Hackers and Startups

The Berlin TV Tower, centre of old East Berlin, harbinger of the new Metropolis


I was in Berlin to give a talk at the O'Reilly/Web 2.0 2008 Web Seminar on the risks of Freeconomics (see here) and at the time felt that it was a vibrant place for art, culture - and technology startups. So much so I spent the weekend there mooching around.

This trope came back again a few weeka go at the FT conference when the Soundcloud team (Swedes) found Berlin to be the most happening place in Europe, a mix of Silicaon Valley and Punk culture. And now here is another interesting article on the subject - Bloomberg:

Things began changing as several Berlin startups scored funding from international sources. In 2010, SoundCloud, among the scene’s biggest success stories so far, received funding that included a $10 million infusion from New York’s Union Square Ventures and Switzerland’s Index Ventures. The service now boasts over 12 million members. Other hits include Wooga, Europe’s largest developer of online social games, which last May announced a $24 million investment led by a Massachusetts VC firm. In November, Atomico, the London-based VC firm of Skype co-founder Niklas Zennström, invested $4.2 million in 6Wunderkinder, a maker of productivity apps.

Encouraged by all the interest—and the money—many Berliners have gotten startup fever. The Berlin Chamber of Commerce reports that 1,300 Internet startups have been founded in the city since 2008, 500 of them last year alone.

Vorsprung durch Technik, as they say...

So, a technology springtime in Berlin. One thing is for sure, it is a hell of a lot prettier than London's Silicon Roundabout. And cheaper.....

From TechCrunch itself - AOL has issued the following statement:

“The TechCrunch acquisition has been a success for AOL and for our shareholders, and we are very excited about its future. Michael Arrington, the founder of TechCrunch has decided to move on from TechCrunch and AOL to his newly formed venture fund. Michael is a world-class entrepreneur and we look forward to supporting his new endeavor through our investment in his venture fund. Erick Schonfeld has been named the editor of TechCrunch. TechCrunch will be expanding its editorial leadership in the coming months.”

But Mr Arrington is still hosting TecgCrunch Disrupt, it seems - interviewing Doug Leone from Sequoia among other activities. But as to the new Arrington vehicle, startup fund Crunchfund, even Seqoia is pointing out its a me too in the Bubbletimes - from PEHub:

Asked by Arrington if Sequoia would squeeze a new fund like his out of a round while it’s working to help shape a young entrepreneurial team, Leone said no, that if an entrepreneur thinks that “CrunchFund has a differentiated set of skills that will help you, then by all means” take its money. (It wasn’t exactly a ringing endorsement.)

Pointing out that too much money is already chasing startups, including from Europe, Russia, and the likes of Goldman Sachs, Leone then told Arrington, “You’re joining the abundant side of market, instead of the scarcity side of the market…Why you want to join [the world of venture capital] is beyond me.”

Mind you, Seqoia is itself not too pleased about the rise of the dumb money tide:

Leone tried to be diplomatic about all the cash sloshing around Silicon Valley these days, but it clearly irks Sequoia that the firm – along with all venture firms – has been painted as a later-stage investor by many seed and angel entrepreneurs, despite that it regularly makes seed investments.

Indeed, Leone said his advice to entrepreneurs is to “think of investors as your business partners” and not just in terms of “what you need over the coming months but over the next four to five years.

The role of the incubators, accelerators etc etc is to now manufacture enough startups for all the sloshing money to be thrown at. Maybe the next Arrington business should be a Y-Crunchinator?

Eric Schmidt laid into British IT education today - BBC:

"The UK is home of so many media-related inventions. You invented photography. You invented TV. You invented computers in both concept and practice.

"It's not widely known, but the world's first office computer was built in 1951 by Lyons' chain of tea shops. Yet today, none of the world's leading exponents in these fields are from the UK."
Television transformed

There are 3 reasons for this - economics,entrepreneurialism,and education

The Economics is simple - the US is a far larger homogenous market, so any company that starts to get momentum there can grow far larger than a comparable British one. The usual plotline is that British companies either Go West (eg MicroMuse) and becomeamerican or get bought by Americans (eg not-so-Autonomy). The Commonwealth - the engine that once allowed British companies to grow larger than the home UK market - is gone and the EU, with its polyglot cultures and (often subsidised) local heroes - is a far tougher prospect to expand into.

The Entrepreneurialism issue is well known too - study after study shows that the barriers are higher for startups in the UK than the US - less money available, ,unVenturous capital, tougher labour laws, more business red tape. The only things on our side are that we speak a reasonably understandable dialect of American and our conditions are still marginally better than most other Western European countries. The US gets a Silicon Valley with universities and an ecosystem, we get a Roundabout as a PR wheeze with a contraflow.

And then there is Education. Schmidt said he had been flabbergasted to learn that computer science was not taught as standard in UK schools, despite what he called the "fabulous initiative" in the 1980s when the BBC not only broadcast programmes for children about coding, but shipped over a million BBC Micro computers into schools and homes.

"Your IT curriculum focuses on teaching how to use software, but gives no insight into how it's made. That is just throwing away your great computing heritage," he said.

Its more than that though. In the UK, Engineering and Science have always been lower class things. In every other country I have worked in or lived in (and that encompasses Europe, US, Asia and Africa), being good at Maths and Science are hugely respected abilities and parents agonise about how to improve kids skills at these subjects. Engineering is a registered profession like Accounting, Law or Medicine.

And then I fly back into the UK and its like being on another planet. The guys that fix my boiler are Engineers. Universities are warning (my) teenage kids that ICT and Computer Science are not seen as a "real" subjects for University entrance - rather do (say) Geography and Chemistry. The way to get ahead is still the Oxbridge PPE (Politics, Philosophy and Economics) rather than the Sciences. The thinking man (and woman's) airwaves are more full of Luvvies than ever, often giving technology a good kicking en passant. The Luddites seem to have have won. PhDs in Physics and maths Tutors in Universities get paid a less than Bar owners, never mind Accountants or Lawyers. Quids (or lack of) Est Demonstratum.

I think Schmidt had it right when he talked about a "back to Renaissance Man" necessity (albeit Victorian ones):

"the UK needed to bring art and science back together, as it had in the "glory days of the Victorian era" when Lewis Carroll wrote one of the classic fairy tales, Alice in Wonderland, and was also a mathematics tutor at Oxford"

In the US when I go to a magazine stand there are lots of publications on Science and Technology, in the UK there are more on faux metaphysics and (typically very British centred) history. That is the difference.

I think there are things the Government can do to help all of the 3 areas, but the key is to do them holistically. No point in making a big deal of maths and science and computing in Education if the job outcomes are crap, or if companies starting in the space can't get money/cant take on subsidised rivals/strangle under the red tape.

But Eric's right too. A start is making damn sure that the top Universities can't get away with the attitude that ICT and Computing are not "real" subjects, whereas say Georaphy and Chemistry are. It'll need some reforming of the syllabuses I'm sure, but it also needs some knocking old attitudes out of heads.

Spotify is being sued for alleged patent infringement already - Techdirt:

just a couple weeks after entering the US market (finally), Spotify is being sued by PacketVideo for patent infringement. I knew the name PacketVideo sounded familiar... and then I remembered. A decade ago it was considered one of the hottest startups on the planet for trying to figure out ways to do streaming video on mobile phones

Now its not that their patents are probably any use, you understand, that is not the game - but by threatening a lawsuit it delays Spotify, costs them a lot of money and hassle....and thus creates an opportunity for PacketVideo to be paid to go away:

Once again, we see patents being used as a tool to shakedown companies who were actually innovative in how they executed, with a ridiculously broad patent that contributed zippo to the actual state of the art.

This is big business in the US now, in fact ex Microsoft CTO Natan Myrhvold's company Intellectual Ventures is dedicated to buying and enforcing such patents (and more - it tries to create patents around emerging areas, not for use but for the purpose of suing others). There was a rather good program on This American Life in the US last week on this issue:

"....people at companies that have been approached by Intellectual Ventures don't want to talk publicly.

"There is a lot of fear about Intellectual Ventures," says Chris Sacca, a venture capitalist who was an early investor in Twitter, among other companies. "You don't want to make yourself a target."

Sacca wouldn't say if Intellectual Ventures had been in contact with any of the companies he's invested in.

"I tried to put you in touch with other people in this community to talk to you about this and they almost uniformly said they couldn't talk to you," Sacca told us. "They were afraid to." IV has the power to "literally obliterate startups," Sacca says."

The irony is software patents have emerged despite the US Patent system supposedly not being allowed to patent algorithms! The US is trying to reform this now, but the proposed changes are deemed to be inadeqate and would come too late for Spotify anyway.

They'e just waitin' for the Shakedown....

EarlyBird Report saying that European VCs have better results than US ones (see above presentation), but I think it is misleading - as GigaOm points out,the reasons are not necessarily great for European entrepreneurialism:

Because venture money is scarce in Europe, on the other hand, companies have to compete harder for funding — which keeps the value of investments down. At the same time, it also means that VCs can cherry pick the very best investments and focus on backing real winners — which keeps their hit rate high. It’s a combination that creates a more efficient ecosystem, for investors at least.

This is encapsulated by a quote in the report from the head of Deutsche Bank Private Equity, who says that “European venture capital is a cottage industry characterized by an insufficient number of private investors with the capacity and willingness to invest in venture capital, mainly due to past disappointments and the resulting lack of confidence which still inhibits the European venture industry today.

I recall looking at this issue for McKinsey in the mid 1990's, and I don't see that - big picture* - much has changed. Its still the same cottage industry propelled by the laws of niche markets, but not maximising the total entrepreneurial potential value in Europe, just the returns to VC investors. The truth is that a startup is still more likely to get funded in the US, and get a higher valuation and more money.

What I have never understood is why the market hasn't become more competitive, and its still not even economically efficient as it is not maximising the total potential surplus from European entrepreneurialism - if it were a real "Free" VC market in Europe then nearly everything with a positive possible return would be funded - and some real turkeys of course.

The outcome is usually that European companies eventually go Stateswards or get bought by larger, faster growing US ones, and there is a dearth of European champions. For the European VCs its great, for Europe's own wealth creation, less so.

A more efficient market - definitely (within the narrow definition used). A more effective one - probably not.

*By this I mean that even though it has changed structurally, from an outside point of view - as an overall industry sector - it still quacks like much the same duck.

Rather interesting talk by Marc Andreessen at D9 (as reported by Liz Gannes) - some nuggets:

If you look at the history of VC, the best firms were generally formed by operators. Over the years, there have been many different kinds of VCs, but we thought it would be kind of fun to go back and do what they did at the beginning.

We’re a throwback in two other ways. We’re focused on computer science and technology, and we’re overwhelmingly Silicon Valley focused. As far as we can tell, we will always be a single-office firm based in Silicon Valley. We think SV is special because there’s a repeatable process for building great companies.

Interesting observation - but I'm not sure they are quite a Back-to-Basics VC, as so far - if you follow the money - they have been investing big money in dead certs quite late in the pre-IPO game. More like Private Equity investment in (soon to be) Public Enterprises.

On Bubbles:

If everybody’s euphoric, then I’m concerned. “If we’re back here in three years and nothing’s changed and nobody’s worried, I’ll be horrified. I’ll wet my pants on stage.” There’s no history of an equity bubble that has not affected the public markets in a major way. Read “The Go-Go Years.” Fast-forward to today, in 2011: Apple’s PE is 12, projected to be 10. Microsoft’s is 7.2, next year 6.8. Google 13.7, next year 11.3. Cisco 7, next year 5.5. “PEs in single digits are what steel mills trade at before they’re going out of business.”

Maybe, but those are not the BubbleCo's - Google, Linked In and other Social media operators are where the bubble is, most with stratospheric P/Es (or virtual P/Es from secondary markets). Marc is quoted as saying "there is no bubble because everyone thinks there is one" elsewhere, but that is not how I read the above. I read it as saying there is risk of a bubble. I think Henry Blodgett is calling this more correctly now, and he should know....

....in 1999, there was actually lots of talk and concern that it was a bubble. But having lived through that one, I'd say there was actually less then there is right now. And the real challenge for decision-makers in that era, by the way, wasn't in determining whether or not it was a bubble--many smart folks thought it was. The challenge was in figuring out when the party was going to end. Because if the bubble lasted longer than you thought it would--which, by 1999, it already had--it didn't really matter whether it would eventually prove to be a bubble or not: You'd have been "wrong" and fired long before you got to do your victory dance.

This is what I believe is really going on in these funds' calculations, and Andreessen is in a roundabout way corroborating that.

And on dotcoms being a predictor of great Web 2.0 startups:

I just had this out-of-body experience where I saw someone reading on an iPad in the lobby and I had a flashback to the Newton. I’m quite confident that there are things we’re funding now that will be great 10 years from now.

Here’s my prediction: Almost every dotcom idea from 10 years ago that failed will succeed. Pet food, diapers, deliveries, they’re all working again now.

Probably true, for any pre-2000 company anyway. A lot of the dotcom ideas before the "end of days" lunacy were sound ideas but failed from a combo of too few customers, too thin bandwidth, not enough functionality in the infrastructure and too high a running cost. Much of this has changed hugely for the positive now.

Long time readers of this blog will know we have been covering research on the underlying system dynamics of what really drives successful startups in a quantitative way. We have always thought this was a good idea, and today we look at the output from the Startup Genome project (WE covered a similar idea, YouNoodle, in 2008). They have just released a report (more details over here), herewith a summary of their initial findings (with Broadstuff comments in italics):

1. Founders that learn are more successful: Startups that have helpful mentors, track metrics effectively, and learn from startup thought leaders raise 7x more money and have 3.5x better user growth.

As Darwin noted, survival is not the “fittest” but those that are most adaptable


2. Startups that pivot once or twice times raise 2.5x more money, have 3.6x better user growth, and are 52% less likely to scale prematurely than startups that pivot more than 2 times or not at all.

Must say I found this initially counterintuitive, then I realized it represents a startup going up the learning curve of “playing the game”and giving investors what they want to hear


3. Many investors invest 2-3x more capital than necessary in startups that haven't reached problem solution fit yet. They also over-invest in solo founders and founding teams without technical cofounders despite indicators that show that these teams have a much lower probability of success.

See comment to 2 above – also adds credence to what I have long suspected, ie that investors by and large don’t know what they are investing in, and that “the great team” of VC lore is just so much bollocks.


4. Investors who provide hands-on help have little or no effect on the company's operational performance. But the right mentors significantly influence a company’s performance and ability to raise money. (However, this does not mean that investors don’t have a significant effect on valuations and M&A)

In other words having respected backers begets other respected backers, but the “we provide added value” story is overplayed


5. Solo founders take 3.6x longer to reach scale stage compared to a founding team of 2 and they are 2.3x less likely to pivot.

Many brains are better than one, and there is probably also just a pure work cycles thing – but what is missing here is the founder payout, ie does the slow-to-build solo founder do better financially?


6. Business-heavy founding teams are 6.2x more likely to successfully scale with sales driven startups than with product centric startups.

i.e if your product is techie, you need techies at the top……


7. Technical-heavy founding teams are 3.3x more likely to successfully scale with product-centric startups with no network effects than with product-centric startups that have network effects.

……and similarly techies by and large don’t get the sales techniques necessary for selling network effect services


8. Balanced teams with one technical founder and one business founder raise 30% more money, have 2.9x more user growth and are 19% less likely to scale prematurely than technical or business-heavy founding teams.

This really rings true with my experience in startups and large company initiatives, techies tend to gold plate the thing and thus miss a market, sales guys tend to forget that you can’t gold plate a turd. There are only 2 key things a business must do – produce something and sell it. Clearly in the early days getting that balance is key, we tend to forget that Bill and Steve would not be where they are today without Paul and Woz.


9. Most successful founders are driven by impact rather than experience or money.

I think this is another way of saying materiality – if you are going after a big thing, even a small success (which is far more likely than a big success, unless you genuinely find a seam of gold no others can see) equals big numbers


10. Founders overestimate the value of IP before product market fit by 255%.

Perhaps, but the history books are full of entrepreneurs being ripped off by all sorts of weasels, from IBM and NCR 100 years ago onwards. Paranoid is probably good for survival


11. Startups need 2-3 times longer to validate their market than most founders expect. This underestimation creates the pressure to scale prematurely.

I recall the first book on starting a business I ever read, decades ago. .It said work out your “realistic” worst case costs and timescales, and double them, then add 50% contingency. Plus ca change……


12. Startups that haven’t raised money over-estimate their market size by 100x and often misinterpret their market as new.

See points 2 and 9 above – having done market research and market entry strategies for many startup businesses, I think it is absolutely true to say you don’t know who is swimming in your pool until you get in. Also no plan survives contact with the enemy (the market), so see 1 above.


13. Premature scaling is the most common reason for startups to perform worse. They tend to lose the battle early on by getting ahead of themselves.

It is a very old truism that it is as easy to kill a business by growing too fast as by decline - it can rapidly outstrip its meare resources (cash, human cycles, ability to grow).


14. B2C vs. B2B is not a meaningful segmentation of Internet startups anymore because the Internet has changed the rules of business. We found 4 different major groups of startups that all have very different behavior regarding customer acquisition, time, product, market and team.

An interesting assertion - our experience is that B2B Enterprise 2.0 problems are by and large the same as Enterprise 1.0, ie it is about basic business dynamics. Comms is a part of this, but it is not the biggest part except for specific cases. In our view B2C has so far been far more impacted by the internet.

...to fund startups, are going upmarket - Dealbook:

Angel investors were increasingly active in 2010, with total angel investments going up 14 percent to $20.1 billion from $17.6 billion in 2009. But angels were more risk averse than they were in the past, investing in fewer seed stage companies.

Given the huge increase in "startup kickstarting" (dare we call it all a bubble? - see point 4 here) one wonders who will fund all the startup seeds being sown. Anyway, the data suggests that VC maths is still a 33% game at this level (for every 10 funded 1/3rd work, of those 1/3rd, about 1/3rd make a great return, and the overall ROI is 1/3rd):

Mergers and acquisitions were about 66 percent of angel exits, while bankruptcies were 27 percent of exits in 2010. About half of the exits were at a profit and annual returns were 24 to 36 percent.

i.e about 1/3rd of startups will be profitable (and traditionally 1/3rd of those will do really well)

Today the Daily Torygraphs process for winnowing down the Tech Startup scene to the Top 100 bore fruit, and here they are - we wish them luck (they're going to need it - anticipated success of startups is in the "less than 20%" area). But I was re interested in a parallel post on the Torygraph about the "Equity Gap" funding as that to me is one of the two main drivers of success. Quouth Kolvin Stone and Giles Hawins said Torygraph:

Whilst publicly VCs maintained a commitment to the early-stage market, this was not being borne out in practice - although recent signs suggest this is starting to change.

This gap in the funding market has been filled by business angels, or more formal angel funds, that, though having shallower pockets, have become a more frequent source of funding. A number of entrepreneurs who have made their money are now re-investing in start-ups, either through formal funds (such as Notion Capital, Passion Capital, Pro-Founders and Atomico) or personally. This is a relatively new phenomenon for Europe, but something that has fuelled Silicon Valley’s success for some time. This trend should continue as we see more European entrepreneurs achieve exits over the coming years.

We are now beginning to see the return of venture capitalists to early stage investing (although it has to be said that the definition of “early stage” differs in Europe to that in the US). From our own deal flow observations, it appears that many venture capitalists are using a “barbell strategy” – investing either at the very early/seed stage at one end or writing large cheques for growth opportunities at the other. Whilst many venture capitalists have rolled out a seed programme, this approach is still evolving and has not yet been standardised: some venture capitalists prefer using debt some equity and some will use either.

Our colleagues in the US are still seeing higher valuations than we are in Europe, and on better terms, with US companies more likely to get funding at an earlier stage. European investors are still demanding to see evidence of revenues, or traction, before they invest, even at an early stage.

This lower funding/more evidence of success required in the UK maps to what I heard at a BIS session on the New VC Paradigm last week at the BIS - in fact when I was impertinent enough to suggest the somewhat long and involved cycles in European funding may be simplified I was rapidly swatted away for my impertinence (Ditto another questioner who wanted to know how creative businesses could be more easily funded in the UK). But this is the literal Million dollar question for these startups - who shall fund them so they can grow quickly enough to win vs the early and well funded US rivals?

One of the issues driving the Input is the Exit - as the Torygraph article notes:

Unfortunately, we are still seeing few exits in Europe in either M&A or IPOs. Compared to the US and Asia, the IPO market for technology companies in Europe is challenging, but there does appear to be some promising news with the recent floats of Betfair and Ocado. Our client Sequans Communications SA, a company backed by Kennet, ADD Partners and Serena Capital, has recently announced its intention to float. While this is notable for being a rare example of a European tech IPO, it is even more notable for being the first listing of a French company on the New York Stock Exchange for more than ten years.

One development in respect of M&A is the rise of the management buy-outs. As technology companies become more mature, private equity will increasingly become a source of liquidity for venture capitalists.

Umair Haque would say that selling to yet another Equity Provider is a hallmark of a Ponziconomy. While I wouldn't go that far, it is clear that the funding cycle in Europe is not really optimum yet. I have great hopes of the StartupBritain campaign, but so far it seems to be more about money-off coupons for digital picks and shovels (and Snake Oil) than trying to change the basic economic structures to increase the probability of success.

Overall, all the glamour around startups is wonderful, but it is all still largely window dressing over the key issues in the UK as the Government withdraws a lot of the assistance that used to be available - it's more difficult to start and run a small business here than in the US, funding is less and comes later. UK entrepreneurs need and deserve a more integrated national strategy (after all, apparently these people are going to create all these extra jobs in the Coalition Plan) - so here's hoping a grander design emerges.

Broadstuff Exclusive - Following the kick-off of Startup Britain, the UK's Venture Capital community has decided to help by announcing a 20% off deal for all funding rounds for New Tech businesses that apply for funding in April. Responding to frequent complaints about the "Equity Gap" and the oft-times difficult-to-fathom funding process, Nik Shylock of Venice Merchant's Fund said that VC's understood the problems as they were also human:

"We VC's have eyes, we have hands and passion, and we eat the same food, have the same diseases and live in the same place as entrepreneurs. We are human - if we are pricked, we bleed too. If we are tickled, we laugh too."

The terms sheets are due to go up later today, but we understand that in principle the VC will value your business, decide what they want to put in, and then give 20% extra for the same level of ownership dilution. They are also changing the way they prioritise what businesses to fund - Phin Barnum of B&BC:

"Normally we look at the team and see if they have run a business before for 20 years, we look at whether someone in the US is already running a similar business for validation, and we see if the business up for funding is making revenue and profits before we fund it. After all, you don't want to take risks with Venture capital. However, for April we will make an exception and look at how disruptive the idea is, the market potential, and whether the idea can be shared with as many others as possible"

There is a catch however - the application proposals have to be filled in today. Responding to criticism that the process of funding can be quite byzantine, members of the VC community collaborated with Government Dept of Business form design User Experience experts in designing a simpler form. Forms can be requested from info@vc.com, but we have put a copy on this post.

Entrepreneurs have welcomed the move. A straw poll we conducted this morning at Silicon Roundabout suggested 67% were in favour, 23% were against, 10% were "Other" and 9% didn't understand the question. Richard Sugar, founder of social mobile location-augmented reality m-commerce game platform Boooooodl said:

"This is a great day for Startups. Usually, if you have to put a proposal together on a Friday its quite hard as it needs to be done before you go to the pub and everyone gets wasted, but the form is so simple we can do it on the iPad while the intern gets the first round in."

Phin Barnum agrees - "It's a tremendous win for Entrepreneurs in Britain" he says "It seems like there is a new startup being born every minute"

Broadstuff's take is that one should always beware of those bearing gifts to geeks.