Wal van Lierop (Chrysalix): We are more than just a financial investor; we are a very active contributor to scaling up companies.
30 Nov, 2021
Stuart Chapman is Director at Draper Esprit. Before that, he was a Partner of 3i Ventures. He was also a founding partner of 3i US. Stuart had 13 years of venture capital experience with 3i in Europe and the USA. While he was at 3i US he was responsible for 3i’s investments in Still Secure, CollegeNet, and Appshop. Following his return from the US in October 2003 he was responsible for 3i’s investments in The Cloud, Telecity, and Searchspace, the IPO of Pixology, and the sale of Magic 4 to Openwave. He is a member of the British Venture Capital Association Council. Prior to 3i, Stuart was involved in software and systems implementations in the Banking sector.
I took that well-worn path of luck if I’m being brutally honest. I left the University and worked for a UK bank which is now HSBC doing arbitrage systems for enabling Latin American debt trading. This was in the late 80s. As a graduate entrance of that bank, you could join other graduate schemes of that bank or their subsidiaries. One of the companies that Midland Bank, HSBC now, had a 15% share of was 3i – the largest venture capitalist here, in Europe. So in 1992, I made a jump from business support or business analyst role to 3i, becoming an associate, and I learned my VC trade at 3i for the next 13 years.
It goes back to 1992 when I talked to my team at Draper Esprit about the olden days. They think that the “old days” is when you didn’t have an iPhone. So when I explained to them we did actually do venture capital with no mobile phones and with no Google, and when you wanted to learn about a technology you have to go to the library – a very strange concept, but you would have to drive to a local university library to find out about the tech. The very first one I made my name on was a printer hub – software to manage a wide area network within office blocks, because back in those days you used to have a printer either per desk or per pod, and one of the most inefficient things was the polling of the request to the printer. This was a piece of software that gave us your wide-area hub. Not very exciting in today’s language, because it’s so easily understood, but back then you were either an HP printer shop or a non-HP printer shop, and the World split 50/50. That little company I backed in Sussex happened to own the other 50% that’s applied all of the Japanese printers – NEC, Epson, Canon. The business went from nothing to £10-20-50M, because it was the only one supply and non-HP one. This company was killing it. That was the early success story that I had. But I can remember many many stories of when you used to have to go and find new businesses, you used to have to drive to an industrial estate, then with a pen and paper write down the telephone numbers of the new companies that were springing up, and then you go back to your office and you ring up and ask for an appointment to meet them to try and sell them the concept of equity and the fact that, if he was to raise money outside of the bank, he could grow his business faster. We spent most of our time trying to educate an entrepreneur to think bigger and take the money, about the price or the entry or anything like that. It was a very different time and venture capital was quite pro vocal compared to what it is now. My favorite business was actually in Healthcare. I backed out a spin out of Manchester University, the husband and wife team. They had to give me a tutorial before the board meeting, so when they announce the clinical trial results and what was happening I could understand what was going on. When we got to the P&L section, I myself had to give them a tutorial about the capital markets and how are we going to grow their business. That was kind of a weird existence of mutual ignorance. The board meeting was quite weird because we spend half of it in deep science and the other half we spent arguing with the university about the cost of desks, or analysts and associates. It was my first experience in spin-outs.
Today I spend most of my time running Draper Esprit, the public company that Simon Cook and I founded in 2006 as a conventional VC fund. In 2016 we went public, we listed the vehicle in the assets. Now I do less of the fund’s job, which is meeting entrepreneurs and making investments, and do more of the entrepreneurs’ job which is running the business. At large, we do the three ways. There are not many funds that are billions in size or larger, and if you’re looking for money from one of those top 10 funds, you will find us. We outwardly use our networks to make sure that we can get netbooks into the best entrepreneurs. Thirdly, we pick up on themes, we do thematic research and then try and find people of like mind that believe in the themes that were looking to back. Typically, those would be the three ways that people find us.
Simon and I are both ex-3i, and 3i is a public vehicle. So it wasn’t scary, I guess it is the first point – we have seen it before. We had acquired a manager of the Prelude Trust, and investment trusts in the UK are public, in 2006, so he had experience of managing public shareholders. In 2015 we had a choice – to raise money in conventional fund size and structure or take a City-lead syndicate of money, which they were happy to invest but they wanted it to be in a public vehicle. The attraction of the City-lead structure was in that they wanted to do Series A and Series B investments which is what we do, but they wanted to be able to fund those entrepreneurs all the way through to their ultimate success point. So one of the attractions for us was actually being able to provide the entrepreneur’s money all way through their life. Being an entrepreneur that has to raise money and the CEOs that we back, fundraising, I think, it sucks! It’s a negative experience, time-consuming, you have to meet a lot of people who don’t even have the courtesy to call you back. I sympathize with the entrepreneurs who come to us in that regard because I had to do it myself. Being public enabled us to do that. The last reason is that, as a venture capitalist, I have the privilege, and honor to see some of the most inspiring people who want to change the world. In return they let me invest in a structure that was first deployed in 1956 and hasn’t changed. How does that match the dynamism of the venture capital and a desire to innovate, if we’re stuck in something that’s 70 years old? We shake the hands with an entrepreneur and say, “We’ll be with you from the start to the finish,” knowing that to build a really big business takes many years, but I just invested in you from a fund that gives me 5 years to harvest the investments. It is an illogical contract. We went public because we could and because we had a back-in and had money to support us, but the other side of that was that we think that the GP/LP structure is not great for an entrepreneur.
Two numbers. The first number my colleague on the board calls “the vanity number”: we have somewhere between 2,500 and 3,000 business plans in the system a year. To be brutally honest, it’s about 500 to 1,000 that fit the criteria for a venture capital transaction, and then it is about 100 to 500 that fit our criteria. If you ask, how many companies do you do second meetings with, it’s in the low 100. We invest in about 12 companies. The lowest number was 8, in 2009 when the financial crisis hit, and a high point of about 16. On average, it’s around 1 per month.
We say that we do tech only, technology with a small “t.” We’re not talking about the creation of intellectual property, but about the exploitation of it. We cover four main areas which are Enterprises, Consumer, Digital Health, and Deeptech which is actually more than expertise or silicone for us but it does cover things like Material Science. Of those 4 areas, you can almost find any business in tech that falls into one of those. The reason why we do the 4 distinct areas is not to put all your eggs in one basket. My co-founder Simon left me at 3i late 1999 to join an internet fund. That was really good until 2001 and then it sucked. Simon learned that lesson that you don’t want to be all in one asset. Myself, personally, I think, you can invest in hardware, but you’d better understand the silicone that is going to drive improvements beyond the vision or storage or connectivity, you’d better understand consumerism about it, how you’re going to sell it, if it is not well, you’d better understand Enterprise, if it’s going to be a data play. I think we do the 4 segments because for an investor to have an appreciation of 4 inputs to a business makes them a better investor and makes them more valuable entrepreneurs. That’s why we do it.
We have worked out the way pretty rubbish at seed investing. I made this claim because really good seed investors are not necessarily great A investors, and it definitely works that great A investors are pretty hopeless as seed investors because your role is different. What we’ve chosen to do on the seed investing side is we’ve become a limited partner in 23, I think, European seed funds. We get exposure to the very early stage through them. We do about 16 1new deals a year in Series A and 6 new deals in Series B. Capital-wise it is about 30% of our capital goes into Series A and 70% of our capital goes into Series B, because the round size is going to be twice as large. Using the public vehicle we have the capability to follow our money at Series C and onwards; the shareholders that invested in us as in the public vehicle also want access to those businesses as they get to the very latest stage. In some ways, we are hoping that we can offer an entrepreneur an efficient way to have access to capital from seed all way through to pre-IPO and even at IPO and beyond.
We are European.
It’s always used to be that the entrepreneurs try dating us for a month and then we tried dating them for a month, then we beat up on the lawyers for a month, and you can close the deal from start to finish in 90 days. In some areas, it progresses faster in areas where we know we want to invest and we’ve already done all the education – it’s quite quick. The COVID, the year of 2020 is forcing us to try different techniques to be able to meet management teams and do what you would normally do in relationship building, face-to-face and how you do it from a remote perspective. I candidly say that it is making it harder and longer at the early stage because so much of the early stages is the trust between the investor and the entrepreneur, the shared vision, and the shared passion. Sometimes Zoom doesn’t cut it. We have done 4 investments since we’ve been in lockdown, March to September in the UK, just a couple behind a normal pace of 1 a month. They will have their issues about how we got them done, but we definitely don’t stop. If the UK will go in lockdown again, I think we get better at it.
Series A check now is probably around 5M (it doesn’t really matter what currency, to be honest, – dollars, Euros, pounds). Since we went public, that’s probably doubled. For Series B it is anywhere from 5M up to 25M.
I’m trying to avoid being a venture capital glip because I think this is a really important question. There are a couple of different audiences. To a limited partner audience venture capitalists will try to present a base case scenario of 3x their investment growth. If you raise 100 million, then they try and present a base case of 300 million return with an upside of whatever homerun they can hit. The outcome of our 20-year history assumes that we get about a third of our investments that will yield us between none to 1x. Then we have about a third of our investments that will yield us between 1x and 3x. If the bottom third yields you nothing and the middle third yields you 2x, those bottom two-thirds just get you your money back. If you want to return 3x the fund, you’re going to have to do 7 times your money on the top third. As a fund manager, I’ll say that we’re looking to return 3x a fund as a base, and if we are successful, then it’ll be more. As an investor, with every entrepreneur in our portfolio, I’m trying to work out how they can be in the top third. Actually, everything else is pretty irrelevant because any business that gets itself into the top third is successful by the very nature, and valuation of the returns tends to take care of themselves. You’re trying to look an entrepreneur in the eyes and say, “Can I get more than 10 times my money from this proposition?” Because it Series A, maybe, we can’t tell the difference between one that gets us nothing, one that yields us 2x, and one that yields us 10x, the easiest way to ask the question is, “I want all of you to have the potential to yield me more than 10 times my money.”
When I was growing up in venture capital and in understanding the job, one of the first tasks I was given was to work out what equity we should take for a particular deal. I must confess, I spent a whole weekend doing my discounted cash flows and my MBA evaluation models and I came up with the number 23.7. I went into the office, and the guy I spoke said that that’s a 25% deal. I said, “How can you work out that so easily? I spent all weekend on his models.” He answered, “Is simple: the management team wants 25%, the original investors are going to want 25%, the new management team will want 25%, and that leaves us the last 25%.” It always struck me the simplicity of how he’d articulated it because if I’m an entrepreneur, I’m going in with the knowledge that nearly every equity deal will get struck between 20% and 33% dilution. Once I’ve tried to work out how much dilution I’m prepared to take, the only thing I can change is how much money. If I want 25% and you only want 20%, then I can win by lowering the amount of money or you can win by increasing the amount of money to get to the same outcome. I do think from an entrepreneurial perspective there is a real lesson here which is “How much money do you really need? How much dilution do you really want to take?” I’m trying to run that equation, because if you only want to take 10% dilution, but need 50 million to be able to do it at the Series A, it ain’t going to work. Likewise, if your equity tolerance may be higher, but the investor is offering you not enough money, you want to make sure that commercially gets you the best deal. Our opening equity percentage is about 12%.
We all have our own barometers of success in this way, and it’s all governed by the people you’ve met in the past, their success, and how it comes about. I think, there are 3 key facets. People have to be out of following you. That means I have to be able to follow you, so you have to sell an equity story to me that sets the ambition and the goal and the morality and the DNA of the company and the ethics and what you’re trying to achieve, where we’re trying to go. Obviously, your current founding staff needs to follow you, but probably more important that new staff needs to follow you. As this founding team, you’ve got to be able to demonstrate you can hire the very best people. Secondly, you have to be able to listen. There are only two reasons that I’ve asked people to leave an investment committee presentation by the management team: the first one is lying and the second one is not listening. I just walk away. If you have me on your board (I’m 28 years as a venture capitalist, I’ve seen more businesses and more transactions than an individual entrepreneur would have seen), and if I say, “I’m not sure I would do it that way because of this and this reasons,” and you don’t even show me the courtesy of listening, reflecting, responding, then we’re not going to get on very well. I am not saying I expect you to do what I say, I am saying that I expect you to reflect on what I said and respond to it. Otherwise, I think, if you’re doing that to me, who are, potentially, an insider and on good terms, how are you going to do that to a customer or a potential trade partner or an ultimate acquirer of the business? The third key factor is a skill you could call storytelling, but really it’s about keeping the conversation high. Quantum computer is fashionable at the moment, there’s a lot of VC money chasing very abstract early-stage concert, and there’s a lot of entrepreneurs that tell me how it works. Quite frankly, it’s not really that important to the investment case, because it’s probably got another few years and few cycles before we know truly which way the market will play out. I rather hear how are you going to apply it. The storytelling is the thing that keeps people high in terms of this is a vision, this is where we’re going. And only involved people in the weeds of the technology or what you’re doing, but they ask for it. I coach kids, soccer, and cricket, since my son was 7, we go up through the ages. When you’re teaching kids football, you’re teaching them basic constructs: we’re trying to get the ball from the defense through the field to the strikers. When you’re teaching elite athletes, you’re not teaching how to pass the ball, you’re trying to teach them the finer points of what you do in transition, where should it be if it’s, say, on the left in transition, which man am I covering if we lose the ball. I think that the whole venture capital experience starts with treating the venture capitalists like a child in coaching – you’re just trying to explain to them what the overriding principle you’re trying to achieve is. And the goal is to put that little ball in the net. As people start showing interest and as we start again through the ages, you get to the point when they understand what you’re trying to do. There is a moment to tell them how you’re going to get there and why your tactics are better than the next person’s tactics. I like it when my management teams can go through the gears of a conversation while keeping it high about were always trying to achieve, and as we go through the gears you get more and more details in the tactics about how they’re going to get there. That way I don’t think you lose your venture capitalist along the journey.
The quality I like best is the founders who own the problem. I don’t mean from a control freak perspective. Do you know the James Bond film where an old man who was the Quartermaster, Q, was doing his exit from the film? He said to James Bond, “Always be in charge of your exit,” and then the elevator went down and he lifted it and left. For me, the best entrepreneurs are always in charge. When you come up with tricky questions, like “Am I good enough to be the CEO?” I’ve been a CEO for this business for 6 years, we’ve now got to a crossover point and now we need someone who is fluent in enterprise sales in Japan because that’s where our customer base is. Am I the right person? I like the CEO’s who says “I’m going to be in charge of finding my successor, of finding the right part for this company.” I don’t like committee CEOs, I don’t like people who go to committee decisions as opposed to owning them. Likewise, the personal qualities I love best are listeners. Out of the 2 characters you mentioned, Jobs would be quite difficult for me because he was autocratic. Michael Moritz wrote a book with Alex Ferguson about management traits (Leading: Learning from Life and My Years at Manchester United). He took the management traits of great investments and got Alex Ferguson to write how they applied to a football world. Moritz was having the Q&A and some of the floors asked the question about work-life balance. And he said that he has a great work-life balance – he’s got to write a book, got to meet Alex Ferguson, and make some Investments, I’m the chairman of Sequoia. The guy from the floor said, “Not you, stupid, – the entrepreneurs that you back!” Those guys have a 100/0 work-life balance. They are all slightly crazy. I must admit, I do feed off of the slight craziness an entrepreneur would put himself through and I do think you probably do need something like that, they do need that drive to prove themselves and prove their idea and prove their technology, and I feed off that as an investor. I think, if that was missing, it would be really quite a struggle for me to back them.
All the time! We rejected Skype because we already had a VoIP technology business in the portfolio that had 10M revenue, so why do we want another one with no revenue? We rejected Just Eat because in a pub Simon I on the back of a napkin couldn’t work out how many pizzas have to be delivered to make Just Eat make any money. We can play here: how you misread a market or how you get yourself in the position to call it so wrong. That’s part of a venture capital’s life. Google Earth came from a business that I founded as a startup. Instead of taking early IPO Google stock, we took cash – that was about a $600M mistake. I don’t think you should lose any sleep in that regard, otherwise, you’re going nuts. I do think you learn. Just take it to the next one and make sure you don’t make the same mistake again.
We do a lot in Health, and I’ve had a lot of success in Health, and I genuinely believe that a large part of venture capital is to do good. Because of the length of time and the specialism required to invest in certain health applications, it doesn’t work for our fund – we can’t do it that long and we don’t have that expertise. That’s a shame. I do think Digital Health which is nearer and we can invest will become a much more substantial part of our portfolio over the next 2 to 5 years.
Since 1992 I’ve been in a few crises. What happened at Drapers Esprit on the twentysomething of March is that we stopped work on what we were doing, we run an emergency drill amongst the investors on how much cash the portfolio companies got, how long have they got to survive, what’s their budgets, go get them to recap their budgets. It was a tried-and-tested emergency drill that you’re doing in bad times. The remarkable thing is that throughout that period we’ve invested relatively low amounts of what you would call “rescue money,” money protecting old money as opposed to money that is funding growth. Budgets did get cut, but people are now operating somewhere between the cut budget and the old pre-COVID budget. This has been remarkably positive, on the basis I predicted to be quite negative. The one thing I’m very worried about is: Let’s say, you have a good business, you’ll survive and will be doing great, maybe, it’s 10% or 15% growth. Trying to raise money the next year, when you’ve had 12 months revenue flip, is going to be a tough story. So I’m actually much more worried about it is not the survival rate in 2020, but about the growth rate in 2021, because my investors are going to have to change their attitude and not rely on this company growing faster than the market (that’s a proxy for success) because maybe the revenue numbers are not growing that great or not growing as historically great. But the Promise is still there, and that means your investors are going to have to work harder.
Do you know the Google eyeglasses? Back in 2000 that was one of my technologies. We ended up raising $65M, we became experts in everything from the lenses to the plastics to the optics to the design to the consumerism to the packaging. We’re a 3-5 systems company. We didn’t have any of those skills, so we had to buy them in at a time when the world was going badly wrong for tech. We lost so much money. In my post analysis, when we analyzed how much money we actually lost in the tech, it was nothing – we actually got that money back for the money that we spend on the tech. We lost all that money becoming experts in things that were peripheral to our skill sets. It told me a real lesson on the whole product and staying in what you’re good at.
I’ve got young investors in my team who are better at it than I am. I’ve been so impressed with that generation and their ability to work with entrepreneurs, create mutual value. No, I don’t think that. I do think that I will spend my latter VC years promoting education and tech between 16 and 25-year-olds.
I play golf, and the more I practice the luckier I become. People ask me what’s the role of a venture capitalist. I say it’s to help hire, to help fundraise, to make sure you don’t make the same mistakes that the previous generation has made, to get yourself into more positions to be lucky. People think lucky is like roulette, and I don’t define luck that way. As a venture capitalist, you’re working with your entrepreneur to help them to get into as many different positions to get lucky as you can. As a golfer, when you’re doing that 60 yard chip onto the green in the Masters, if this is the first time you’ve done it, the probability of you being lucky is low. If you’re a player and you’ve been doing it for 60 years, the probability of you hitting the right place is high. That’s my definition of luck.
Be honest with yourself. What I mean by that is some things don’t work out, some people don’t work out, and some dreams don’t work out. If you’re a CEO and you got to make one of those really difficult decisions, don’t duck it. The second one is around these “Listen, Reflect, Respond.” You talk the network and talk to as many different people trying to secure as many different mentors that can help you along the way – listen to them. But what they tell you is not necessarily gospel or is not necessarily fact. You’ve got to reflect on it, play it to your own situation, and then respond back on – it is really important. And the third one is never stop. The number of young entrepreneurs who we talk to, maybe, fall into the bottom two-thirds – their first idea may not work. That’s just the first one! It could be the first one of twenty. Don’t stop going forward where the forward goal is to make a difference, to be successful, to have a million customers, to whatever your metric of success is. But don’t stop!