The Ignorant VC as counterpart to the Ignorant Entrepreneur

I decided to fully republish a great post by David Woodward that was fuelled by an interview we did together but which captures the views I previously developed here better than I could express them.  Hope you enjoy !

A few days ago, I had an interesting chat with Fred Destin, Atlas Venture's ebullient technology partner. Atlas bought a stake in the property website Zoopla at the beginning of 2008, which wasn’t exactly a fun time to be involved in the property game. It was also a pretty difficult period to source capital in any sector—all in all an investment climate fit to make even the coolest of VCs twitch. Destin, who has a seat on Zoopla’s board, adds that at that stage, his firm’s investment was in “two people and some PowerPoint slides”, hardly an invulnerable guarantee of success.

It is often said of European VCs that they lack the gumption of the Sand Hill road mob—the kind of formalised chutzpah that turns garage upstarts into grade A businesses. European investors, it is said, need data, data and more data, followed by proof of concept, before they are willing to stump up any capital. And to some extent that remains true. But Destin added an interesting spin.

The problem with European investors, he told me, was that even when faced with unmistakeable proof of concept, they tend to undercapitalise, thus hampering their investment’s ability to scale to its full potential. Put it this way: not many US VC's get accused of undercapitalising a potential winner.

He also did a great job of making early-stage investments sound very much like sticking it all on red and preying to the gambling gods for clemency. Destin says he actually prefers working with unknowns. He says:

“Our job is to manage risk proactively. We don’t think about it as a casino at all. We scrutinise and think about it very hard. But it’s our job to take these shapeless risks. I am early-stage, my natural DNA is around early-stage. It’s tough to make investment decisions without much data, [but] that’s what makes it exciting. Your average market practitioner does not how to deal with that level of risk. You take data away and they panic.”

Conversely, Destin says he revels in a vacuum of information.

“I profess ignorance and I use that as a tool. I can assess market attractiveness. I can assess the management team. We then make absolutely no assumption as to what’s going to work because if you do, you lock yourself into a strategy that you haven’t [yet] proven. You tend to be internally led rather than market led. This is where the risk may seem inconsiderate because you’re willfully declaring ignorance about the market you’re addressing.”

But ignorance allows you to

“…force yourself to be smart. You use what you know in terms of company building, supporting entrepreneurs, discovering the market. We will design the product around what the market needs with an intuition, but then we’ll go and test it. We don’t want to be smarter than the market we are entering.”

And here’s Destin’s view on Europe’s investment weakness. There are, he says, three stages involved in readying a start-up for potential greatness:

“At Atlas we call it ‘prove-build-scale’. You spend very little at the prove stage. You have 6-15 people, spend as little as you can proving the hypothesis. The build stage is [about] scaling up the management team, adding talent, putting in place the technology you need to accelerate. Only when you’re ready can you understand how to scale properly, go into a big investment round and hit the accelerator.

“I think that Europe usually fails on the third category: we tend to undercapitalise the businesses that are doing well. And this is where we get a competitive disadvantage to the US. They have a tendency to overcapitalise early, but when they scale they scale well because they are able to raise repeat large rounds of money to really capture an opportunity.”

[Republished with permission, authored by David Woodward, an Awarded Alien who also writes at Director]

Comments

[Farhan Rehman]

I'm wondering if perhaps it's this ability to follow one's intuition that is also a key differentiator between the European and US VC marketplace. Where in the US everyone likes to 'overpromote' themselves, and sell themselves more than they might be.. In the European marketplace perhaps our conservatism provides us with a way of being more in tune with a slightly wider, more diverse marketplace?

Personally, I think perhaps Europe needs more VC's willing to invest more at an earlier stage, to support startups here in a way that VC's do in the US, if indeed they are 'over investing' as you suggest.

[DavidSmuts]

Fred, this is a great article by David Woodward. I get the Director but haven't seen this article published there yet.

You do know you stand out a bit, in your ignorance is bliss theory. If I were a VC I would be behaving exactly the same way (at least as far as early stage is concerned)!

I think the difference between US and European VC behaviour is more stark than just the Series A over-funding vs under-funding behaviour. By and large European VCs tend to follow the market, whereas US VCs (at least the Big names) tend to take more risks in venturing into new markets.

There are very few European VCs backing with sufficient capital, new market concepts. They'd much rather back another Twitter, iPhone or Facebook app or Spotify clone than they are to back something which is unfamiliar to them. In this regard, they'll wait for a US VC to take on this risk and prove a new market exists.

As I'm getting to learn more about you, I gather you take a different approach. Good for you, and good for the companies which you partner up with!