ambit ventures white paper

1 Copyright Ambit Ventures LLP, 25 Harley Street, SW1G 9BR, London @ 2013

A new model for VC investing in Europe by Daniel Stachowiak, Managing Partner, Ambit Ventures

Summary In this white paper we argue that the European VC industry needs to change its modus operandi if it is to continue catching up with the US equivalent – it needs platform investors, which provide a suite of non-‐investment services to its portfolio companies. This strategy should work particularly well in new EU member states (“New Europe”), which have emerged as a source of innovation with global potential but lack the social infrastructure to scale fast beyond their boarders. The best place to run such an operation is London, which should become both the Delaware of Europe as a place of choice to incorporate start-‐ups and the premiere European tech hub. Investing in tech in New Europe should offer returns seen in ‘emerging markets’, but should offer lower risk due to the ‘EU membership dividend’ – ability to borrow mature institutional frameworks for corporate governance and easy access to a rich internal European market.

It will take a highly entrepreneurial and multi-‐ethnic VC management team to take advantage of this opportunity, which is not without risks. We at Ambit believe that we have built the team that has what it takes and are now ready to engage with Limited Partners.


The New Model for VC investing in Europe We believe that the days of investing only in those start-‐ups that are within an hour’s drive from one’s office are gone. Good ideas can come from anywhere these days because of the dramatic fall in tech infrastructure prices and the democratization of access to that infrastructure. This makes the job spec of a VC much broader than before. Finding a good idea in Arizona and moving it to California is easy compared to turning an Estonian start-‐up from Tallinn into a London based European player. A new breed of VC firms is needed to do that job well. The US has something to teach Europe in this respect but only to a degree, as the EU has the additional complexity of varied cultural, linguistic and legal traditions of its members. A successful European VC needs to structure itself properly if it aims to build tomorrow’s European tech powerhouses. The “to do” list includes:

1. Assemble a team that culturally and linguistically mirrors the European countries one focuses on. We believe that it would take a multi-‐ethnic management team that speaks local languages to find and build rapport with great entrepreneurs. That is not an easy task as cultural diversity within a management team might be both a curse and a blessing, especially since teams need to last for at least a decade.

2. Build a platform of non-‐investment services. Platform investing was arguably first developed by New York’s Y-‐Combinator, then taken on by Andreessen Horowitz, and then by Dave McClure’s 500 Startups. The concept is based on the idea that a VC is much more than just a provider of high risk capital but also an agent which maintains a platform of non-‐investment service providers who support portfolio companies operationally and function as ‘shared-‐resources’. Some focus on building in-‐house recruiting and business development functions, others also include technical expertise around product design, user experience and technical architecture. There are currently no platform investors in Europe although Rocket Internet, a ‘clone-‐ builder’ showed how ancillary services benefit the speed of growth of young companies but do not replace true innovation. In a European context, the platform should include ‘internationalization services’ – ability to launch products beyond one’s home market shortly after testing it in one’s home market.

3. Use English law for transactions. Arguably, UK has the most fungible European legal system with the US, making migration across the pond and syndication of later stage capital rounds faster and cheaper. It is also important for the legal documentation to be written in English from an early stage, to simplify due diligence and cross-‐border migrations.

4. Use London as the base. To add the value mentioned above, the VC team should be well connected with high tech ecosystems. Although there are several cities in Europe which try to become the high tech capital of the continent, it is London which is most likely to win the race due to the breadth and depth of its human capital and infrastructure: from its creative and music industries, the financial district, through to thousands of active angel investors. It is also one of the most international cities, with over a third of residents born abroad and almost a quarter who are not British nationals. Silicon Valley is too competitive and too far from most European early stage start-‐ups to be a viable home in the early stages. Its image has also been tarnished by unfriendly immigration laws and the promise of entrepreneur’s visa which is still in the works. The UK stole the thunder of putting one in place making London even more attractive to those who originally set sail for the Bay area. London is not as cheap as Berlin to


live in, which is the biggest challenge for the city to keep its attraction as the best place for young, clever brains.

This strategy is likely to work anywhere in Europe, but particularly well within a subset of European countries which have recently joined the European Union, which we call New Europe. We first explain why the European VC asset class is the place to be, what New Europe is and why more capital should flow there in particular.

European VC asset class It is important to dispel some perceived wisdom about European venture success. A recent study commissioned by BVCA1 argues that Europe is no longer a poor cousin of the US in terms of various entrepreneurship and VC performance metrics. Part of the misconception had to do with a smaller track record of the European VC industry, which started later than the American counterpart. The conclusions of the study are encouraging:

a. The same vintage years produce similar results in terms of the probability of an IPO although the US is still more likely to produce a trade sale.

b. Venture success has the same determinants in both Europe and US, with more experienced entrepreneurs and venture capitalists being associated with higher probabilities of exit. The fact that repeat or ‘serial’ entrepreneurs are less common in Europe and that European VCs lag US VCs in terms of experience explains the remaining difference in performance.

c. There is no evidence of a stigma of failure for entrepreneurs in Europe.

There are additional factors that inspire even more optimism. On the start-‐up supply side, the financial crisis had the unintended consequence of pushing more and more young university graduates into entrepreneurship, who are no longer sucked in by the financial services industry. On

1 European Venture Capital: Myths and Facts; Dr. Ulf Axelson, Mr. Milan Martinovic, LSE, 2012


the demand side, the tax breaks and publicly backed funds (SEIS and EIS schemes in the UK, KFK funds in Poland for example) have provided a growing pool of seed funds that was not there even five years ago. The best years of early stage capital providers in Europe are just beginning.

What is New Europe? We define New Europe as the new EU member states from Eastern Europe: Estonia, Latvia, Lithuania, Poland, Czech Republic, Slovakia, Hungary, Romania, Bulgaria, Slovenia and Croatia (soon to join the EU). They are mostly middle income countries with the exception of Slovenia. On Purchasing Parity Basis, some are perceived as developed economics (Czech Rep., Hungary, Poland).

It is worth mentioning that there is no Eastern Europe at it was once known. During the Cold War the term described the countries between Western Europe and the Soviet Union, ruled by the Communist parties of various hues, mostly subservient to Moscow but included the mavericks of Romania, Yugoslavia and Albania. Since the fall of Communism in 1989 and subsequent expansion of NATO and the European Union, Eastern Europe quickly became an outdated and even dangerous term, as illustrated by this 2 minute clip produced by the Economist: http://www.economist.com/blogs/easternapproaches/2012/07/%E2%80%9Ceast%E2%80%9D-‐dead.

Countries of New Europe


Why New Europe?

The countries of ‘New Europe’ continue to share certain useful characteristics, which make them a particularly attractive operating theatre of an early stage Venture Capital firm. These characteristics include:

FDI patterns moving into knowledge based sectors – since 1989 one could divide the FDI flows into New Europe into three broad categories: the first wave involved the creation of low value adding assembly plants of white goods, cars and engineering products; the second wave involved the creation of BPO and near-‐shoring centres of accounting and back office functions; the third was driven by the creation of Research & Development centres of some of the most innovative global corporations (see below a list of those centres in Poland) . The FDI migration towards knowledge intensive industries was based on the observation that local labour force is relatively inexpensive but very well educated, especially in technical fields such as mathematics, physics, chemistry and computer science.


Low cost & world class programming talent, shortage of commercial talent – New Europe has a long tradition of world class education in mathematics, computer science, chemistry and engineering. University graduates with technical degrees are usually free from educational debt. Most of them choose to remain in their home countries which offer a low cost of living and high social standing. A top notch programmer in Cracow costs a third of what he or she would cost in the US, or half of the cost in London. One based in Sofia or Bucharest is even less expensive. Building tech teams and prototypes of products is therefore cheaper in New Europe than it is in America or London. The cost quality ratio is also very favourable (programmers from New Europe, especially Poland, are high up in the international programming competitions2).

The problems begin when internationally experienced commercial talent is required. Successful companies that broke out of the region managed to source western executives (AVG, Skype, LogMeIn), although finding senior management early in the development cycle is difficult and is often perceived as unnecessarily expensive by the founders.

True innovation is the only option; building local champions is a risky strategy – it is very hard to replicate the success of Allegro which built a successful ecommerce franchise across the region and managed to defeat several attempts of eBay to take the limelight. Nasza Klasa, which copied Facebook, used to dominate the Polish market but has since ceded more than half the traffic to the US giant with the worst yet to come. Entrepreneurs took notice. Copycats are seen as a naïve approach to getting rich. In the last several years the region started producing true innovation with regional or global potential. Most of those start-‐ups use their local markets to test their prototypes, some start with an English version of their products from day one. The lucky ones are snapped by better funded US companies (Ivona, Topicmarks), probably too early. Others are now looking for foreign capital partners who can help them leave the region and swim in deeper waters.

World class entrepreneurs without social capital – inspired by early high tech success stories coming out of the region (see below) and a growing cadre of world class engineering talent, New European high tech entrepreneurs are increasingly well resourced, well organized, confident, and ambitious. They lack however the social and advisory infrastructure present in California or London for that matter. The societies in New Europe, with the exception of Estonia, are under OECD average in terms of social trust3. Most still suffer from weak legal systems, which are based on Napoleonic code that limits the freedom to unbundle voting and economic rights of share classes making the job of structuring VC transactions difficult. Lawyers conversant in those structures are expensive and few and far between, the courts in turn are slow and have little experience adjudicating cases involving early stage institutional investors. Finally, there are few wealthy entrepreneurs who made their money in the digital economy. Most local ‘brick and mortar’ millionaires do not understand tech and do not speak the same language as the up and coming generation of entrepreneurs, who are left with few mentors to look up to.

2 Source: http://community.topcoder.com/stat?c=country_avg_rating 3 http://tinyurl.com/bmrusb6


Why isn’t everyone a believer in the New Model?

Dysfunctional and under-‐resourced local capital scene – Based on Ambit’s interviews with companies that raised local early stage capital, it seems that many deals that do get done suffer from over dilution of entrepreneurs leaving little room for follow on investors without the need to redo the cap table which again, increases the cost of deals. The angel networks, which effectively replaced early stage VCs in the US, are very weak in New Europe. State sponsored seed funds are trying to fill that niche although they suffer from structural problems. They are unable, for example, to co-‐invest with their peers because of legal restrictions which cap the total capital provided by publicly seeded funds that can go into a single company even across many transactions. Mistrust and little deal sharing plays its part as well. The seed funds also need to rush to spend their money which creates an artificial over-‐supply of seed capital. Entrepreneurs try to take advantage of this situtation by bidding up valuations. Those who place little value in having an institutional investor on-‐board go straight to the public market (ex. NewConnect in Warsaw, an equivalent of London AIM). Both strategies tend to turn sour when follow on funding is required. Having a mispriced and structurally complex seed round turns off Series A providers, who shy away from the region, while having a publicly listed start-‐up leaves entrepreneurs without the counsel of experienced investors as VCs cannot or do not want to invest in listed equities.

Infatuation with Silicon Valley – it is not surprising that those entrepreneurs who can, try to escape the constraints of their local eco-‐systems and go where they think they can flourish: the Bay area. Since most of them speak English rather than German and French (although the Romanians might be an exception), the US with its vast market, seems like a good choice. They are not in any way unusual about falling for the American dream. Even Western European governments commit serious recourses trying to showcase the Swedish, German or British start-‐ups in the Valley. While (still?) well-‐resourced Western countries are trying to promote their own champions, New European entrepreneurs are on their own: without the financial muscle of public coffers and a welcoming US-‐based diaspora. It is not a surprise that most of them fail – going too early in the development cycle, spending too little time there, shuttling across 8 time zones to manage their R&D teams and


families. Most are unpleasantly surprised at how competitive the Valley really is, how expensive it is to hire good people and how committed one must be to the US market to succeed there (if one gets the immigration matters sorted first). Their eyes then migrate towards London, an overlooked English speaking tech hub – where Spotify and Skype made their intermediate home having left Sweden and Estonia, respectively, to get ready for a global expansion.

Low supply of capital, hence highest expected returns. It is a well-‐known fact that Europe is severely underserved by providers of risk capital compared to the US. However, New Europe is particularly poorly served. An incremental capital provider, especially one who also offers additional “platform services”, will therefore be able to access the best available projects and will not face the pricing pressures over valuations present in more competitive markets.

Ambit Ventures We have what it takes. New Europe remains different from the rest of the EU because of its deeply rooted idiosyncrasies explained above. We believe that only a dedicated specialist team can do justice to the region. The right team would expect to produce higher returns than an equivalent Western European VC because of lower competition for deals, lower entry price, and a more robust operating environment allowing for more reliable exits.

Ambit Ventures has already built the team, the advisory board, the investment processes and part of the platform required to implement the strategy described above. We have already started investing as an informal angel syndicate. We are now launching the fund raising effort of our dedicated New European Tech Fund. We welcome the opportunity to discuss our ideas and approach with potential limited partners and other interested parties. If you would be interested in learning more about our team and approach, please do get in touch.

Daniel Stachowiak, Managing Partner, Ambit Ventures [email protected] +44 7792970679

ambit ventures white paper

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