March 30, 2012 Leave a comment
An area that is often lamented by European entrepreneurs is the conservative approach that their target investors take to achieving profitability relative to their American counterparts. Whilst I don’t dispute a difference in attitude and appetite for risk, if you read some of the underlying thinking behind these investment theses and think through the logic behind investing in Fred Wilson’s “large networks of connected users”, I don’t believe American professional investors are discarding the importance of commercial success to the extent we may believe, rather they have changed their metrics. Anecdotally it is also interesting to hear that companies like Facebook were actually profitable at a very early stage which is probably a departure from conventional thinking.
The first implicit assumption that our US contemparies have become comfortable making is distinguishing bottom line profitability from unit economic profitability. It’s clear to me that the value of an Internet/software company should derive predominately from its ability to grow extremely rapidly (accompanied by potential to sustain/accelerate this), closely followed by the underlying unit economic profitability and its future prospects. That being the case “Net Profit” is no longer as relevant a measure of value in a startup or even developed Internet/software business, but financial guidelines are still needed to help steer the business. Bessemer’s 6 C’s of cloud finance do a good job of this (http://www.bvp.com/cloud).
It’s not just the software markets that are being disrupted, it’s the way these companies are being valued too.
Take the large networks of connected users. By 2001 it was clear that Google had stumbled upon a way of effectively monetising an internet service that drew in the attention of millions of users. That monetisation has clearly been spectacularly successful. Is it really so difficult to believe that Facebook, Twitter et.al will be able to capitalise on user engagement to achieve significant commercial benefit?
The ability of US investors across the spectrum to appreciate and adopt a shift in valuation metrics, from investors in Salesforce at 10X revenues to start-up investors, creates the funding eco-system that is necessary to provide these companies with an unfair advantage in financing their quest to capture global markets.
That unfortunately is where we Europeans come unstuck. Much as we’d like to build the global Internet and software companies of tomorrow, unless those that advise the larger providers of capital this side of the Atlantic wake up, early stage investors in Europe have little option but to raise growth capital in the US (and hence start to migrate West) or sell early.