At What Stage Should You Invest in European Startups?

European Straits #127

Dear all,

We normally would be holding the last banquet of the season at The Family’s office in Paris on Thursday, prepared by the great Guillaume Heckmann, our in-house chef. Alas there’s a heatwave in Paris, with the temperature expected to rise up to 39°C that day. And so we decided to postpone to a later date in July.

39°C doesn’t necessarily sound unbearable. But you have to remember that Paris is in Northern Europe, which means that temperatures are usually moderate, both in winter and in summer, and air conditioning is scarce. That makes us Northern French (and British) people ill-prepared for facing such extremes. And in a city like Paris, the car-generated pollution only adds to the inevitable headache.

Meanwhile, London is fortunately cooler and it has finally stopped raining, which means that my wife, kids and I can now enjoy our garden in Hackney. I’ve been reading there, notably Scott Kupor’s Secrets of Sand Hill Road, which (as I expected) is a compelling and straightforward introduction to today’s venture capital industry. You can check out the many extracts all over the Internet, but if you work in the startup world, reading the whole book is definitely worth your time!

What’s the best timing for investing in European startups?

1/ These days I’m focusing on how to market opportunities to investors who are not used to being involved in European tech. A dimension that I find particularly promising is that of timing. One reason why Europe is still lagging behind (although it’s making progress) is that we haven’t figured out at which point in the techno-economic cycle it makes sense to accelerate capital deployment in European startups. Lacking our own framework, we usually end up with the worst of both worlds. Let me explain.

2/ One world is inhabited by European investors that closely match how Silicon Valley invests. They invest early in the cycle—usually when a new technology is only just emerging and promises to create opportunities for discovering new businesses. We’ve seen this kind of craze happen with cloud computing (see the well-documented case of Ben Horowitz’s Loudcloud, which as explained in Ben’s book was on the market too early), virtual reality (there’s a great Silicon Valley scene about that), artificial intelligence, and more recently . Alas, investing at that stage doesn’t work in Europe.

3/ It works in Silicon Valley because some venture capital firms there are so successful, they can afford to lose money making early bets on entrepreneurs interested in the new technology of the day. It is highly improbable that even some of those bets pay off (although there are exceptions). But investing early still makes perfect sense: It trains a generation of entrepreneurs who will come back for more when the dust settles, and (as acknowledged in a recent conversation with my colleague Balthazar de Lavergne) it sends a signal of early interest that later makes it possible to attract the best deals on the market.

4/ An example of that approach is crypto, which I discussed in . When crypto started to emerge as the new big thing, a few firms, among them a16z and Union Square Ventures (which is in NYC, not in the Bay Area, but still), positioned themselves as early supporters and deployed capital so that they demonstrably had skin in the game. This didn’t translate into obvious successes as we’re still early in that cycle (with Coinbase being the exception). But it did make it possible for those firms to be in a better position now that the music is starting up again. That’s why it shouldn’t be a surprise that both are founding members of the Libra association. And guess whose door the next generation of crypto ventures will knock on when they raise funds in the near future?

5/ Compare that with investing in similar startups in Europe at exactly the same time, and you end up with a very different outcome. At best, European VCs support early champions that then flip to the US because they need a larger ecosystem to help them grow—or they get poached by US acquirers like most 'successful' . At worst, a firm just loses a lot of money without building a track record that reassures its LPs when it comes time to raise the next fund.

6/ The other European approach is to delay as long as possible, waiting until Silicon Valley (or China) has proven that the new big thing is indeed a thing. But this doesn’t work either. If you wait for US startups to mature in a given industry, there’s a chance that the winner-takes-most dynamics will make it impossible for European startups to catch up and grab significant market shares. This happened with e-commerce: European VCs long thought that locals had a chance to compete on that market once it had been discovered by Amazon. But now Amazon has gone on to eat most of the market, not leaving much room for European competitors.

7/ I think the right framework to decide the best time to invest in European startups in a given industry is one that I designed back in 2015 and then detailed in this paper: The Five Stages of Denial. For those of you who don’t know it, let me brief you on the basics. The idea is that all industries go from non-tech to tech via five consecutive stages:

  • Stage 1: A first wave of startups appears in a given industry.

  • Stage 2: One of these emerges as a potential winner.

  • Stage 3: The incumbents strike back, notably on the regulatory front.

  • Stage 4: Incumbents merge, trying to acquire critical mass against tech rivals.

  • Stage 5: Tech companies diversify up the stream, cementing a new balance of power.

8/ In this framework you can recognize the stages at which misguided European investors deploy capital. Either it’s Stage 1 (the new technology of the day), and it’s too early: European players don’t have Silicon Valley’s firepower to sustain their investment effort over several generations of (likely failed) startups. Or it’s Stage 3, and then it’s too late: at this point, a potential winner has already positioned itself (think: Amazon, Uber, Netflix), and that position will only be cemented by the incumbents striking back, which usually happens at the expense of lesser, would-be European competitors.

9/ The logical conclusion is that we Europeans must learn to play at Stage 2. That is after software eating a given industry is well understood thanks to a great deal of trial and error (Stage 1). But it's still before incumbents strike back (Stage 3), and so there’s still room for everyone to move at a fast pace: entrepreneurs building new ventures; investors deploying capital; and maybe even governments creating a favorable regulatory environment to prevent incumbents from killing the whole effort before it really gets rolling.

10/ If European investors don’t play along with that framework, it’s non-European investors that will figure it out before them. Indeed there are reasons right now for investors to be looking beyond Silicon Valley. As I wrote a few weeks ago, the Bay Area is nearing the as regards hosting more startups and talent. And then there’s the fact that the US is being presided over by, you know, Donald Trump, which creates the risk of leading the country into the ground—or at least of cutting it off from valuable relationships with its trading partners. Meanwhile, China is complicated. No wonder why investors are taking a close look at Europe!

I can’t say we’ve ever articulated The Family’s investment thesis with these specific words and concepts, but I can definitely spot the pattern. Many startups that join The Family are in industries that have typically reached Stage 2, but are not yet at Stage 3. We’re not interested in the initial Stage-1 wave, with only rare exceptions, because it’s about technology more than business. But we like the idea of helping startups position themselves for their industry’s move to Stage 3: that’s when you reach that tipping point, when things start to accelerate, and when being part of The Family makes a real difference.

So please, if you’re an ambitious entrepreneur and you’re trying to enter an industry that you think is at Stage 2, drop us a line!

😔 Our dear friend Vivek Wadhwa lost his wife Tavinder last Tuesday, as she passed away after battling a rare form of cancer for several months. Vivek usually writes a newsletter, but had stopped sending it for a while as he wanted to spend more time with his wife. Last week he sent a message to share the sad news and express the urgency that we should all feel when it comes to fighting cancer—including by accelerating the pace of innovation and using cutting-edge technology that works. You can read parts of Vivek’s letter here: Our Medical System is Stuck in the Dark Ages.

👩‍💻 Earlier this week, my wife Laetitia and I had lunch in London with Roy Bahat. He's a managing partner at Bloomberg Beta, a venture capital firm that’s solely focused on the future of work. I got to meet Roy when he and his business partner James Cham invited me to talk about my book Hedge in San Francisco last November. I’ve since been impressed with the depth at which you can explore an important topic when you’re as focused as Roy is. Here are two pieces of content that I would recommend to discover his ideas on the future of work and his approach to venture capital:

🤼‍♀️ One of The Family’s entrepreneurs, Emilie Bellet, recently published a book on improving women’s financial literacy: You’re Not Broke, You’re Pre-Rich. This is a topic with both personal and societal aspects, and so we’re thrilled to have her, together with European Deputy Trade Commissioner Oriel Petry, with us at The Family on July 8 to talk about how understanding finance is a critical tool for strengthening women’s positions in the world. The event is part of our public affairs outreach, led by my colleague Zineb Mekouar, so if it’s the kind of topic you’re interested in, stay on the lookout for more of our events that touch on public policy.

💰 Obviously, European fundraising isn't just a question for investors—entrepreneurs and even just the general public often have lots of questions (and misconceptions) about what it's really like for a startup. My cofounder Oussama just published a new video on exactly that, which you can see here: Fundraising 101 💰 Oussama Ammar, Co-founder at The Family.

Here are more readings about timing investments in startups:

Warm regards (from London, UK),

Nicolas