Friday, 14 January 2011

Coadec Panel - Government and the Digital Economy

On Wednesday night Techhub hosted a panel discussion organised by Coadec on government and the digital economy. No doubt the video will be up somewhere soon enough, but in the meantime here's a quick summary with some thoughts.

Big Apple, Big Smoke, Big Taxes
Several perennial issues came up such as taxation and shortages of skilled labour. More interestingly, the debate moved from the endlessly rehashed Europe vs The Valley to London vs New York, which is a much more useful comparison.  Looking at the east coast of the US we can probably pick up a few tips on how startups and tech firms can compete for labour with the finance sector. On the subject of New York, Sean Senton-Rogers of PROfounders Capital noted that once you take into account all the relevant taxes, startups actually pay more tax in New York than London. Similarly it was mentioned that Dublin's low corporate tax doesn't really make much difference to startups (and presumably is done to favour larger companies who are considering expanding to Europe).

Too busy to care about government
On the topic of the hastily enacted digital economy bill, Wendy Tan of Moonfruit highlighted that most startups are so focussed on minding the shop (quite sensibly) that they don't have time to consider government policy making. This is a particular problem when their interests may not be aligned with those with more lobbying firepower. Tory MP David Davis suggested that this doesn't mean that startups should get together to hire expensive lobbyists, but rather that they need to become more effective communicators. I'd be curious to see how this is handled in the US - can early stage startups abdicate this responsibility to VCs and grown-up startups like Google? Sean suggested that individual VC firms could do more, rather than relying on the BVCA, although one would assume government lobbying is one of the main reasons for the BVCA's existence.

The opposite of Dr Beeching
Regarding the thorny topic of net neutrality, David Davis made the observation that were we to have huge oversupply of broadband, we could make it a moot point. A few tweeters wondered how this could be reconciled with small government, but I'm not sure this is a huge issue. There's a big difference between governmental nudges to push infrastructure in the right direction and wholesale nationalisation as suggested by someone in the audience. If the marginal cost of increased bandwidth is relatively low, then this doesn't seem like a bad idea, although it carries the risk of the overcapacity being rendered obsolete by new innovations.

Politics 101
It was good to see two MPs that seemed to have a decent handle on tech affairs, and they made the point that if you want politicians to educate themselves on an issue, then the best way to do that is to make it an election issue. This presumably is the House of Commons equivalent of the classic schoolboy "Sir, will this be on the exam?"

Focus, Daniel-San
Overall a worthwhile way to spend a few hours, with a good turnout. The panel was probably a little too large to allow for proper discussion, but I'd be hard pushed to say who should have been dropped. Perhaps an event more focussed on a single issue might be an option for any future sessions.

Wednesday, 5 January 2011

Government and Startups: Financing

How can the UK government help with startup financing?

London co-working space Techhub recently hosted an event featuring a Q&A with government minister David Willets on the topic of how the government can help the local tech startup community. Several interesting points were raised, but the two main issues seemed to revolve around finance and labour. In this post I’m going to focus on startup finance and I'll do another one later with thoughts on labour issues.

All businesses need capital in order to function - both seed capital to get going, and further capital to grow. Broadly, this capital can take three forms, and the government can assist with all three.

1. Debt Financing
There was some discussion during the event about how banks weren't lending to startups. It’s important to understand that banks aren't generally in the business of risky financing (relative to equity). Banks will only lend where there is reasonable expectation that the borrower will be able to meet the repayments schedule. This normally means either stable cashflows or reliable outstanding receivables. They will often want personal guarantees or collateral. 

The Silicon Valley Bank coming to London is good news - they’re a bank which knows how to deal with startups, and will no doubt make life a bit easier as well as encouraging other banks to up their game. But ultimately they are a bank with exactly the same fiduciary duties as any other bank - they're not going to be handing out credit like candy.

Debt financing may also come in the form of loans from friends and family. I'm not sure structuring this kind of financing as debt is a particularly great idea since most likely they’re taking on quite a lot of risk for limited upside, and so it's a better deal to offer them equity. However some might prefer the simplicity of a loan. 

How the goverment can help: In truth I think there’s not a lot the government can (or should) do to interfere with bank lending procedures. Schemes like the Enterprise Finance Guarantee are a useful short term measure for a tight economic climate, but will only help those on the margins of lending decisions. 

2. Equity financing
For the vast majority of startups, equity financing is the most important source of capital. Equity investors will usually specialize by sector and investment stage depending on the level of risk they are willing to take. Early stage investment will usually always be riskier than later stage.

Equity finance might come from individuals (business angels, friends etc) or from institutions such as VC funds.

How the goverment can help: As with debt finance, it's not the government's job to change investment criteria or decide which individual businesses should get investment. However there are at least two ways the government can increase the total quantity of equity capital available for early stage ventures -

a.) Capital Gains Tax. The presence of taxation skews the risk-reward curve, since it affects the ultimate cash return from the investment. By reducing capital gains tax investors get higher returns for the same level of risk.

b.) Increasing the supply of capital directly. The best way to do this is to invest alongside outside investors with an existing fund manager. This is exactly what ECFs are designed to do. It would be great to see some top tier VCs participating in this program. David Willets promised to come back for a second session with somebody involved with the ECFs in January, so keep an eye out for this. In particular it will be interesting to see what the minimum investment amounts are for these funds and how they can balance that with attracting the best fund managers.

3. Internal Financing
Finally, the best kind of financing is from customers (i.e. from revenues). Typically most startups will not be able to make enough from this source to fund high speed growth, but we shouldn't ignore this as an source of finance.

How the government can help: Buying from startups. This includes making startups aware of opportunities to bid for government work, and also the “competition prize” model for innovative solutions as with the Technology Strategy Board.

Should the government help with startup finance?
We've addressed some of the things the government could do to assist startups. Whether they should do these things or not is more difficult question. Some will carry a financial cost (like reducing CGT), which may not lead to an immediately measurable return. Every pound spent in this way is a pound that could be spent on more established industries, the NHS, education etc and is ultimately a policy decision for the government. 

In addition to the usual government capital allocation problem, any situation in which a the government is directly injecting cash into startups risks crowding out private investment and ultimately weakening the ecosystem. This kind of intervention only makes sense where there is market failure, and it's not immediately clear that this is the case. 

Saturday, 1 January 2011

Charity begins at Startup

I usually like to get some reading done over the holiday season. In truth this means I order a stack of books from Amazon and then maybe get through a small fraction. This year, top of the reading pile was Behind the Cloud by Marc Benioff, recounting the early days of CRM startup

It's a worthwhile read if you look past the occasional veneer of self-promotion, and one of the things that caught my attention was the chapter on corporate philanthropy. Charitable giving by corporations can be a tricky topic; while the end goals are usually very worthwhile, it can be hard to avoid the image of a company reaching into shareholder pockets to donate money on their behalf. 

In general, corporate giving (in cash or kind), like any corporate spending, should only be done where it results in a return greater than could be achieved by a shareholder donating the money themselves. There are many cases where this is true and results in value creation. 

The problem with corporate social responsibility programmes is that they can often seem like a bolt-on or afterthought on the part of the company. Salesforce took an interesting approach by insisting that giving back to the community be embedded in the DNA of the company from the outset. In particular, Marc Benioff and his co-founders created a charitable foundation at the same time as incorporating their company, and donated 1% of their equity to the foundation.

I love the simplicity of this idea - it requires no cash outflow and ensures that the foundation's endowment grows alongside the company. 

I'm not necessarily suggesting that all startups follow the foundation-on-foundation idea. In most cases it's probably not worth the paperwork until you're making real money. But it would be a simple thing for startup founders to agree in principle to set aside a small chunk of equity for for a foundation, much as they would with an employee option pool. Alongside agreeing to set aside this equity, it would be prudent for the founders to decide on the guiding goals of the foundation.

In addition to the initial 1% equity, Salesforce also donates 1% of employee time and 1% of profits (in the form of software discounts to charities). They also took the quite unusual step of moving all their education and large NGO customers to the foundation, providing the foundation with a sustainable income stream. 

A big advantage of baking corporate philanthropy into the core of a startup from day one is that all employees and investors know what they're getting into up front. Is this likely to put off some investors? Possibly. But as long as appropriate safeguards are in place (regarding rules on profitability), it may even attract investors that are better aligned with your own goals.