Go Deep — a VC Investment Strategy
By John Spindler CEO of Capital Enterprise
John Spindler, CEO of Capital Enterprise and Co-Founder at AI Seed, describes the four frameworks that guide VC investment strategy with regards to AI First and Deep Tech startups.
Recently, I had a conversation with two partners from well known American VC’s who were in Europe to look over our startup ecosystem. They commented on the fact most VC’s they saw in Europe were not differentiated by “Investment Thesis” and the vast majority of European VC’s they met had boasted of their ability to make great investment based on either their ability to attract great startup founders, preferring founders of previously exited startups (the Venus Fly Trap model), or their ability to sit on a fire hose of startup deal-flow and filter out the bad ones while building pearls out of the good ones (the Oyster model). They mentioned that it must be difficult for startups to know who to approach when every investor states they invest in great teams who build great products in big markets. (Who would purposely want to invest in the opposite?).
We talked more and aware that I was not immune from their criticism, I put up a sturdy defence of our investment thesis at AI Seed (So I thought). There are, in my understanding, 4 basic frameworks that guide a VC’s investment thesis. All of them ( I do not know why) have a nautical theme. They all carry varying amounts of execution, market, technical/product, business model and return risk that will face anyone who invests in ambitious tech startups. The strategies are :
Red Ocean — Go where the market is today. Remove the fear that there is no demand and back great teams with better customer focused products to beat the numerous competitors that are feeding on the target market’s evident insatiable demand for a new solution to an evident and growing problem. The hope is that the startup you have backed after years of battle becomes the biggest fish in this red ocean. Think markets like Cyber-security, think HR tech, think Data Analytics. The problem is it is literally a bloodbath and with little or no early signals, if you invest at the Pre-Seed, Seed or even Series A stage, on who will win or even what winning looks like in these easy to enter, quick to market traction but hard to scale “Red Ocean” markets. Investing in startups in these markets looks tough to me at pre-seed unless you can find a startup that has a superpower (probably beyond being a great team that can execute) that can beat all the numerous rivals.
Blue Ocean (Long Tail) — Is it still possible to take a recent technology (e.g. AR) proven in another market (e.g. China), a new proven business model innovation (e.g. e-commerce as subscription) or execution play-book (e.g. Cookie Cutter) and apply it to a market that has yet to be disrupted, which has few or no competitors and where first mover advantage could be crucial. Are you the “ByteDance for …” , or the “Uber for ….” , the “Twilio for …”? Rocket Internet made a fortune on this strategy but how many Blue Ocean markets or long tail niches are left to cross/conquer in Europe and what off-the-shelf models, new technology or playbooks are right to use? Recently it hasn’t been easy to find Blue Ocean/ Long Tail opportunities but they will be there.
Ride the Wave — The biggest and bravest of all investment strategies for it requires you to invest in startups (paddling on the ocean on their surfboards) before the big wave builds up on which these startups, and the applications they have built, will ride to market dominance. This big “wave” when it hits the shore will destroy all the existing strategies and advantages of the market incumbents and enable these wave riding startups to become a billion dollar company. So the story goes. Think Mobile First and then what Facebook did when it realised it missed the wave and needed to catch up. Think what Microsoft did when it realised it had to be Cloud First, or how Calm has rode and amplified the mindfullness wave or how Babylon Health is riding the growing wave for remote diagnostics. In recent years, DLT/Blockchain was the big wave on which new enormous companies would be built upon and in the USA big VC’s raised new funds, and in Europe smaller funds, to support startups to ride the Distributed Ledge Technology wave. Who is still brave enough in Europe to back their conviction on what is the next big wave?
Go Deep — Deep Tech is where and when solving the scientific or engineering challenge effectively creates a new market category or, if less ambitious, at least almost guarantees customer demand and a “Castle & moat” for your technology/product. In most Life Science investment going deep to solve a big scientific/engineering challenge, prior to entering a market is taken for granted. Then you are investing in the team, the research achievements to date, the likelihood of hitting technical and product milestones (including regulatory approval), the strength of the IP or “Castle & Moat” and whether the size of the prize is worth the risk given the likelihood of failure. When you are following a “Go Deep” investment strategy you need to give the teams at least more than one attempt to solve the technical challenge. You need to understand that if they solve the technical problem then it could create new markets and new demands and not just serve today’s customers, and that you will need to be sure, especially if you are investing in AI startups, that there will be a data or expertise moat strong enough to defend. The risk by going deep is that you need either deep pockets to fund the team all the way through to market (through the valley of death) or that once the teams reach technical milestones there will be investors with deeper pockets ready to invest. For AI First startups, we believe it is possible for a select number of AI First Startups to get through the Build-Deploy-Test-Repeat-until-right stage on very little capital and in many cases achieve early stage commercial traction that is sufficient to attract later stage investors. In 75% of AI Seeds portfolios, VC’s have participated in the pre-seed round (thereby giving us some reassurance) but it still remains to be seen if UK/ European investors will fund AI First Teams that have used pre-seed funding to build out world class ML models but have little repeatable income at present.
Finally, “Go Deep” can not only be an investment strategy but a pre-market entry strategy for a startup who needs to build a super-power (such as the ability to predict “insider attack”) that enables you to out compete others in a Red Ocean market like Cyber Security (Think Darktrace). The same pre-market strategy applies for Blue Ocean and Wave, and as you may of guessed, we believe this is a viable investment strategy for pre-seed investor like AI Seed.
So “Go Deep” is the “investment strategy” we are following at AI Seed and the one I described to the American VC’s I met. All strategies are not without risks but given our expertise and market position I think “Go Deep” is right for AI Seed and it is seemingly sufficiently strong to both attract great technical able founders (Venus Fly Trap) and to allow us to filter out the ones in our extensive deal-flow pipeline (Oyster) that we believe match our thesis, and that our post-investment can provide added value support to get them through the valley of death.
In my calculation there are presently at least 85 Series A funds operating and investing in scaling startups in the UK. I think going forward these VC’s will wait until startups reach product-market fit before investing and if they all follow the same go earlier move then they are also going to need to strongly differentiate their investment thesis to attract and filter out the best. Hopefully some more VC’s will join us in a “Go Deep Strategy”.
On Friday 12 July 2019, Capital Enterprise will be hosting a Members Event on the subject of Deep Tech. The event, “Accelerating Deep Tech Startups: Supporting the growth of Deep Tech companies”, will see us take an exploratory look at the Deep Tech sector in London. To register your place, please follow this link.
