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Risk-aversion or market maturity?

March 22nd, 2008 by Mitch

In a recent Tech Crunch UK article, Mike Butcher reported on a brief, but enlightening, blog posting of The Accelerator Group‘s Robin Klein. The key quote from the article, and the TAG blog, was Robin’s assertion that “funding business plans from first time entrepreneurs just won’t happen anymore.” Robin listed his criteria for new deals to include:

  1. Founded by 2nd and 3rd time tech entrepreneurs
  2. Aspiring to build global businesses with scale
  3. With genuinely original ideas which are game changing or a significant advance on current state of play
  4. Where the founder(s) have built prototypes or are already demonstrating momentum in customer/consumer adoption
  5. Where founders have shown an ability to considerably ‘bootstrap’ the business with very little or no external cash (outside of friends and family).

On its face, this could be interpreted as yet another UK VC following the worrying trend towards more conservative investment strategies and later-stage investment. But is it truly another example of the classic perception of the UK as a risk-averse nation? Or instead, is it an indicator of a growing maturity in the UK start-up and venture capital communities?

The answer to this lies in the growing supply of good ideas, rather than [the traditional explanation] of a falling supply in risk capital. TAG, perhaps due to its position as one of the few remaining institutional investors in seed-stage enterprises) is witnessing a healthy increase in the quality of deals crossing their desk. Accordingly, this has allowed Robin and his partners to be even more selective, cherry-picking those deals demonstrating quality across the continuum – from concept to management team to market to proof-of-concept.

In and of itself, this isn’t a bad thing, as long as there are other investors willing to provide capital for the good ideas which don’t reach Robin’s (and the other institutional VC’s) strict criteria. In other words, who will fund the ideas from first-time entrepreneurs for whom bootstrapping is not a viable option?

Bootstrapping a technology-based business is great if you’re a programmer or technologist with access to all of the tools of your trade. However, it is not as easy to achieve if an entrepreneur originates from the ‘commercial’ side — perhaps with detailed knowledge of a market and a potential area of need. Such an individual is less able to build a prototype him or herself, and will need funding to recruit the technical talent to do so. Is this commercial entrepreneur less valuable than the technical entrepreneur? Is his knowledge of a market less valuable than a technologist’s knowledge of the engineering? Is his start-up idea inherently less valuable than the technical entrepreneur? Robin’s statement — or at least his criteria — would seem to imply so, but I would disagree.

So if Robin and his ilk aren’t willing to kick in the initial seed money, where will it come from? In Silicon Valley (where I spent much of my career), this space is filled by the ample number of business angels – frequently ex-entrepreneurs who have made some money and are interested in staying in the game as an investor. The robustness of the Valley networks enables a smooth flow of information between would-be entrepreneurs and the informal investor community, such that quality ideas are able to find willing investment (and vice versa) even in those circumstances where all of Robin’s criteria are not met. Furthermore, the abundance of risk-tolerant technologists sniffing out their own chance at start-up stardom makes it much easier (and cheaper) for a Valley entrepreneur to recruit technical talent with the hope of success (read: equity) rather than hard currency, enabling him or her to bootstrap the operation or stretch their angel dollars that much further.

But here in the UK, despite recent developments, such a fluid network of investors, entrepreneurs, and risk-tolerant technical talent does not yet seem to exist. Robin’s statement and Mike’s analysis seem to imply that this vacuum should be met by friends and family. But if the start-up ecosystem relies on such, it limits itself to those start-up ideas coming from people wealthy enough, or with friends and family who are wealthy enough (and I’d guess that there is a strong overlap between these two groups) to provide seed funding. But does this community represent 90% of the good start-up ideas? Or 20%? If the latter, then the UK clearly needs some facility to fill the capital vacuum left by the institutional investors. Otherwise some great UK ideas, and great potential UK start-ups, are going to fall through the cracks. And the US, with its wealth of angel investment and support, will continue to dominate the space.

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