Big rounds, big risks: some thoughts on the changing market environment for early-stage venture investors

There has been an enormous influx of later-stage capital in our market in recent years. Our meta-thesis says why: every industry is now a tech industry, every value chain is being reinvented from the perspective of the end user, software is eating the world.

In a world of zero interest rates and massive quantitative easing, tech has been the equity story of the last ten years. And so it's no wonder that capital has poured into our market "from the top."

For founders and early-stage tech investors around the world, this has been a boon. More competition around later-stage deals, higher prices, and ever larger investment sums. 

But as the pressure has mounted on later-stage firms to deploy capital, at the margins this is leading to some worrying behavior: investment decisions from the hip, low to no diligence, an extreme willingness to pay up that introduces significant asymmetric risk for founders, earlier investors, and companies as a whole.

Venture fund performance is driven by a fund's top outcomes. This pareto distribution, or power law, means that from the portfolio perspective an individual investment is "just an option", a "shot on goal." This is an awful way of thinking about VC investing, so bear with me. It's true from a portfolio perspective (it doesn't mean it should be true from an operational perspective). 

You build a portfolio of options and through gradual de-risking of the individual portfolio company, you identify the ones that are performing well. And then you allocate the rest of your fund's capital to those companies that look like they will be the biggest outcomes. We do this through a well-defined capital allocation model that gets updated at each quarterly portfolio review. 

A part of de-risking individual portfolio companies is whether they manage to raise an externally-led round, what the quality of that investor is, what valuation is put on the company. It's the moment of truth when the founders and you stop "drinking your own kool-aid" and get feedback not just from customers, but from the capital market.

But with the changes in later-stage investor behavior, raising follow-on rounds nowawadays feels less like de-risking and more like "kicking the can down the road." The new investor coming in has a risk-adjusted rate of return calculation that's much more similar to the earlier investor. And so a high valuation and a good sum of money may well be a false positive.

This is worrying not just from a perspective of founders who must meet some extreme growth targets. E.g. the Wired story on Revolut seems to me to ignore the incredible pressure that their founder must feel, having raised $300 million plus for a relatively early-stage business.

It's also worrying for earlier-stage investors who are sitting on a large amount of paper returns. This isn't quite RIP Good Times 3.0, but I have started to think about what that will look like. I think we'll be in for a significant number of restructurings that will involve non-traditional venture investors that may not exhibit best behavior. 

In the meantime, the best you can do is to focus on actual company building: execution quality, team quality, and making sure you're not fundraising at next year's valuation today. Think about what risk an outsized post-money means for you, your team, and your early supporters. By all means, negotiate the best deal that you can. But then take money from the people who are actually aligned with you and your goals.

Products of belonging

At Heartcore we understand consumer brands and products as systems of meaning

Our framework for assessing consumer-facing products looks at both functional and emotional characteristics: what does it do for me and how does it make me feel? We call the first differentiation; the second, aspiration.

Over the last 50 years the Western world has started to question traditional identity-conferring institutions en masse - nation, family, religion, employers. Each is in a crisis in its own unhappy way. 

The outcome of the rise of individualism has been the atomization of groups of belonging. A mere thirty years ago, we listened to rock'n roll, or maybe "metal." Today, we are into post-hardcore, indietronica and chillwave. We are making ever finer distinctions in gender and sexual orientation, race and origin, and belief systems. The personalization of society is at least in part the result of the internet, and its possibility to identify and connect with ever more specific sub-groups. Thus: Rule 34. 

The majority of consumer products have historically been meant to make us feel special (successful, trendy, happy, smart). From an evolutionary psychology perspective, they promise to increase sexual attractiveness by signalling status, fertility, or conscientiousness. But as part of our relentless quest to question and examine everything, an increasingly sizeable segment of consumer is skeptical: of the claims of big companies, the system of "fashion", conspicuous consumption, the sexualization of marketing, and so forth.

Enter the "mass-market products of belonging." 

Increasingly brands are becoming communities. Unlike the fake luxury fashion products, where carrying the same Hermes handbag or wearing the same Valentino dress may be acknowledged in embarassed silence, the mass aspirational community-oriented brands encourage recognition. Away, Allbirds, Glossier are not brands founded on separation but on community identity, much more like mini-Harley Davidson's.

I believe that because of the loss of traditional identity-conferring institutions, this trend has a long, long way to go. We all want to belong. We want to feel safe in our choices in a world that is made up of nothing but choice. My gut says there will be multiple, very large consumer-oriented companies built that will put communities of belonging at their center.

These companies may look more like religions than many people will be comfortable with (remember Apple in its heyday?). But then I maintain that a new religion is probably the single greatest market opportunity in the Western world today.

P.S. Inspired by a brief chat with the co-founder of LOT

Civilization: a personal view (1969)

If you know me personally, you know I get slightly obsessive over things. Part of it is just a natural curiosity, though it may sometimes border on the compulsive hoarding of knowledge and different points of view. I've gotten better over time, but I'm not over it.

A few days ago I got into the very old BBC 2 documentary "Civilisation: a personal view" hosted by Kenneth Clark and first aired in 1969.  

If you can deal with the rather heavy QE accent - at times indiscernible from a melodious series of modulated yawns - it's well worth the viewing. Parts of it have aged rather well, though the fervently anti-imperialist crowd might disagree. I'm not saying it isn't biased or that history and the study thereof haven't progressed, but that surely there are nuggets that like its subjects have stood the test of time. 

Here's the link to the first of 13 episodes:

I do like to think of our role as venture investors as the capital that greases the wheels of civilizational progress. And having a longer-term view on where we have come from can help inform where we may be headed, and perhaps where we should be headed.

That, and it's just great fun as old documentaries go.

Heartcore's Low Resolution Investment Thesis

We have a number of high resolution investment theses in different verticals like direct-to-consumer, food, mobility, travel, finance, and healthcare.

But I thought for those of you who don't follow Heartcore Capital on Medium, it would be worthwhile reiterating our high-level (= low resolution) investment thesis for consumer technology. So here it goes (I wrote this together with Yacine Ghalim earlier this year): 

Over the last 30 years, computing, software, and in particular the internet have radically changed the way we live, work, and play. Billions of us carry a computer in our pocket. The majority of humanity is always on, always connected.

Who would have thought back in 1988, that there would one day be a website on which you could buy (almost) everything? That there would be an app on your phone with which you could message all your friends? And another that would let you see and chat with your family, instantly? And still others that would reliably get you a ride, a meal, a movie, or a date?

Who would have thought that we’d have easy and inexpensive access to the most powerful computing infrastructure ever built? And that it would be totally up to us what we ran on it. That all you’d need to get started building these massive, world-changing consumer-facing services was the incredibly powerful, personal computer right in front of you, loaded with free software and limitless possibility?

This is the eternal promise of technology and, perhaps more so, of the internet: to change the equation of markets forever by putting power into the hands of the end-user, the consumers and developers of our joint human future. This is what’s behind the tremendous success of consumer-facing technology companies like Google, Apple, Facebook, Amazon, Netflix, Uber and many others: they give us “superpowers” — the ability to do things that mere decades ago looked like they were beyond “natural” human capacity.

And we’ve only just begun. Every time that technology finds a new way to help people better achieve their aims and fulfill their desires, there is an opportunity to build a category-defining consumer brand. One that lets you leverage technology to become more of who you really are.

We believe that human desires are universal, stable, and relatively predictable. While the tools of technology change constantly, people stay mostly the same. Functionally we want to do what we have always been doing, but better, cheaper, faster. Emotionally, we all want to belong, to be safe, free, and ideally a bit special. Humans are also all hard-wired to improve themselves and the world around them. And occasionally we just need a break and escape from the mundane. At Heartcore we have laid our thinking out further in this internal framework. Each time we consider an investment, we carefully examine how the products and services offered answer these key human motivations and whether the company has the potential to become a category-defining brand.

So where do we go from here? We know that despite a majority of people being online, most of their money isn’t. In Europe, e-commerce only accounts for 9% of retail sales and less than 5% of total consumer spending. Retail is one of the categories that most easily yielded to the “end user revolution” of the internet. But major consumer spending categories such as housing, healthcare, education, or food have barely been scratched yet. In more mature categories like travel, finance, or entertainment, we are also seeing different kinds of online businesses being built — more vertically integrated, tackling harder problems, building bigger moats.

Every time a new technology matures it finds applications in various consumer markets. And thus we are actively looking for online businesses using new technological building blocks such as machine learning, cryptocurrencies, virtual and augmented reality, voice computing, brain-computer interfaces, or quantum computing that can be leveraged into building the consumer-oriented companies which will shape our joint future.

It’s a future that — as our name suggests — we care about deeply. In the West, we are seeing an accelerating loss of meaning and erosion of trust in traditional institutions such as government, religion, or even the family. We believe that brands that can capture and perhaps restore our common belief in ourselves and our human journey are poised to be significantly positive contributors to this future. Those winning a share of hearts will become core meaning providers in our lives. Organizations around which people build their identities, through which they express their belief, and perhaps grow closer to one another.

In a short 20 years, computing, software, and the internet have changed pretty much everything. We believe that the next two decades will accelerate and deepen the changes to the ways in which we live, work, and play. Many new iconic consumer brands will be built in the process. These are the companies that we are looking for. And we’re incredibly excited to spend the next 20 years looking for them.

You can follow Heartcore Capital on TwitterMediumFacebook, and LinkedIn.

Why is Heartcore consumer-only?

We launched Heartcore Capital yesterday and positioned it as "Europe's consumer-only VC." I wanted to take you through some of our thinking that led to this fairly unique positioning.

Let start with: we've actually had good B2B returns in the past. Neo4J, the graph database, is a great company and recently raised an $80 million growth round from Morgan Stanley and OnePeak. We've sold businesses like IPtronics, Trunk Archive, Game Analytics, and CloudMade, and took Asetek public on the Oslo stock exchange. Prezi, while it started as a consumer productivity company, is now firmly a SaaS player. 

To some extent, the need to focus is a result of more capital flowing into the industry. The VC market has tripled in the last decade in Europe. We were seeing more and more deals and the good investments were becoming more competitive. There's a limit to how many companies you can look at with a small team, especially if most of your partners have a "full load" of board seats. 

Both in terms of preserving our sanity, but also from a perspective of meeting and then converting the best founders, we knew we needed to specialize. We also felt like a broad positioning was preventing us from developing "deep" investment theses which are a prerequisite of investing from a place of conviction

At the same time, we were starting to see a lot of "deep tech" investments. A kick-ass team from ETH and KIT, doing some super interesting robotic sensors for manufacturing in several specific verticals was my "moment of truth." I knew I would need three months of diligence to really figure out whether the company was as interesting as it seemed, and in the end it would be a judgement call that I still wasn't really qualified to make. Would I really be the best partner to these folks?

The network effects of specialization extend to your ability to source, select, and convert the best founders and companies. But they also extend to the value-add you can provide afterwards. A focused network of founders, operators, and other experts in consumer internet, from ecommerce to consumer productivity software, is much easier to build and maintain than one that tries to encompass "the entire tech stack." Over time I've become much more interested in depth than breadth.

Consumer came naturally for our whole team, because it was where we had been gravitating anyway. With exits like Boozt, which returned more than our first fund, with some of our most recent top investments like GetYourGuide, Natural Cycles, or Seriously (the makers of Best Fiends) it was clear that we were better at B2C (or B2B2C) than B2B.  

It didn't hurt that consumer tech has historically yielded larger outcomes. If you think of European venture-backed outcomes, they are exceptional companies like Spotify, Skype, Minecraft, Farfetch. Sure, there's an Adyen or an iZettle as well, but it had been a long time since Business Objects and SAP. In the Pareto distribution ("power law") world of venture capital, investing from a portfolio point of view isn't about minimizing risk or playing it "safe." It's about maximizing your potential outcomes.

What we love about consumer as well is that there are essentially two buckets of consumer investing: the adoption of new technology by consumers (think Google, Facebook, etc.), which have so far contributed the bulk of venture returns, and which we still believe can yield great investments. In terms of timing, there is a bit of a lull in this market as folks wait for consumer adoption of things like voice computing, AR/VR, decentralized web. And hence the time to invest is now

But there is a second bucket, which is companies applying existing technologies to old industries and very stable consumer preferences. Many of these currently look like they can build category-defining trusted brands that will likely be very large companies and given network effects may hold that position for a long time. 

And finally, going consumer-only is a contrarian take, which is also something we liked. Much of our market has been talking about enterprise, SME, SaaS, deep tech. In contrast in the US, Forerunner and Maveron have built consumer-only firms that have been very successful. 

So we're joining a small stable of funds here in Europe: so far we know of Felix, JamJar, and Eutopia that have a primarily consumer focus. We'd love to connect with other folks who share our thinking.

You can follow Heartcore on TwitterMediumFacebook, and LinkedIn.

Introducing Heartcore Capital

For 12 years now, we have operated as Sunstone Technology Ventures under the joint brand Sunstone Capital with our friends from Sunstone Life Science Ventures.

Over the last decade, we have poured our heart and soul into helping founders build European technology businesses from the ground up. We’ve gone from seed to NASDAQ IPO (Boozt), from small Hungarian software team to Silicon Valley-based SaaS leader (Prezi), from Series A to fastest-growing travel marketplace in Europe (GetYourGuide). And we’ve had our share of f̶a̶i̶l̶u̶r̶e̶s̶  opportunities to grow.

Since launch in 2007, we’ve raised four funds totalling €350 million in assets under management. And we’ve helped create over €3.8 billion in enterprise value for our founders, co-shareholders, and limited partners.

Over the last decade, the European tech industry has come of age, and so have we at Sunstone Technology Ventures. It became time for us to sharpen our positioning, narrow our focus, and be clear about what we stand for.

And so, after operating for 12 years as Sunstone Technology Ventures, today we are becoming Heartcore Capital. 

Heartcore is a "consumer-only" venture capital firm. We invest 100% in B2C, though that includes marketplaces with a consumer angle as well as consumer productivity software (e.g. Dropbox, but not Salesforce). We've posted our short-form investment thesis on Medium, so you can read it there.

On ne voit bien qu'avec le coeur; l'essentiel est invisible pour les yeux. - Antoine de Saint-Exupery

We're also doubling our partnership in size, from three to six. Previously, Jimmy Fussing and Christian Jepsen were in Copenhagen, and I was in Berlin. 

Levin Bunz joined us in January in Berlin from GFC, Rocket's $1 billion investment arm. I've been working with Levin on Memorado/HeyJobs for the last few years and I'm so thrilled to see him on a daily basis now.

Yacine Ghalim, whom we hired from Goldman Sachs in 2013 as an associate, has been promoted from principal to Partner (go, Yacine!). He heads our new Paris office, where we also added Yohan Pereira as an analyst. Yohan joins us from First Minute in London.

We're also delighted to welcome Signe Marie Sveinbjoernsson as our new Partner & Chief Operating Officer. Signe will head operations from our Copenhagen HQ and be in charge of everything from transaction execution to compliance. She's a former M&A Lawyer and ran operations for Total, the oil company, in Kenya (so cool). 

I'm going to write a lot more about Heartcore over the next few days. For now I feel the happy exhaustion of the new parent... welcome, Heartcore!

Heartcore is on Twitter, Medium, Facebook, and LinkedInFollow your heart :) 

2019: tough times for Europe?

2019 is starting to look like it might be the perfect storm for Europe. 

The ECB has pulled back on and will completely cease its massive asset purchase scheme in early 2019. Markets expect Draghi to raise rates in the last months of his term. We’re at -0.40%, so not a lot of wiggle room in any case. 

Brexit is looming. We’ll know more after December 11, but whatever happens it’ll be a massive disruption. Except for an about-turn to continued membership, all alternatives look fairly poor. Including the prospect of a “democratic socialist” government under Corbyn. 

Italy’s debt crisis is accelerating. The country is probably already in recession and banks and companies are having trouble refinancing themselves. 

German lenders (and tax payers) will be left holding the bag. Deutsche Bank, which never recovered from 2008, is looking particularly vulnerable. A money-laundering raid of its HQ this month didn’t help. 

Populist discontent is growing. It has spilled onto French streets and is changing politics in multiple other countries. Expect more unrest. This is a key theme in European politics, pitting elites against the middle classes. Dissatisfaction stemming from inequality of economic opportunity, but with a particular focus on failed immigration policies and multiculturalism, will be a defining factor of European politics for the next decade. 

The electoral win of AKK as the conservative party’s chairman to replace Merkel communicates clearly: the elites don’t get it (yet). Germany’s politics will fragment further - expect Greens and AfD to become the largest parties, leading to a similar polarization as in the US. 

The schism between Western and Eastern Europe is widening. The EU is one to two more Brexit type events from total stasis, if not (informal) dissolution. And it doesn’t look like Merkel/Macron will be able to heal that divide. There needs to be a policy alternative to “ever closer union” and centralization. 

Trump has declared a temporary truce with China (markets have caught on that it really may be temporary). But he’s not a politician who operates without an enemy. 2019 is looking like it will be tough for him domestically. Look for the rhetoric to switch to Europe - Germany’s car industry leadership has already bent the knee. But I expect him to push on further on trade and NATO and dial up the rhetoric. 

And then there’s the wildcard of Russia. Ukraine is volatile to the point where both parties may find it beneficial to escalate the conflict. 

None of this matters for startups per se. Europe’s travails will be a rounding error in the narrative of successful founders. But economic volatility spooks capital and the contagion is psychological above all. Europe may well be the crucible for global recession in 2019. 

It’s not quite RIP Good Times 2.0. 

But raise your next round while you can and bunker down to keep building the future. 

Spotify Top Songs 2018

It's amazing how much music reveals about you. I've known this at least since my first angel investment, Last.fm

I wish Spotify made it easier to see other people's top lists. 

Here's mine. The one thing it clearly shows is that I'm getting older...

Password management

There's an assumption of security in technology that has never been true. 

More and more of how we live, work, and play is intermediated by online services. Every time you get in your car. Every time you buy a coffee. Every time you pick up your phone. Book a flight. Wire some money. Watch a movie.

From unauthorized access to social engineering, the core fabric of online services is not secure. And that won't change for the foreseeable future. If anything, breaches will be bigger, more impactful, more costly.

The fact that one of the largest hotel chains in the world didn't find out that its guest database was leaking passport and credit card numbers is mind-boggling in its implications. 

And so I want to encourage you to take one annoying but necessary step to protect yourself: use a password manager.

Most people use a primary password, or some tiered level of "more secure" passwords that are nevertheless the same between services. 

You only need one breach for it to become a real problem.

I personally use 1Password, but I've heard good things about LastPass and maybe Dashlane. 

Do it today. 


The supremacy of Mind in human affairs

Kapil Gupta MD, coach to athletes, CEOs, and perhaps most notably (in our world) reviewed very favorably by Naval Ravikant, tweeted this in response to my previous post and comment "Not everything is political": 

Doesn't that feel right? It does to me. 

And reminds me reflexively, media-addled mind that I am an owner/a slave of, of this somewhat less beautiful Simpsons quote:

Image result for beer the problem solution simpsons

Ha!

It is an addiction of mind, this obsession with news and politics and media. The ingestion, processing (labeling, judging), regurgitation of information, data, the attempt to accumulate, to hoard "knowledge", to better and lecture and prescribe. And the belief that through this same process we can relieve the symptoms of the pain... 

The process is the pain in the first place.

We forget that we give permission to being disturbed by meaningless things. But once you're in the mind-world, it is much harder to stop. Just like an addiction.

I have days that I live without. Where I am with the world. Where I see, touch, smell, taste, am more. 

Interestingly it is those days that my connection to others is strong. Where I am fully there and others - strangers, too - unfailingly notice. 

On days like these I seem to be able to live more smoothly. There can be no wrong. Mind is my tool, rather than I a tool of it. 

These are not fleeting times, a few minutes, here or there. It goes a while if I don't hit... a bump. It feels less like a different "state" than what the mystics write, and more "hyper-real." 

Oddly it is not practice that makes it better. It's just awareness. There is no tension in it. 

But then I wake up another day and it is gone, disturbed by... I am not sure what. A "bump." Some event, some anxiety, some future plan the outcome of which matters so much. And then we're back on the merry-go-round.

I think it is a form of self-sabotage. Surely I am overthinking this. :)  

Go follow Kapil Gupta in any case + check out his books (free with Kindle Unlimited).