Tuesday, 27 October 2009

How to fund the bailouts, part two

Thanks to Tory MP Brooks Newmark, we can now view the spiralling public debt in a new and more frightening way: that is, rising at a rate of £700,000 every minute. Quite an image, regardless of your political bent. It doesn’t end there.

As the angriest of angry bloggers, Wat Tyler, so eloquently puts it: if you add the cost of future state pension payments, throw in the liabilities of our two largest semi-nationalised banks, consider the burden of decommissioning our old nuclear power stations, and remind ourselves of our PFI obligations, that hole in the public finances does actually start to look a bit scary:

If we wanted to be cautious—admittedly not something our present rulers have been much good at—we'd say our real national debt is now in the range £7-8 trillion. Or around £300 grand for every single household. Gulp.”

Gulp indeed. But for the time being, the size of the debt is irrelevant. We can only begin making cuts once the economy is back on its feet. If nothing else was learned from the horrors of 1929, the importance of managing the recovery slightly better than the decline is paramount. A third-quarter contraction of 0.4 per cent suggests we are not ready to commence tinkering.

Whatever Cameron says, we must stop thinking of the public budget in the same terms as an everyday household budget. Households balance the books by spending less when the pay cheques become lighter. Governments do precisely the opposite. £700,000 a minute is a scary image, but every time we sensationalise the DEBT CRISIS, there is a risk of undermining valuable spending projects that only months earlier seemed perfectly reasonable. All that hyperbole increases the pressure on the Chancellor to say no to everything.

One sector up for review
is the UK's space industry. For those of you surprised to learn that the UK even had a space industry, it is worth recognising that British success in this field over the last few years has been largely incidental—at least as far as the government is concerned. We spend about £200m of public money a year on space, a pitiful sum considering the sector’s huge contribution to our economy—70,000 jobs and more than £6bn in revenues. But space is precisely the kind of industry that needs continued financial support to go on producing a net benefit.

The Space Innovation Growth Team (IGT) is currently preparing a plan for the next 20 years of UK involvement in the sector. The report, due in December, will outline how to turn a potentially greater government subsidy into a competitive advantage. There is of course a very real chance that the report will be ignored completely. And here, in a nutshell, is the potential DEBT CRISIS fall-out: industries that contribute vital skills and revenues starved of the necessary investment capital by unnecessary meddling.

Europe’s space industry is only as competitive as ESA, one of the space industry’s largest client, allows it to be. It is no coincidence that French lobbying of ESA is much more effective than UK efforts. France’s government spends almost £2bn on space—ten times the UK’s contribution. That £2bn is very difficult to ignore. When those lucrative private sector contracts are handed out, it is the countries that have sufficiently greased ESA’s palm that triumph. It may not be particularly democratic, but these are the rules. Making poorly timed, schizophrenic spending cuts may remove us from the game entirely.

Tuesday, 6 October 2009

Fred Destin’s ignorance theory

A few days ago, I had an interesting chat with Fred Destin, Atlas Venture's ebullient technology partner. Atlas bought a stake in the property website Zoopla at the beginning of 2008, which wasn’t exactly a fun time to be involved in the property game. It was also a pretty difficult period to source capital in any sector—all in all an investment climate fit to make even the coolest of VCs twitch. Destin, who has a seat on Zoopla’s board, adds that at that stage, his firm’s investment was in “two people and some PowerPoint slides”, hardly an invulnerable guarantee of success.

It is often said of European VCs that they lack the gumption of the Sand Hill road mob—the kind of formalised chutzpah that turns garage upstarts into grade A businesses. European investors, it is said, need data, data and more data, followed by proof of concept, before they are willing to stump up any capital. And to some extent that remains true. But Destin added an interesting spin.

The problem with European investors, he told me, was that even when faced with unmistakeable proof of concept, they tend to undercapitalise, thus hampering their investment’s ability to scale to its full potential. Put it this way: not many US VCs get accused of undercapitalising a potential winner.

He also did a great job of making early-stage investments sound very much like sticking it all on red and preying to the gambling gods for clemency. Destin says he actually prefers working with unknowns. He says:

“Our job is to manage risk proactively. We don’t think about it as a casino at all. We scrutinise and think about it very hard. But it’s our job to take these shapeless risks. I am early-stage, my natural DNA is around early-stage. It’s tough to make investment decisions without much data, [but] that’s what makes it exciting. Your average market practitioner does not know how to deal with that level of risk. You take data away and they panic."

Conversely, Destin says he revels in a vacuum of information:

“I profess ignorance and use that as a tool. I can assess market attractiveness. I can assess the management team. We then make absolutely no assumption as to what’s going to work because if you do, you lock yourself into a strategy that you haven’t [yet] proven. You tend to be internally led rather than market led. This is where the risk may seem inconsiderate because you’re willfully declaring ignorance about the market you’re addressing.”

But ignorance allows you to

“…force yourself to be smart. You use what you know in terms of company building, supporting entrepreneurs, discovering the market. We will design the product around what the market needs with an intuition, but then we’ll go and test it. We don’t want to be smarter than the market we are entering.”

And here’s Destin’s view on Europe’s investment weakness. There are, he says, three stages involved in readying a start-up for potential greatness:

“At Atlas we call it ‘prove-build-scale’. You spend very little at the prove stage. You have 6-15 people, spend as little as you can proving the hypothesis. The build stage is [about] scaling up the management team, adding talent, putting in place the technology you need to accelerate. Only when you’re ready can you understand how to scale properly, go into a big investment round and hit the accelerator.

“I think that Europe usually fails on the third category: we tend to undercapitalise the businesses that are doing well. And this is where we get a competitive disadvantage to the US. They have a tendency to overcapitalise early, but when they scale they scale well because they are able to raise repeat large rounds of money to really capture an opportunity.”