time entrepreneurs, none of them experienced and many of them just out of uni.
In the six years since it was taken, those same entrepreneurs have sold more than eight companies for a total of over $200M. Many are now on their second or even third startup. Some like Ian and Michelle of Songkick or Daniel and Jason of Disqus are still running the tremendously successful ones they started back then. Third from the left at the back, you’ll see Drew Houston and at the front in the middle between me and Jessica: Arash Ferdowsi. The plugin they wrote that summer was called Dropbox and at their last valuation was worth $4Bn.
However, even in Silicon Valley, a dearth of exits means a dearth of startups. In 2007 the best companies in our class got valuations that were only a fraction of the most mediocre of today’s YC startups and it took most of us months to raise anything at all. Much of the excitement that heats today’s frenzied demo-days comes from the millions of dollars released by those early entrepreneurs’ exits and the many others that followed them.
The more the British government and Tech City can use their powers to help match-make startups with acquirers, to incentivise UK companies to buy startups and to inject those acquirers with fresh teams of talent, the more the scene will stabilise and flourish. Acquisitions beget acquisitions. Seasoned entrepreneurs and investors beget more entrepreneurs and investors. As those things happen the density of good companies will increase and we too will start to see the emergence of billion-dollar superstars like AirBnB, Dropbox and Facebook.
If we make the acquisitions happen, the investors, engineers, jobs and IPOs will all follow. If we don’t put our balls across the line though we will will lose the right to stay in the tournament. Without exits the next generation of entrepreneurs and investors will go back to the city and make Power Points or buy properties like so many before them. Unless exits start happening soon, Tech City will turn out to be little more than an over-hyped Reading 2.0.