Google Ventures comes to Europe

I think this might be some of the best news for the European tech scene in a long while. Sure the new Google Ventures Europe fund isn’t the biggest, but having seen how they work in the US, I think it’s going to really change how investment works over here. There will be no thick carpets in Mayfair. No investing in stuff that doesn’t have the potential to change the world. No trying to screw founders over with funny terms.

Even better GV is truly about ‘more than money’ which I think is sorely needed in Europe and will hopefully mean that other investors up their game and start hiring more diversely. As the release says, “Startups need more than just capital to succeed: they also benefit from engineering support, design expertise, and guidance with recruiting, marketing and product management.” Amen to that.

So huge congratulations to Eze, Tom, Avid and Peter. Please do things differently. Don’t accept that startup investment has to be done the way it is now. Then we’ll really start motoring.

Tricky business: closing a seed investment round

(Also posted over on the BGV blog)

When people have said ‘yes’ to investing in your venture and you’ve agreed on the basic terms, you’d imagine things might get easier. Unfortunately it’s usually trickier than that. Seed rounds can rumble on for several months before you actually get the money in the bank and start building the business.

There are a few reasons for this, each of which you can do something about to help speed things along.

Not everything is in the term sheet — when you go from term sheet to the actual documents that will be used in your investment deal, you’ll tend to find that the wording of clauses gets a bit more complex and causes a few surprises. I think that’s proabably especially true for social ventures where there might be some wording around safeguarding the social aims. Using lawyers who are experienced with seed investment deals will help here. They’ll know how to go from standard term sheets to standard documents.

Due diligence — at seed stage the due diligence done by investors varies from fairly rudimentary to pretty officious and will often take the form of covenants where you promise that you’ve done or disclosed everything that’s in a list — some will get you to prove each thing. The way to keep this process short is to keep all your key documents organised and ready. Everything from your incorporation certificate to each contract or agreement you’ve signed. Keep them all in a folder in Dropbox.

You need a bit more money to close the round — even when you’ve got one investor committed it might not mean you have enough money committed to get to your next major milestone. If you do need to ‘fill up your round’ ask the people who have committed if they know others who might be interested. Keep your AngelList profile up to date and let the team there know you’re looking for help.

Co-ordination problems — the final reason it takes time to close a round is that there are usually quite a few people involved. Previous investors, founders, lawyers, accountants, as well as the new investors which could be multiple people if you’re working with angels. The only way around this is to be clear with everybody about the process and then overcommunicate so everybody knows what is required of them and when. Working with good lawyers will help here. There are some in London who will patiently explain the practical process as well as watching your back. If you find you get stuck, ask somebody who has been through it before. When you’re in the middle of what can seem like an interminable process, another perspective can help you see the best next step.

So there you go. Seed investment in the bank. Next week we’ll look at other forms of seed financing including what grants are available for tech-based social ventures in the UK.

When impact investment meets ethical investment

Over the last few weeks I’ve started to wonder whether we might see two trends coming together to create something new.

The first trend is the growth of impact investing (sometimes known as social investing) which aims to help create and grow new ventures that have a social or environmental impact. With investors in this group predicting that they will invest $9 billion this year, that’s a lot of ventures. It means that there will likely be a lot of big successful companies in five years time (as well as many failed attempts of course) with investors and founders who would like to exit from the businesses they create.

The other trend is increasing demand from large institutional investors for more ethical places to put their money (known as ethical or socially responsible investing). The Church of England was stung a few weeks ago and I’m sure would love to be able to put more of its money into companies that it can be sure are doing good in the world. On a much bigger scale, investors like Norway’s oil fund (worth a whopping $760 bn) are also coming under pressure to invest more ethically and large charities (the Wellcome Trust’s sits on £14.2 bn) and public sector pension funds (the Local Government Pension Fund is worth £148 bn) also have to find ways of delivering a return on capital across a portfolio of assets without causing controversy. One estimate I’ve seen says that there is £21 billion that is managed as ethical investment in the UK but I think we can expect that to grow substantially in the next few years.

The opportunity I can see is where these two trends meet. It’s for an asset manager that buys whole mature social businesses and acts as an ethical shareholder. I’m imagining a Warren Buffett like approach where companies are bought for their long term earnings potential rather than to take advantage of flux in their share price. These asset managers would most likely be private (ie not listed on the stock market) but probably provide information publicly and importantly they would have skills closer to private equity firms rather than fund managers with deep management and strategy skills in order to support the firms they buy.

I’m imagining they would be able to buy companies which are mature but don’t quite fit the current model of ‘exits’. Take Meetup or Etsy which were both funded through venture capital but also have strong social motivations baked into them — Meetup is part backed by impact investor Omidyar Network, and Etsy is a B-Corp. An acquisition by another company doesn’t make sense — if Google were to buy them, they’d probably lose the ‘community’ side of what they do — and an IPO would also be very risky — publicly listed companies are very volatile, especially when it comes to leadership (just ask Andrew Mason) and that also doesn’t fit with the ethos of the companies.

However if there was a shareholder who had a dual reason for owning shares combining getting a dividend over a long period of time and maintaining the social purpose of the company so that their own ethical stance is intact, I think that could work for everyone. The original founders and investors would get paid out and start investing the proceeds in the next generation of ventures and the new shareholders would get a stable, ethically sound return.

This of course has implications for the types of businesses that impact investors would back. In the same way as the venture capital business adapted after Sarbanes-Oxley to back companies that were ‘acquisition friendly’ rather than gunning for an IPO, if these ethical asset managers grow then impact investors will start to build companies that fit their needs.

The only alternative I can see is that we might see the growth of ethical stock markets and there’s some evidence of that happening. The two aren’t mutually exclusive, in fact they might complement each other nicely. But setting up new stock markets needs a critical mass while there’s nothing stopping a team just going ahead and creating something like I’ve outlined above. In fact, thinking about it, I’d be amazed if there aren’t people out there fundraising as I type.
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Our ordinary investments

We’re going through induction for the next cohort of BGV teams at the moment, part of which is sorting out the paperwork around our investment. A few months ago there was a bit of chat online about ‘handshake deals’ rather than complex legal contracts. Fred Wilson particularly would rather things were simple:

We negotiate a sophisticated set of documents when we invest in a company and for the most part, those documents never come into play. Many times when things go badly, we rip up the documents and decide what to do based on an honest discussion among the interested parties. When things go well, all we need are the stock certificates.

We get a few questions at BGV about why we make investments in the way that we do. Especially because we’re ‘social’ which means there are a whole range of options to choose from such as loans, revenue participation agreements or even social impact bonds.

We make £15,000 equity investments based on receiving 6% of the ordinary (sometimes known as founders’) shares in the company. We don’t ask for any preference or special rights. We don’t ask for a seat on the board. We don’t even ask the founders to draw up a shareholders’ agreement with us. The paperwork is still a bit fiddly but we try to make it as easy as possible for the teams.

Why do we do it that way? Firstly it’s the simplest and if things go well for our startups, things will get very complicated with later stage investors if we mess around. But secondly we do it because it feels right. Once we hand over the money, we have very little say over what the teams do with it. However our incentives are exactly the same as the founders because we have exactly the same type of shares as they do.

David Lee writes that ‘investors are not your friends’ and he’s right. I like his analogy of us being like fans. We’ll stick with our startups through thick and thin but that doesn’t stop us from having opinions about how they should go about getting to the top of the league. Fundamentally we’re on the same side.

Measuring your impact for impact investors

As impact investing catches on I think one of the most important things will be how the social and environmental impact of the ventures it invests in is measured.

At the end of last year, our friends at Nesta published their ‘Standards of Evidence’ for impact investing which are really helpful. Rather than trying to define all the different types of impact and setting standards (which would be incredibly difficult and I think could stultify innovation) they’ve defined different levels of collecting data about impact that they expect to see as startups develop.

It’s a bit like the way you can categorise startups into pre-seed, seed, series A etc in financial terms but with the focus on evidence of impact rather than the finances.

Here’s the short summary of the levels:

  • Level 1: Account of impact – this means a potential investee can clearly say what a product or service does and why this may have a positive impact on one of our outcomes in a logical, coherent and convincing way.
  • Level 2: Correlation – at this stage some data is being collected which show a positive impact on the users of the product or service, but it is not confirmed that the investment caused this.
  • Level 3: Causation – here we will expect to see that the positive change amongst the users of the product or service is happening because of the product or service.
  • Level 4: Independent replication – the claims behind a product or service will have been validated, such as through an independently conducted evaluation. At Level 4 we would also expect to see that the product or service can deliver this positive impact at a reasonable cost.
  • Level 5: Scaled – to reach this point it is clear that the product or service can be operated by someone else, somewhere else and on a large scale, whilst continuing to have positive and direct impact on the outcome, and whilst remaining a financially viable proposition.

With BGV we’ll accept teams that are at or below level 1 but our aim will be to help all our ventures get to level 1 by the end of the programme and level 2 by 6–12 months after the programme.

As a social venture it’s well worth getting your head around this because the earlier you start thinking this way, the easier it will be as you go along. The whole impact investing world is getting a lot more savvy and this will be one of their most important tools for differentiating themselves from one another and from more old school investors.

Why social investment is more than a fad

I’m no fan of buzzwords or phrases but sometimes there is something substantive behind them. Over the past few years ‘social investment’ (also known as ‘impact investment’ in some quarters, particularly the US) has been growing as an idea and, while I was a bit of a cynic early on, I’m coming round to the idea that it is more than just flavour of the month.

I got the chance to see Sir Ron Cohen give a couple of talks in London earlier this year. You might have seen him on Newsnight or similar over the past few months as he’s become more high profile as Chairman of Big Society Capital. His back-story is that he played a very significant role in the development of the venture capital and private equity industries in the UK and elsewhere, setting up Apax Partners in the 1970s. There’s a long list of interesting companies he’s either invested in early on or turned around using a more private equity like approach.

He tells the story of social investment slightly more formally in this SSIR article but about twelve years ago (apparently after a phone call from the Treasury of Gordon Brown’s era) he started thinking about how the approach he’d developed in financing businesses and delivering a return to investors could be applied to tackling social issues. The scale of the challenge was what interested him. He saw social problems getting bigger but charities and the public sector less able to innovate because all their time was spent servicing existing needs.

He set about proving that social investment could have an impact so co-founded Bridges and the Social Investment Business and played a role in the creation of social impact bonds that are now spreading to other countries. Sir Ronnie talks about social investment having a range of returns and for Big Society Capital he talks about an average return of 5–6%. Some people think that’s very ambitious in the current economic climate, but in the venture investment world that’s pretty low. VC funds that go fundraising would be predicting a 15–20% IRR.

Investors often talk about a ‘pipeline’ of investment. I’ve been watching this field develop over the last few years in the UK and one of the things I realised is that there’s a kink in the pipe right by the tap. As Seedcamp has done a fantastic job in solving that in for European tech startups over the past 5 years, the social investment world has to now focus on creating opportunities for the brightest and the best to start new ventures. BGV is our attempt to do that and I think it’s good that a few other people seem to be doing that too.

I think social investment will continue to grow and start to be an appealing source of finance for founders where they can see a match between their aims and those of their investors. It’s already becoming a bigger part of the investment world in Silicon Valley with many of the big names (such as Mitch Kapor) setting up ‘impact funds’. I’m sure there will be plenty of mistakes along the way but I’m pretty hopeful that the growth of social investment will be a good thing.

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Why startups did better than pasties in the budget

Amongst the maelstrom of pasty, caravan and charitable giving budget screw-ups, very little seems to have been written about what the UK Government has done on investment into early stage startups which is a shame, because it’s very good news.

The main announcement was a new scheme called the Seed Enterprise Investment Scheme (pdf) which has many similarities to the old EIS but is aimed at investing in very early stage startups (less than 2 years old, less than 25 staff and with assets of less than £200k). I went along to a workshop this week by Keystone Law to find out more. I think all the details below are correct but it’s worth getting advice yourself.

If you invest in a qualifying company straight away you get 50% of the amount you invest off your income tax bill for that year. So if you invest £25,000 you’ll get £12,500 off your income tax. Provided you hold onto the shares for 3 years you’ll also be exempt from any capital gains tax when you sell them which if everything goes well could be pretty substantial. And if everything goes wrong and the company goes belly up, you’ll get a further 28% of your investment off your tax bill (£7,000 in our example above). So, in effect, a ‘failure’ only costs you 22% of your investment — you’ll only have lost £5,500.

All in all it makes investing in early stage companies for people with a bit of money very attractive. There are of course lots of rules around it — the Treasury have to justify their existence somehow — but if you follow them and get a bit of legal help along the way, it’s a very tempting way to invest your money, especially if you’ve just come into a bit of money in this tax year — there’s an extra bonus for 2012/13 which allows you to put money from capital gains straight into shares in a new company and not pay capital gains tax.

I also think it’s interesting because it makes investing in early stage companies comparable in tax advantages to charitable giving. It used to be that if you wanted to ‘do good’ with your income the only way was to give money to a charity or sneak it off to another country that was more ‘tax efficient’. But that’s changing. I hope we see a culture shift so that people who’ve been fortunate start to really invest in the next wave of companies trying to solve real problems.


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