Reflections from 10+ years amongst startup investors
This article appeared in the December 2024 edition of Tech.Mag
I had hardly heard the term Venture Capital until I was in my late 20s. Growing up in Malta, business people are bankers, construction moguls, lawyers and accountants not startup founders or venture capitalists. I did not have first-person connections to anyone who had built and scaled a startup, nor did I know anyone who had raised millions of capital to build a business based on an innovation they had concocted. Yet, the allure and brilliance of the tech world was also catching up to Malta, software was eating the world and I had started to take notice.
In the early 2010s I was working for one of Malta’s leading financial services firms, making hay as this industry boomed locally as a corporate and tax advisor. My favorite clients by far were a group of Swiss family offices. As the appointed company secretary, I would sit in their board meetings and listen in as a team of world class experts would argue the case for a multi-million investment or acquisition of an up and coming small business growing on the back of a fresh new technology. The goal was to buy the business at a low multiple, appoint leading management and execution professionals from around the globe and within 5-8 years sell off the business at a significantly larger multiple. Rinse and Repeat.
I was hooked, it was the coolest career path I could imagine for myself (by some margin) and I did not care about anything else life could throw at me, that was going to be my future. 10+ years later, I have helped more than 100 startups raise more than $25 million from business angels as part of my first experience with a Swiss business angel group, and currently, I am part of a U.S. venture capital firm with $1 billion assets under management investing across the globe into the industry of digital media and entertainment. Whilst I am thankful and proud of my path, I honestly feel I’ve only just got started!
Lesson 1: If it ain’t risky im not interested
Tom Green (name changed for privacy reasons) was the hottest business angel in our community of Swiss business angels. Two years earlier he had sold his payments business to eBay for €20 million or so, and he was the company’s main shareholder. As we sat in our investment committee meeting, a pitch was the point of discussion, and some argued that the proposal had too much uncertainty surrounding it, even though the founders presented a world class outfit. Tom said “If it ain’t risky I’m not interested”, that is where true opportunity lies, as he led the team into an investment that required conviction and the team to go beyond mere logic and reason to underwrite the opportunity.
Business Angels invest their personal wealth into very young business ventures in search for capital gains upon its divestment 6-12 years later. The long term feedback cycle makes any investment highly risky: the founding team may break up, the market is unproven or a competitor may emerge from anywhere. When new technologies breakthrough (ecommerce, mobile, cloud, A.I. in recent years) simply tweaking old processes to new technology rarely creates the disruptive impact that turns an unknown entity into a market leader. Incumbent managers will not put their career on the line in the service of a new technology, their job is to keep their best clients happy and to meet next quarter revenue budgets, their incentives are aligned to this. Therein lies the ecosystem for disruption, and it is only the actions of the bold entrepreneur who is fully dedicated to discovering the optimal business model from a series of uncertain outcomes that can reap the full rewards of the new market emerging. Profit does not lie merely in risk, but more so in uncertainty, where the only solution is doing the thing and taking action in a form that is native to the new technology that has emerged. True startup investors focus on disruptive gains where the outcomes compound and the profits are exponential.
Lesson 2: Focus on Fit
Venture investing is a game of the 1%. It is an experience of constant “No!” with a few sprinkles of “heck Yes!”. In its most simple form, it’s a battle between optionality (or “maybe” or “good enough”) versus the conviction and discipline that is required to be great! A focus on “fitness” helps top investors dedicate resources of money and time to the right opportunities.
Fit can be categorized amongst: Founder-Market Fit, Product-Market Fit and Thesis Fit. Early stage investing often requires investment before the business has tangible and repeatable metrics, so the decision revolves around a team and dream. When our firm invested in a smart vision system for intelligent automation, we did not do it solely because we believed in the market for autonomous cars, but also because at the helm of the company was a deep tech proven entrepreneur whose family member had perished in a traffic accident. A founder with great “fit” is one that has an initial, compelling, and unique insight. Peter Thiel (famed investor) argues that a contrarian thesis (i.e, why do you think the existing players are wrong) and why you think a startup (and yours specifically) will win, makes for a great investment diligence discussion. Additionally, “Super Founders”, or founders with a previous success in a field also make for a strong component for future success.
Paul Graham (Y Combinator) says that initially founders need to build something a small number of people want a large amount. Obsession on the problem leads to deep market knowledge, and only later should the team focus on forging a parallel path into a wider market lane. Product-Market fit requires demand driven growth, in my experience, in a space that has recently experienced an inflection point across cultural dynamics, new regulatory and legislative updates or emergence of new tech. Domain expertise and insights do matter too. Without a strong understanding of the space you can’t identify real gaps and real opportunities.
Investors should be identifiable by their investment thesis, which can and should evolve over time, alongside new inflection points in the market. When an investor successfully invests into a company that goes on to dominate a market, they develop their “fit” and inherit a subtle but powerful understanding of the underlying currents in that market, the key supplier and sales marketing channels that influence such markets. Fit is identifiable both at local champion levels, amongst business angels, families and corporate investors as well as at international levels, with institutional investors or big-brand venture funds. Just like a founder should seek an unfair advantage for its product, so should an investor identify an unfair advantage for the market within which it invests. Of course the combination of these two elements is the most desirable “fit” and approach.
Lesson 3: Breaking the Meta
When humans first started transmitting images over screens they opted to do what they knew and understood, that is, to record classic theater plays in a wide shot camera angle. As more daring directors entered the fray, they experimented with new technologies and the audience experienced masterpieces in camera work like in Citizen Kane, use of computer graphics like in Jurassic Park and novel storytelling techniques like in Inception. The most significant outcomes, not only in early stage investing, occur when some people dare to be different and tackle an uncertain problem head-on and let go of safety nets.
Whilst timing the market is undefeated in terms of making profit from investment, nobody can accurately predict the future over time. It is a useless endeavor attempting to perfectly time an investment, but the best investors are well prepared to become aware of the signals leading to winds of change and incredibly disciplined at having the resources in place to make profit from the opportunity as it emerges. My experience has shown that the most prominent investors keep counsel with industry experts across various disciplines, they co-invest with others and build multi-disciplined teams with diversity across skills, age, culture and location. Investors need to be rigorous in their search for truth in order to be right and be courageous in developing their thesis in order to be alone (or unconventional). Finally a great investor must have conviction in their process so as to make a sizable investment. Being right means nothing if you have no gain to prove it!
Lesson 4: Asymmetric Bets and Power Law
The mathematics of venture capital is such that one from every 15-20 investments is successful. Additionally the one successful outcome, must be so successful that it recovers the lost investment from the others as well as renders the full portfolio more profitable than an equivalent portfolio in more traditional alternatives like stock market investing or investing in a real estate project. This transition from investing into traditional sectors like oil and gas, banking, and pharmaceuticals to technology highlights the profound impact of venture capital and innovation. If we examine the top 100 companies globally by market cap 20 years ago, a significant percentage were from traditional industries. Today, a large portion are US or Chinese tech firms, underscoring the rapid growth and dominance of the tech sector and the venture capital asset class. Unfortunately, Europe has not kept up with this transition and has failed to produce sufficient world leading tech companies to make it a tech powerhouse.
Tearing down your grandma’s townhouse in Mosta to build a block of four apartments certainly has its risks, yet the process and outcomes are known and financial forecasts can be reliably made by your local accountant. The chance of total loss is remote even though profit is not guaranteed. 95% of startups fail within their first three years of operation. Venture Capital firms invest in less than 1% of the business pitches they receive and still most of the ones they do invest in fail to live up to expectation. Tech and software is exponentially scalable, so whilst the loss may be total, the ceiling for profit is momentous. A company which IPOs at $5 billion, may have received its first seed stage check at a $5 million valuation (a 1,000x growth). In the U.S. investment hot spots, everyone knows of an entrepreneur or investor who experienced this type of outcome, so venture investing is not seen as speculative but rather an asset class. Endowment and retirement funds actively pursue venture capital strategies to great benefit (research “Yale Model” by David Swenson), a key difference in culture between the US and Europe.
In summary, the data shows that the outcome for early stage investing is dictated by Power Law dynamics. The framework to achieve this involves (but is not limited to) understanding the mindset balance between risks and uncertainty, having the discipline to focus on fit and developing the courage and systems to break the meta.
On a personal level, whilst companies in our business angel portfolio have exited at 100x on invested capital, I am yet to witness the full force of a billion dollar outcome from seed to exit. Critically however, in both my startup investing experiences I have been surrounded by people who either built or invested into such ventures. I sometimes argue that my biggest asymmetric bet was “forgoing” a couple of years of a traditional career path in corporate finance by betting on a career in startup investing which has led me to encounters with world class founders, professional elite investors and experience investing across all continents. Hopefully the future holds a first-hand true venture outcome in the short to mid-term. We shall see!
Author profile: Adrian Galea is a professional in venture capital and portfolio management for early stage startup investors. He also manages a facebook group called Malta Startup Space that inspires startup culture in Malta. For more information: www.clutchplayadvisors.com
