There’s no denying it, the funding environment for start-ups has become almost as irrational in the current downturn as it was during the investment peak of the late 1990s. Venture capitalists (VCs) are pushing down valuations for quality, high-growth start-ups, and there is a danger of entrepreneurs giving in to them at these prices.
Not that we expected the high valuations of the past to remain unchallenged. The markets are down and exits are looking less profitable. VCs, understandably, have to be more discerning, and we have to be realistic.
But VCs are now in danger of leaving Britain’s brightest brains high and dry. My advice is that entrepreneurs should hold on to their assets and build them rather than sell out. Valuations are simply too low at the current time. Not only is innovation continuing, there are plenty of start-ups with technologies protected by patents, with customers in the pipeline and solid management teams in the driving seat.
If valuations do not improve, some entrepreneurs will just give up. Innovation Britain could come to a halt. And it’s not just because of the hard bargains the VCs are driving. It’s because they are taking fewer risks. They are venturing less.
Some venture capitalists might have taken too much risk in the past, as they scrambled over each other to invest in start-ups with little track record. But today, they seem willing to invest only in companies with a solid line of customers and with revenues rolling in. They only offer their capital once the risks have been taken by the start-ups. They are offering capital, but not venture capital.
As a sign of the times, we at Brightstar, BT’s corporate incubator, have had to make dramatic changes to our business model to combat the fluctuations of external investment cycles. When we launched the incubator in 2000, we relied on VCs to share the risk with us. They would fund the technologies that we mined from the 14,000 patents held in our research labs. Traditionally, we would find the best patents, rigorously examine their market potential, build a management team and only then approach venture capitalists for funding before the market launch.
Our model has now changed. We have now created an Accelerator to build companies in-house up to and beyond the stage when they have gained customers and revenues. In effect, we have cut the VCs out of the equation at the early stage. We are doing the venturing.
This is not ideal. We did not establish ourselves to take on all the risk of building enterprises. But we know that creating companies of real value is preferable to spinning them off to an uncertain future at too low a price. Our change in model will mean that in the future we will be seeking first-round external funding at a later stage. Our companies will have already proved themselves in the marketplace. In that case, BT’s shareholders, who will have taken on the risk, will be correct in expecting a higher reward, and it will be the start-ups driving the hard bargain, not the venture capitalists.
We have five companies in the Accelerator. Together they generate revenues of £25 million (€40.4m) per year. It is not that these companies are no longer receiving interest from VCs. On the contrary, the companies Brightstar has been creating have been attracting considerable interest and financial offers. But those offers are not good enough to secure the long-term future of our start-ups. We are simply playing a longer game than VCs.
For Brightstar, the change in model has been possible because we are a corporate incubator. We have some room for manoeuvre. And we are secure in the knowledge that we are based at Europe’s largest R&D campus. But I worry for Innovation Britain if stand-alone entrepreneurs and incubators are forced to give in to valuations from venture capitalists who are no longer venturing.