Whilst in Arrakis

The Future Will Be Better Tomorrow

Month: January, 2012

The golden age of Angellist

(This article appeared originally on Kernel Magazine under the name “The Age of AngelList“, this is the original draft which is very much NSFW. The final article had some minor corrections that have not been fixed here.)

THE GOLDEN AGE OF ANGELLIST

By Rodolfo Rosini, Storybricks CEO

TL;DR version: UK tech investors that avoid seed stage funding (i.e. almost everyone AFAIK) are going to be losing out on the most exciting investment opportunities after Facebook goes public. A $100bn IPO will create an incredible pool of seed money that will be showered onto wiling entrepreneurs.

A bit about my experience in fundraising

Golden shower

Where you raise your first round of venture funding matters as you are going to develop in that area. Your management is expected to move there. Some of your investors will follow on in later rounds if you are close, they will usually syndicate with their networks and can hook you up with local key mentors and employees.

I raised money in October for my new new thing, Storybricks [1]. While searching for funding I hustled pretty hard on AngelList [2] (at one point I could access the entire database of investors) and through my personal network. Ended up raising a seed round from a syndicate of Israeli, French, US and British angel investors thanks to AngelList.

As I am planning to go for another round of funding soon, I was re-checking the database the other day and saw how many new investors have added their profile in the last four months. To my surprise the number of angels was through the roof, or at least seemed so. Yes, some tech clusters like New York or Berlin are growing significantly [3], but the list of angels in SF Bay Area… it goes on forever – and – oh my God – it’s full of stars!

It takes one only 10 minutes to follow everyone with a chequebook in the UK on AngelList. But what about the SF Bay Area angels? I have been adding people to my follow list over the past few days in-between emails and calls and still no idea when it ends (Update: I checked the actual number after writing this, it’s at least 2,300 investors and I have just followed my 1,050th angel).

And this is when it starts to get interesting

As I was reading their profiles I started to notice a pattern: they were in groups. Either they had invested in some cool startup that exited and made great returns, or a company that made a killer IPO employed them. Google, BEA, Netscape, Oracle, Salesforce etc, they were all there. Like a lot of them.

Then I started observing former employees of newer companies, like people who sold their companies to Twitter and Zynga and left long ago with a wad of cash. And then – imagine what might happen this year! – Zynga’s shares lockup will end on May 29th, Facebook is rumored to go public in April (if so, the lockup should end in October 2012). Twitter is still private but gingerly trading on SharesPost at $34.50 a share [4]. Goldman Sachs made a list of 30 tech companies likely to IPO soon and most were based in the Bay Area. There is a healthy secondary market for cool consumer startups since all the action is moving away from public markets. These are truly exciting times.

All this made me realize how screwed UK VCs are. Let me explain.

I have been fundraising on both sides of the pond and have been speaking with many UK angels, many of whom either did not know about AngelList or were like (actual quote): “Oh, yeah, heard about it. But it’s an American thing, isn’t it?”

And this from people who are seeking to invest in early stage and that should know better.

Silicon Valley has about $1,000 of venture capital per capita, $600 in Israel, $10 in Europe (source: DLD12). And it’s not just because there are more people or that Europe does not have a cluster. Those are silly excuses.

Want a practical example? Autonomy, founded in 1996 in Cambridge, went public in 1998, sold to HP last year for a really cool $12bn. That must have made a lot of people happy.

Cry havoc and let slip the angel investors from Cambridge!

Err… not so fast. There is only one person on AngelList who worked at Autonomy that is now an active angel and invests in “4-6 startups at $50k-$100k each a year”.

And where does he live? Well you should have guessed it by now: San Francisco.

Basically most investors are missing out as more and more startups start using AngelList (and not just for fundraising as it now has a high-quality, curated job board).

The shape of things to come

The worst of the UK venture community is few insular investors. Angel groups in Cambridge who do not hold events in London. Pay to pitch scams. Advisors who charge 5% of money raised. You get the idea. Not all is bad, but there is a lot of badness.

Alas, the positive side is pretty small. At the last count there were only eight seed stage VCs in London [5]. None will fund a PowerPoint with a killer team.

UK VCs make all kinds of noises about developing an “ecosystem” of serial entrepreneurs that can jumpstart a utopian Silicon Valley in East London with a fancier accent and a lot more alcohol. But the reality is that the money simply is not available in the UK and is not being reinvested, especially at an early stage. Sounds familiar? Yes, we have been here before. Many times. It was called the “Equity gap”. But now the problem is going to get worse.

The Facebook IPO is going to make a lot of people wealthy. Accel Partners alone are going to make 20x their entire fund (source: @bgurley). None of the other early Facebook investors have a presence in the UK. All the FB employees with significant shareholding are in Palo Alto and will probably invest locally.

There is little reason to limit yourself by raising money only in UK or the Continent for that matter. My startup, Storybricks, is a Delaware corporation (I have never been to Delaware in my life nor plan to) that owns a UK limited entity and investors acquired shares in the US parent. All R&D is based in London (yes near Shoreditch but alas we are not on the Tech City Map) and expenses are incurred by the UK entity. Since it’s 100% owned by the parent, according to HMRC rules we could issue EIS [6] share options to UK employees if we wished so.

A new startup can pack their bags and move to San Francisco for 3 months to raise capital just by using Gmail, Airbnb, Dropbox, Rapportive, Skype, LinkedIn, Kayak and obviously AngelList. US banking for startups is also so much better than in London thanks to banks like Silicon Valley Bank [7]. The second most senior person in my company actually lives in California and is a US citizen so there is no visa issue for us and that is not hard to replicate.

Moreover Tier 1 VC funds in the Valley have immigration lawyers on staff. It’s likely that immigration rules will be relaxed to allow founders to move to the US (and very importantly pay taxes there). If you follow @SteveCase and the work he is doing with Startup America to bring great entrepreneurs to the US you should be keenly aware that it’s definitively going to happen. It will become easier to start your own company in Silicon Valley. Not harder.

Unless UK venture investors can come in as first investors and add significant value they will have a hard time to survive [8]. AFAIK there are very few that can pull it off (Passion Capital is an example, but they made a boatload of great investments in 2011, and so are probably going to be quiet this year. Another example is the fund being set up by Anil Hansjee [9], former head of M&A at Google Europe. Anil’s plans are not public yet but from what I have seen it’s going to add terrific value to any investment. His fund is being structured to offer operational help on both sides of the Atlantic using his extensive network of connections. He is pretty badass.)

Down and out in San Francisco and London

When I founded my first UK startup in 2005, there were a lot of terrible VC funds, remnants of the dotcom boom that were managed by blatantly incompetent people [10]. Luckily we have moved away from that and those gentlemen went back to investment banking (or AA, or both) and accounting after selling their portfolios in secondary transactions. But a lot of investors are still too focused on risk aversion and rely on the imaginary fact that a startup can only raise money from one of the handfuls of investors in St. James or Cambridge.

While this is changing, there are still some great opportunities in London and the valuations are much lower than in SF. But it won’t survive 2012. On top of this, you have suddenly more competition from all over the world, not just Silicon Valley. Think about 500 Startups (based in San Francisco) and Kima Ventures (based in Israel), which are the most active angel investors in the world (and Kima is also the largest investor in Storybricks). Jeremie Berrebi at Kima invests in two startups per week, anywhere in the world. In some cases Kima expects to be part of the founding with just a great team and some code. And they take a week or less to decide, in some cases 24 hours. Or less.

I am really, really happy to be an entrepreneur right now. I’d be fucking terrified of having to compete with all these great funds and experienced angel investors on an early stage deal. And syndicating the deal might end up pushing the price of the deal high up thus impacting negatively future returns. [11]

Growth is limited by that necessity which is present in the least amount [12]. And right now the scarce commodity is early stage capital in the UK and people in the Valley. Who do you think it’s more likely to move: young, brilliant, tech-savvy, entrepreneurial graduates or 40yo venture capitalists with wife and kids? [13]

At the time of writing this there are 2594 2616 European startups and 577 582 London startups listed on AngelList (the numbers keep growing between drafts of this post). At least 100 of the London ones are fundraising at this moment.

Joining AngelList as an investor is difficult as it requires verification. If you are an active UK angel that is interested in joining please do ping me.

Rodolfo is the CEO/Founder of Storybricks, a startup working on an emotive AI system for online games. Previously he was CEO and founder of Cellcrypt, a mobile security company. He is also known for his near-legendary descriptive abilities and punishing insights. You should really follow him @rodolfor.

Notes:

 

[1] Storybricks is a game company developing an AI (artificial intelligence) SDK for casual users and children to make their own MMORPG (Massively Multiplayer Online Roleplaying Game) with the click of a button. As a side note, every single VC lost money on AI and MMOs so it was a very tricky fundraise. The deal was never made public but it is not a state secret either. Since we do not have a product out yet it is pretty pointless telling people we exist. None of the readers of Kernel are our target customers; this article is for entrepreneurs looking to raise money and investors who are not investing enough in seed deals (at least in my opinion).

[2] AngelList, started in 2010, is a curated community where startups and angel investors can connect. It provides a simple way of displaing information about startups, funding, teams in a standard format to make angel funding efficient and scalable.

[3] I am sure there is a vibrant investor scene in Berlin and another in Stockholm / Copenhagen / Helsinki but the UK absorbs more venture money than the rest of Europe in the same way San Francisco takes the lion’s share of US venture funding. Moreover the UK has a superior legal framework for startups (employment, share options, taxation, dealing with US taxation nightmares) and unless Germany reform their bankruptcy laws, among other things, they are not going anywhere despite the supply of cheap office space in Berlin. London/Berlin feels like San Francisco/NY. At the end of the day they are both great and flawed. There is no such thing as a “perfect” place to start a tech company. And if you like to deal with absolutes you are probably in the wrong industry anyway.

[4] SharesPost is a secondary market for private companies that exists as a result of excessive SOX regulation. US households invest a larger part of their savings compared to the UK in the public markets but post-Enron regulations made it impossible for smaller startups to go public early. All action has moved onto the private markets as tech companies go IPO now only after their growth phase is over. Apple went public at $1.7bn (-ish) in 1980 [4.1], which would be around $4.5-5bn today. Microsoft went public at $1.5-2bn in today’s money. Compare with Groupon ($17.8bn) Zynga ($7bn) and Facebook (rumored at $100bn).

[4.1] Could not find Apple’s exact market cap at IPO but 16 days after it was $1.7bn

[5] Since you asked here is the list: Passion Capital, Amadeus Capital Partners, Atomico, Index Ventures, Octopus Ventures, Profounders, Octopus Capital, Wellington Partners (thanks to Imran Ghory for fact-checking these portfolios). Hoxton Ventures is still raising their first fund and is expected to seek early stage opportunities as well.

[6] The Enterprise Investment Scheme (EIS) is a tax-friendly scheme for UK taxpayers. Not enough for an entrepreneur to move to the UK but still nice. Tax breaks are easy to implement and popular with policy-makers but are not sustainable and create a culture of dependency.

[7] Don’t get me started about UK banking for startups if you do not want to see me foaming at the mouth. HSBC is singled out as being particularly shit. (Just go ahead and sue me for libel. Trying to open an account with you guys was so painful I wanted to cry. I could almost not meet payroll for the first month after getting funded, when people were at risk of being evicted from their homes. And it was not a fluke as it was the fucking 3rd time I tried to open an account over the past 10 years with HSBC.)

Silicon Valley Bank is supposed to open a UK branch in early 2012. Last time I checked they were waiting the go-ahead from the FSA. I cannot recommend them enough.

[8] Of course I am not suggesting that VC funds in the UK are going to die. But the two most important things for VCs to generate returns are dealflow (aka how many startups you screen per year) and pattern recognition (aka the ability to spot the next Google at seed stage), and the latter is more of an art. Losing access to a high quality dealflow is key, without that a fund is locked in a negative feedback that will deliver lower returns and in future hamper its ability to raise another fund and so on. Fucked in slo-mo is the scientific term for that.

[9] Disclosure: Anil sits on the board of Storybricks as an independent director. He is not an investor in the company.

[10] These VC funds were incompetent at investing in startups but not at fundraising. Most partners had backgrounds in investment banking in the City and easily raised money hoping to fleece public market investors during the dotcom boom.

[11] Even if you syndicate, if there are too many VCs in the round you will probably lose the right to follow on and will have to fight at the next financing. 

[12] Yes. It’s from DUNE, deal with it. You should really read it if you haven’t yet. Seriously.

[13] I am familiar with the research that says that the best companies are created by 37 years old and Mark Zuckerberg is the exception. But these 37 yo once were young entrepreneurs who failed and gained experience. Grab ‘em while they are young.

Random dude leaves one game company for another

UPDATE Jan 19th: Just two days after I wrote my original post, Trion announced that they have raised $85m in new funding from Ontario Teachers’ Pension Plan as well as existing investor Bertelsmann, thus bringing the entire funding to date to an obscene (and highly enviable) $185m. Despite the fact that none of the previous investor participated in the round and that no VC put money either, not a single journalist questioned the news or Trion’s execution record ($85m buys you a lot of ads). Hardly a sign of confidence in their future.

UPDATE Jan 24th: Today Trion announced that RIFT is going to be available on EA’s digital publishing platform Origin. So much for becoming a publisher, eh Trion?

So,

saw the news on Venturebeat that a Trion (they make an MMO called RIFT) executive defected for CCP (they make another MMO called EVE Online and own White Wolf). None of the companies are named after a dead dog (creepy!). CCP raised a sliver of VC funding compared to Trion but they have been around for longer.

Just wanted to share some of my thoughts, assume that I am full of doodoo because I could end up competing with both companies. Not really but we are in the same industry and it’s not always classy for a CEO to speak out about its peers (but hey ho who gives a fuck).

Basically the underlying problem is that Trion raised too much money. With that cash they were expected to release multiple games and one WoW-killer. Which obviously didn’t happen and the rifts gimmick has gotten stale as it’s not enough to justify switching costs for their users.

Recently (I am assuming, having no inside knowledge) their investors who put money at crazy valuations in exchange of exclusivity in some regions (mostly Asian media funds) found themselves without money or a game to sell. So Trion switched to making noises about being a “publisher” and the fact that they wanted to make a “platform” – obviously in order to do that they need more money and what better chance to do that than going IPO?

Basically their plan was to scam new investors to pay off the old investors. Exactly the same thing Zynga did, only they did it with much bigger stats like revenues, users and growth. But as Zynga went IPO and fizzled (last private round was at $14, went public at $10 and today closed at $9.22) Trion is discovering that public markets like growth.

Maybe I’m reading too much into this but the departure of Trion’s publishing officer signals a shift in their strategy, probably they will not devote significant resources to this rumored “publishing platform” but the reality is that A) they will cut costs and this means reducing unused infrastructure (which is already happening and they are spinning it as trial servers, yeah riiight) B) Lay off customer support and some of the live team B) possibly sell one of their games like Gazillion did to reduce overheads and generate free cash flow D) Reduce price of subscription for RIFT (happened already) so they can massage the numbers and show a surge in subscriptions ahead of E) raising more money from institutional investors, maybe publishers to keep going and aim for a trade sale or maybe still an IPO (UPDATE: lo and behold it happened two days after this post).

Either way I don’t want to be Trion or THQ right now (see $THQI stock price for lulz, unless you are a stockholder in which case no lulz but lots of tears). Late stage Zynga investors are stuffed but the company is healthy and has a massive user base and it’s unlikely to go titsup.

If your model is about selling MMO subscriptions, rely heavily on retailers for distribution, do not have mobile or social products and your company name is not Blizzard – you are all kinds of fucked. Not an “if” question but a “when” one.