The Coasy world of UK Venture Capital

Over the last week there have been a number of interesting thoughts on the Startup Venture Capital market. Three stand out to me, and I think there is a thread emerging here:

Firstly, Fred Wilson (A VC) on a discussion about industry and company structure and the impact of transaction costs (ie Coasian Theory) on business structure, and thus their funding:

...it's not surprising to me that the Y Combinator model is being adopted and adapted by others. Last summer my friend Brad Feld helped sponsor TechStars in Boulder Colorado and a number of interesting startups have come out of that program.

I was at a meeting recently where a University was considering starting a venture fund to back companies coming out of their school. I encouraged them to look at the Y Combinator model for inspiration and suggested that they back 10 teams at $25k each instead of one team at $250k. Two reasons. First it's hard to know who will get it right, by backing 10 opportunities instead of one, you vastly increase your chances of success. And second, you can get a lot done on $25k now, particularly if you back young software engineers right out of school (or even in school) who can live for at least six months on $25k.

Secondly, a post by Mike Butcher on TechCrunch UK today on the future of European VC's made this point about the state of play in the "Equity Gap" range of c £250k - $750k:

we are seeing the rise of the “super angels”. These are often former entrepreneurs who’ve had a big exit from their startup and now consider themselves to be potential investors. Some are good at this, some are, to be blunt, crap. But the shrewder ones are guys like the Samwer brothers (European Founders Fund) or the ex-Skype crew at Atomico.

The theory is that these ’super angels’ are going to come to the aid of startups who need seed capital just as it gets harder to kick seed out of the bigger VC houses.

But the alternative view is that super angels are a “blip”. That they are following the “spray & pray” strategy of investing in what’s hot at the moment, haven’t done it for long (3-4 years) and they are post-bubble anomalies who won’t last forever

Thus there may well be an appetite now for some form of investment diversification / trading market.

Thirdly, an interesting post from Sarah Lacy (yes, that Sarah Lacy), who has been in London this week and noted that the startup scene, well:

....there's no startup "game" here like there is in the valley that continually sucks you back in, whether you want it to or not. so success doesn't necessarily beget success in the same way it does in the valley.

i'd heard before that was a factor of entrepreneurs not sharing the stock option wealth-- so you don't have the story of the secretary going to work at google and becoming a millionaire that makes every secretary want to work for a startup. i still think that's part of it. but for alastair it all seems to come down to this issue of a "scene."

amid startups in london there is no "scene"-- there's not a place where you go and see the same people regularly. it's not as interwoven into your entire world. he sees internet people once a week, maybe, outside of work. there are some cliques (like the lovely one that kept me out until 3 am!)-- but no larger scene where the cliques combine and interact. (i realize now i used the word scene in my bleary eyed 3 a.m. post...."clique" might have been better.)

I can identify with the clique thing, but I think the reason is not just cliquey people (though there is certainly some of that), but also the "where" thing - London is a huge city, most of Silicon Valley's CBD is about the size of a small UK city or large town (albeit more spread out). There is so little chance of "bumping into" someone other than at the few conferences every year. Coffee Club, Tuttle Club and various other approaches have been tried over the last few years but there really is no aggregated scene.

Anyway, the gist of this is a thought that is beginning to go around my head - in essence if:

- Coase's Law is restructuring the economics of the start up supply chain
- UK angels are becoming more interested in diversification of investment
- There is no real coherent structure in London among the funding community

Then it seems to me that some form of "Incubation 2.0" model may be very useful - using the lower structural costs of the modern supply chain, based perhaps on the lines of a Y Combinator model, which acts as a physical hub as well as a funding diversifier.

How would this work? In my mind is something like the following:

- Funders put money into pooled fund
- Small startups apply for funding, but its in small amounts and in tranches. Contracts are simple, understandable and standard.
- Funders get a share in each one accepted equal to their % invested
- At some point in the funding cycle, as it reaches that point each company's shares become tradeable on an "AngelDaQ" of sorts. At this point, Founders can also liquidate some of their shares, thus minimising somewhat the lousy game theory of the Founders Discount

Just a thought at this stage, but the few entrepreneurs I have spoken to really liked the idea so far.

Update - Umair Haque has been fairly forthright on some other implicit issues in the current Coasy World of UK funding:

There’s little turnover in the actual pool of venture investors or venture funds, especially relative to the pace of innovation. And, that, in turn, means that the venture industry is fast becoming an old boys club: one big boardroom mostly full of guys with the same perspectives, beliefs, and incentives.

And so what's happening isn't surprising. The dynamics of old boys clubs are almost deterministically predictable: they fight tooth and nail against risk, against the radical, against any kind of change to the status quo. They're great at "monetization" - cutting deals - but the last thing old boy's clubs are good at, unfortunately, is sticking up, come hell or high water, for innovation. From music, to publishing, to food, to autos, the outcome of locked-down boardrooms has been innovation stifled and suffocated.

What business are venture investors really in? You may disagree with me – but I think they’re in the business of creating new industries, markets, categories, and value chains. The problem with risk-aversion and cronyism is that investors end up creating exactly the opposite: low-value services and features. Is it any surprise that there's a lack of economic interest in those?

While I have certainly had thoughts like this on very rare occasions ;), I also know from experience that managing risk is non trivial - my thought is more on the lines of Eric Beinhocker's view, ie to force neutral market competition early, and to help to increase the "Darwinian Gene Pool" early on, and thus create an Entrepreneurial Ecosystem that is economically rational by exposing it to a semi-liquid "AngelDAQ" Prediction Market early

(Just a quick aside here - Sarah Lacy also noted that:

no idea if this substantive or just anecdotal, but whenever i get written up in techcrunch in the US i get a flood of pownce,(yes, pownce is still around) facebook and myspace requests. after i was written up in techcrunch UK, i got more direct emails, twitter followers, and linkedin requests. surprising low myspace or facebook ads for the footprint they're supposed to have in the UK.

Now Sarah, I was one of those who pinged you, but have yet to see an answer - and here's a thought as to why imho we prefer the more "chatty" media - in the UK we kinda expect you to reply, people don't really "do" the Faithful Follower thing that well )