“Adapt or leave” – why the rules of the investment game in Europe will change in 2013

Thomas Grota 2013-01-09 8

Robert Griffin III

Thomas Grota (T-Venture, HackFwd, MyTaxi, 6Wunderkinder) believes we’re about to get a new set of rules for the investment game – more money, closer valuation ratios and fewer VCs. Here’s his take on how to end up a winner, not just a survivor. 

The New Year began with a surprising turnaround. Traditional NFL team Washington Redskins came back from 3-6 and went into the post-season with 10-6. We don’t know how far the Redskins will go, but this turnaround in this year NFL season is something we can learn from. Young rookie quarterback Robert Griffin III led the team, and was promoted to captain. And he did lead the team to success. He crashed the news conference of his coach Shanahan after the last game:

What did you do for New Year’s?” Griffin asked the surprised coach.
“I tried to put a good game plan together. I wasn’t sure how healthy you were, so it was hard without you calling me,” answered Shanahan.

It will be similar for startups and investors this year. Everybody will try to put a game plan together but the uncertainties are very high. The funding scene as we know it will change, and founders need to adapt or leave. Prepare for a different and new way of raising funds. But the real change will be from an investors’ perspective – so I will leave out the founders’ view this time. They will not play the main role in this new drive.

We read a lot of ”Series A crunch”, “not a Series A crunch” and “no crunch at all”. The experts talk about tailwinds and headwinds. For 2013, this is not of the essence anymore. Change is imminent and the real players will be the investors this time. After four years of a startup scene where founders led negotiations, the coming year will change the rules of the game. Here is how and why:

poker all in

Game change #1: More money will be injected

First indications of new deals at the end of last year showed massive injections of new cash in successful startup stories. There will be more of this. Why? Investors will select targets from a whole bunch of startups in a certain trend area. After selecting their target they will go for “All In”.

Investors have understood that the bloodbath is around the corner and they need to make winners, not just survivors. To win, those companies need cash – a big pile of it. They need the money for hiring the top talents; they will need the cash to drive market-making by features and advertising, and they will need the options to take over the weaker ones who will not be able to raise big funds.

Investors in those survivors – not the winners – will look out for mergers and takeovers rather than the fate of a long-lasting death and a cheap asset deal. Those investors who come to their senses early in the year 2013 and push for those deals will be winners at the holiday season this year.

Investors injecting those massive rounds will also be winners in their sector. Running a startup is a marathon, but you need a sprint once in a while to get the advantage over your competitors. You need to get a gap between you and the peloton to make sure the number of opponents on the finish line will not be a mass sprint.

For most of the startups in the promising trend areas, it is time for a sprint in 2013. Investors are willing to give this bottle of Gatorade to make sure their targets will stay ahead of the peloton. Investors are prepared for a few, but big, rounds in real winners. No time for small rounds, nor for mere funding survivors.

gymnast

Game change #2: Valuations will be reasonable again

Big funding rounds need higher valuations. But valuations will be measured by their ratio to the investment sum. This ratio will decline – not necessarily the absolute number.

We have seen high cash injections when the lead investor took a low percentage in the company. Two-digit million dollars for single-digit percentages in a winner company. Those days are over in 2013.

Fighting for the big pots will lead to two-digit percentages in a winner for the leading investors, while existing investors will pay high for their pro rata. Additionally a lot of early-stage investors will leave those deals via a secondary transaction from their investments. It will help their reputation for limited partners and they will be able to raise new early stage funds in 2014.

They will not experience IPOs or mega exits, but it will be high multiples to costs for those investors. They will be happy to report high returns, and a lot of angel investors from 2010 will have some happy times.

Those angel investors from 2011 and 2012 will only see good times if they sign those secondary deals. Most of them won’t in 2013 because they will misinterpret the signals of the market. So watch out, angels, and have a look on what times are ahead and not what wishful thinking is making you believe.

Game change #3: The investors’ landscape will change

There will be a fundamental change in who is investing in startup companies. We already know, it will be fewer VCs due to lack of funding by Limited Partners (LPs) in 2011 and 2012. More and more medium-sized VC firms will run out of cash for funding new ventures. Also, less cash is left to help those survivors.

Even if those VC firms benefit from the secondary transactions (discussed earlier), they will not be able to reinvest those proceeds. Those proceeds will help to raise new funds but will not be available for investments in 2013.

The rest of those smaller VC firms will pass on the big deals and focus on the next era of startups for 2015 and following. The remaining and cash-full VC firms will put big bets on the winners. But with each investment, one card is played and betting big pots on two players in the same area has never happened.

poker face

So, three to four players per trend area will get big investments by consortiums of those cash-full VC firms. The rest will be survivors and struggle to make a profitable exit – most of them will fail while trying.

What do these consortiums look like? Corporates have tested the grounds in 2012 on various occasions. They will be more confident doing more deals, especially along with experienced VC firms. Those will be strategic deals but on fair VC terms. Those corporates who haven’t tested grounds will do in the first half of 2013.

Don’t be surprised about who will enter the funding scene. Those corporates will not seek majorities in startups, nor is this preventing exits in the future. Those strategic investments will help to build the winners. They will bring cash through orders, product integration and marketing activities.

They will be valuable customers in the memorandum when times for exit – trade sale or IPO – arrive. Even after the exit, those customer relations will be profitable and have a value for the acquirer or the IPO story. By the time of the exit, those strategic investors will have found their niche within the company and product line. A complete takeover isn’t necessary to keep this customer role with the former startup.

What are we left with? Here’s the game plan for 2013

Investors, journalists, corporate strategists and entrepreneurs should expect the funding market to develop in two main segments:

game plan

1: Early stage and pre-seed companies building new startup ideas
They will get their money from various funding sources: crowdfunding, angels, small VC firms, government programmes and others. None of those young ones will have a major impact in 2013. Keep them growing, nurture them, kill them if needed, merge their talents and products if this will create more value than the separate entities.

2: The rookies: winners and survivors
The rookie year will make the decision if you are a winner or a survivor. Investors will create classes, and they will make the decision which road to take for the startups. Those winners will close huge rounds and will aim for the world in 2014. The dropouts will start over in the early-stage companies or seek rest in corporate jobs.

A closing note for the players

Robert Griffin IIIOne more thing: For Berlin, it will be a “make or break” year. After successful years, we see a correction development process starting, since some months ago.

It will be important to see how founders, investors and journalists adapt to the expectations of markets. Important investments have been made by well known VCs into the local ecosystem. But next moves need to be made, promises need to be kept and the ecosystem needs to mature.

It won’t be just enough to stay on the same level and do what has been done over the last years. Other ecosystems and regions are up to your heels, so watch out for not losing your advantage versus those locations. They will be happy to take funding, press coverage and talents away from you. Avoid it by any means, even if it means befriending your enemies.

For all parties it will be of the essence to make tough decisions early in the year. Go “All In” or “Pass” on your cards. There will be no “In-Betweens” in 2013.

For the survivors (rather than the winners), Robert Griffin III has a quote for you, too. When walking off the field that night, after defeating the Dallas Cowboys, he said this to Tony Romo – the quarterback throwing the game-deciding pass interference at the end of the game:

“Hey Tony. I just wanted to say to you, don’t listen to what anybody else is saying about you. You’re a great quarterback, man.”

Take his advice, move on and start over in the next season.

Image credits: Richard Griffin III, by Keith Allison (and again); poker chips, by Reza Vaziri; gymnast, by lemonjenny; poker face, by lawrencechua; chalkboard, by Proctor Archives

This article originally appeared on Thomas Grota’s personal blog, A Personal View on Venture Capital. Follow him on Twitter @thomasgr

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