Venture capital investment: Value beyond the cash?

James Hurley asks if the traditional venture capital approach is more about control than value

If you call Dan Wagner a venture capitalist, don’t expect a warm response. Then again, the pioneering internet entrepreneur is careful to stress that he’s not an angel either. So what exactly is Brightstation Ventures (BSV), the $100m technology fund that he heads alongside Shaa Wasmund? “We’re fundamentally different because we don’t invest in other people’s ideas,” he insists. “The concept behind BSV is that we leverage the talent and the vision of the entrepreneurs that are part of the team.”  Essentially, BSV backs the people in BSV. “You’re backing the entrepreneurs in the venture fund,” he adds. “It’s a very different business model.”

Fighting talk

Indeed. While the exploits of Wagner and his team, which also includes the famously precocious Ben Way, might not have an immediate impact on the burgeoning, London-based technology VC and angel scene, it’s disruptive enough to warrant closer attention, especially in the context of Wagner’s controversial and outspoken views.

“The VC world is so alien to what we’re doing,” he says. “We might be considered a venture fund, but we’re not really. We want to create a factory for entrepreneurs. Our approach is different from the ‘spray and pray’ approach of a VC. They’ll invest in 10 businesses in a certain sector in the hope that they’ll get one winner. Our approach is that every one of our entities should be a winner. We can’t afford for it not to be. In reality, it’s unrealistic to think that everything is going to be successful, but we’ll fight to make that happen.”

Wagner believes that the VC community tends to invest in businesses because they want to run them on the behalf of the people they invest in. They don’t really back the entrepreneur, he claims, because they want to take their ideas and do it their own way, often installing their own management team in the process.

Of course, no entrepreneur takes the decision to sacrifice equity lightly, but surely VC money also comes with some added value for inexperienced entrepreneurs who are seeking accelerated growth?

“If you had lots of money, would you go to a VC?” asks Wagner. “They say that they add value, but they don’t – they provide money. Actually, they bring bureaucracy and frustration and hold back an entrepreneur. Sometimes, if the person with the idea is useless, they add value, but that person would go to a VC in any case, because they need the help.”

It’s strong stuff, but he’s not done yet. “There are lots of examples where, because of the agenda that a VC has, there will be conflict with the people that run the business,” Wagner continues. “I don’t like the practices that some VCs deploy to take control of businesses. It’s immoral. I have a different approach – I want to help, not take value out. But I’m not as rich as a lot of VCs. There’s a certain ruthlessness and I can do without that involvement.”

While BSV has no equivalent in Europe, a US-based firm established by Peter Thiel, a former Wall Street derivatives trader who became chief executive of PayPal, has similar objectives and is the source of much debate in the States.

The $220m Founders Fund is already making a name for itself as a major financier of the current internet boom, but is attracting at least as much attention for its partners’ outspoken attacks on alleged flaws in the traditional VC way of doing business. One of them, Sean Parker of Napster fame, has been quoted as saying that the fund is an example of “the pendulum swinging back” in favour of entrepreneurs.

Thiel’s chief proposition is that founders should get more of a stake and a say in their companies and not have to wait until exit to gain liquidity. The Founders Fund, which has been dubbed ‘VC 2.0’ in the US press, allows entrepreneurs to ‘cash out’ a small percentage of their stake in a funding round, so they don’t have to wait until the company is sold or goes public.

BSV has developed four stages of growth for its companies, and Wagner says the whole process, from start-up to exit, ideally lasts between two and three-and-a-half years. Yet both funds espouse greater flexibility and fewer unrealistic exit pressures. “We will monetise our investments when we feel it’s right. In some cases, we may never monetise them. We may continue to retain them as profitable go-forward businesses,” Wagner says. “We make something happen without any investment committee. We are entrepreneurs who can make decisions about investments without any third parties.”

Portfolio approach

It’s hardly surprising that this kind of talk is an anathema to the traditional VC community. But alternative sources of equity are nothing new. The rise of the ‘super angel’ – a wealthy individual capable of investing at much higher levels than traditional business angles – is increasingly providing an alternative source of capital for those looking for a major sum of cash in return for a reasonable stake, with the entrepreneur left with enough autonomy to grow the company as they see fit. But entrepreneurs hoping for a quick-fix solution to the age-old equity versus autonomy dilemma could be in for a shock if angels want hands-on involvement in the business.

“As an investor, the big question is: ‘How can I make money out of the investment?'” says Sam Richardson, investment director at sustainable technology fund e-Synergy. “If you’re an entrepreneur investing in a company, the question you may end up asking yourself is: ‘If I was running this business, how could I make it successful?’ Unless you’re planning to run the company yourself, that’s not the right question.”

Richardson is well qualified to speak from the other side of the divide. The original founders of e-Synergy are all entrepreneurs, while Richardson has been in VC for the last eight years and has not yet run a business. “It gives you a different take on things,” he says. “Someone with a background in fund management will assume that a good investment involves the people running the company now, plus market opportunity. OK, that could mean me sitting on the board, adding some value and helping strategically, but it doesn’t involve me running the business.”

Richardson acknowledges that there’s value in an angel investing in a business on the basis that their secondment could make a company successful, but how much impact can have they have on the investment scene if they’re locked into a small handful of ventures at a time?

“If they are taking more of a portfolio approach, and want exposure to 10 companies, that isn’t going to work,” he says. “There’s this idea that entrepreneurs are more operational people who think the VC approach is not the way to do it, but we do add value.

“As a VC, your responsibility is to your investors. We have to return capital gains to them, so if we got heavily operationally involved in a company, we’d be breaching the terms of our LP agreement. If you’re an angel, you’re investing your own capital and you can do what you want. That can work and you can be very successful, but not in a portfolio approach. I could see it working if you had three or four entrepreneurs collaborating together by pooling their money and expertise in a small number of investments.”

VC star

In that context, it sounds like Wagner could be onto something. BSV hires talented and experienced managers at phase two of a company’s growth to avoid too much hands-on involvement from the entrepreneur investor – to execute all of his ideas, Wagner can’t get too involved in any one venture. “The difference between me and a good corporate business person is that I’m a risk taker,” he says. “They will have less of an appetite for risk, but may well be a better manager than me. A lot of entrepreneurs are like that. That’s why they allow management to come in underneath them and step away once the business is rolling. Bringing in a chief executive at the outset has merit. When you layer in our contribution as entrepreneurs to an executive manager, you get it right.”

But are his comments about VCs justified? While it’s common knowledge that recent financial turmoil has hit global VC funds hard, research by Library House suggests the first quarter (Q1) of this year has seen a dramatic rebound, with an 80% rise in VC investment from Q4 2007, reaching £510m, its highest level since Q1 2006.

One of the undoubted stars of a burgeoning London-based technology venture scene is the venture partner at Index Ventures, Saul Klein. You couldn’t ask to meet a more vociferous advocate of the ‘added value’ that VCs can provide.

So what exactly does Klein, a name enviably synonymous with Skype, Last.fm and Lovefilm, make of Wagner’s accusation? “It’s a tabloid headline. Most successful entrepreneurs have a helpful investor alongside them,” he says. “Of course, there are bad investors, but to broad brush stroke and say that VCs don’t add value is extremely naïve. As an entrepreneur, the VCs that I worked with helped me close deals, recruit people, raise additional finance and gave me incredible insight into the strategy and the positioning of my business. If you work with the right investor, they add incredible value.

“There’s a lot of capital available to people and I think it’s important to both investor and entrepreneur that you can add value above and beyond just the money that you invest in the business.”

While Klein takes issue with the term ‘angel’, he says powerful independent investors can only be complementary to VC interests and are part of an “ecosystem” that will foster an improved enterprise culture. “It’s great that there are angels that are more active and knowledgeable in the European market,” he says. “But I differentiate between angels and seed investors. The latter is a professional investor. To me, an angel is a part-timer, investing between jobs because they’ve got extra cash and fancy a flutter on the side. But there are people who are seriously and methodically carrying out seed investments in Europe now. In the States, this has been going on for a long time and is an important part of the ecosystem.”

However big your seed round was, Klein argues, if you want to build a very significant business, you’re going to need to raise additional capital – or you’re going to want to have the credibility of a VC as you hire senior talent or do a large business development deal.

“VCs don’t just bring access to a lot more capital, they bring access to full-time professional investing and credibility that can help with hiring and exits,” he says. “A lot of people underestimate how important a good VC is at managing and structuring a good exit. I think it’s definitely not an either/or – most businesses that become very large have had both seed and VC.”

It’s tempting to agree with Klein’s inclusive view, but if BSV has as many successful, accelerated exits as Wagner says it can, the model is bound to be replicated by entrepreneurs who would have otherwise sought out vehicles for angel investments. If that happens, we might be hearing talk of VC 2.0 a little closer to home.

Value-added investment?

GB Young Gun Jamie Murray Wells of Glasses Direct on securing a £2.9m investment from VC firm Index Ventures

“We wanted to create a billion-pound business and that wasn’t going to happen at the previous rate of growth. Now we want to be a household name in the UK, and our investors can see the potential for global growth. Index Ventures is renowned for being the premier investor in mega-disruptive web businesses. Whether that’s Betfair for gambling, Last.fm for music, each company in their portfolio is dynamite in their respective industries. Index is the obvious choice for any company wanting to change the world with their business model, which is why we aligned ourselves with them in a multi-million pound investment deal last year.”

Losing it all

Award-winning entrepreneur, seed investor and BSV director Ben Way (above) on a bruising encounter with VC investors

“Some very wealthy Jersey-based entrepreneurs approached me following a TV documentary that I’d appeared in. They wanted to hear my ideas. They picked up on Waysearch, effectively the first comparison shopping engine in the UK. I asked for a £25m investment because it sounded like a nice round number; I didn’t have any idea if this was the kind of level they wanted to invest at. When they accepted, it was like winning the lottery.

“It took about six months to do the deal and we spent £80,000 on legal fees. The original idea was that I would have control of the company. When the day arrived to sign the contract, they said: ‘We want control or we won’t do the deal.’ It was like being gazumped. But I was 17 and I took the money. They had pre-planned to bring in one of their investments, a technology company, to run the project and take me out of it. They spent a year and £1.7m going back to my original idea. It was a nightmare.

“And then the dotcom crash happened. The investors decided that I was an expendable part of the business and diluted me out of it; they had rights to do so within the shareholders’ agreement. They terminated my directors’ contract and backdated it by three months.

“I was on a big salary and had just spent a lot of money. I was left with £30,000 of debt, no house and narrowly avoided bankruptcy. That was the end of that relationship. It taught me a lot. No matter how long you spend on the legals, people with deep pockets generally win.”

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