On Rich People and Startups
Today: European startups need money; rich Europeans have some. But is it really that simple?
The Agenda 👇
Should wealthy Europeans invest in startups rather than real estate?
Takes from Hussein Kanji, Dragos Novac, Dominique Sistach
Why it might be too early for rich people to get involved
All about financial repression, with Byrne Hobart and Joe Studwell
All about elite overproduction, with Patrick Ryan, Matt Clifford and Sarah Taber
Thumbs up/down for last week
Sifted published a piece about why rich European people need to change their allocation habits and deploy more capital in tech startups. I admit to not reading the entire thing—I basically stopped when I saw that the main source, German investor and TV personality Frank Thelen, was the host of Germany’s equivalent of Shark Tank. But the article kept crawling back into my orbit in two ways.
First, Hussein Kanji of Hoxton Ventures said that he doesn’t want such people joining the venture capital industry:
Second, Dragos Novac dedicated the better part of yesterday’s edition of his weekly Sunday CET to the topic. Let me quote Dragos directly:
The easiest and most straightforward way to get rich is to buy something cheap and sell it more expensive, as fast as possible and as often as possible.
However, investing in innovation or new tech means a different behavior and way of thinking, as it hasn’t been done before, therefore there’s a lot of unknowns and risks and no clear path to return. The probability of good multipliers, if any, is very low and that is why the good VC business is terribly hard in spite of an apparent glam and being seemingly easy accessible. And fact of the matter is that European wealthy people have little experience with this kind of deals.
Historically throughout the past hundreds of years, the European rich have mostly made money from information asymmetry i.e. buying cheap and selling high or other ways that may or may not have involved conquering countries and doing other crazy stuff that’s in the history books but that’s the topic for another discussion - when you have done this for a long time, it is hard to change your modus operandi and mindset.
That is why now they may be reluctant to take risks investing in things that have never been made before, their behavior is intuitively influenced by a different pattern that involves familiarity.
I’m interested in this topic for several reasons. I think I first realized why wealthy people can contribute to under-development with bad allocation decisions in 2012 when reading an article in a local newspaper about the real estate market in Perpignan, in the south of France. Here’s a rough translation (social scientist Dominique Sistach speaking):
Thomas Piketty is now observing what researchers from Perpignan have noticed here for twenty years: an economic culture based on rent. One does not need to be a PhD student in economics to understand that when capitalism does not release enough cash for investment, companies die and unemployment rises. Here, the investment economy has taken precedence over the productive economy. This reproduces the social framework of unproductive haves and have-nots who will soon be scapegoated for this cumulative and visible poverty. Capital has flowed back to where more wealth is produced. Here, it has flowed back into real estate wealth. But real estate is the worst investment. We earn little but we earn for sure. This is the case almost everywhere in France, but here the trends are heavier; we find ourselves in a system where very few people own the vast majority of the assets. The big names and investors have left the city and the department these last fifteen, twenty years for Barcelona, Paris, London.
Perpignan has always been afraid of the elite. It's not just a myth to say that its people have always been wary of economic development because they were afraid that a business leader would have plans for Perpignan or simply take over the city. Paul Alduy [the mayor from 1959 to 1983] thus refused the opening of a University Hospital Center, hand in hand with a university president. They had a negative view of doctors running the university and positioning themselves as notables in the city. There was also IBM which wanted to set up in Perpignan, which Jean-Paul Alduy [who succeeded his father as mayor in 1983 and remained in office until 2009] did not want. The same thing happened, in the seventies, with the industrial development of the Vallespir Valley. When the clothing factories closed, the socialist-elected representatives of the time were not dissatisfied and did not seek to replant seeds.
Only later did I discover works such as Why Nations Fail by Daron Acemoglu and James A. Robinson, and then, in Joe Studwell’s How Asia Works, the concept of “financial repression”:
Studwell’s thesis of “2 policy tricks and 1 prerequisite” requires the last “trick” of development exemplified by the East Asian economies: financial repression. Unlike Southeast Asian economies, Japan, South Korea, China and Taiwan employed financial controls that trapped capital in the country to aggressively finance export lending.
For Studwell, the key to development is, thus, not laissez faire economics, but rather strategic policies implemented by political leaders that generate capital accumulation and, eventually, rapid growth. [Source]
In general, as explained by Byrne Hobart in Lessons from the East Asian Economic Miracle, the concept of financial repression means that people in a given country have to tighten their belt if they want the local economy to develop: it’s about investing collectively in a productive capitalist economy, so as to have a chance to reap the rewards down the stream. Here’s the process as described by Byrne:
Invest the trade surplus from food into light industry, i.e. textiles — this is a business where the main input is unskilled labor, so any poor country with a port and a smidgen of capital is, presto, the global low-cost leader.
Invest the trade surplus from that into heavy industry (at first: steel and basic chemicals; eventually heavy machinery, cars, specialty chemicals, electronics).
Relentlessly push your heavy industry to export; sell products that can compete globally, even if you’re taxing your population to subsidize your exporters.
On that note: use aggressive financial repression; force people to save a high proportion of their marginal product (i.e. standards of living can rise, but should rise a lot less than GDP); direct that money into industries with economies of scale.
Once you are the scale leader in a scale-driven industry, you can relax. But only a little! Now you have to worry about somebody else copying you. Japan’s world-beating steel industry got copied by South Korea, and their car industry faced competition there, too; Japan also lost their lead in electronics to China.
I echoed this view (at about the same time Byrne wrote his essay) in Europe Is a Developing Economy (December 2019):
Studwell’s playbook addresses what he calls “repressing finance”—that is, that the state should prevent free movement of capital and force those with capital to invest mostly in developing the domestic economy. It comes with costs. When finance is so “repressed”, capitalists are pushed to renounce the higher returns that can be found in foreign assets.
And so you see why I’m interested in this idea that wealthy Europeans could invest more in local tech companies, thus contributing to developing the European economy over the long term rather than turning the entire continent into a giant version of the cursed city of Perpignan.
Why doesn’t it work? Dragos lays out the arguments neatly, so, again, go read his piece (TL;DR: the rich just want to make more money; investing in startups is far from being the most straightforward approach to doing that.)
Yet, on the other hand, you can read about all those famous and powerful people who actually deploy a lot of money in venture capital and use their wealth and connections to access the best deals. (This includes musicians, movie stars, athletes—see the cases of Jay Z, Ashton Kutcher, Serena Williams, The Chainsmokers.)
Here’s my view: you need to make a clear distinction between a mature/advanced/healthy ecosystem, such as that in Silicon Valley, and one that is the opposite (immature/lagging/toxic), which is the situation in Europe. In the latter situation, rich people might invest in startups but they won’t do much good for the founders they back—except, maybe, funding their education.
A case in point is Fairchild Semiconductor, the company that’s seen at the origins of Silicon Valley. Some people know that the launch of the venture was thanks to now-famous financier Arthur Rock (who went on to found the VC Firm Davis & Rock). But only a few of these people realize that Rock didn’t deploy venture capital per se. Rather, he arranged financing so that the new venture would become a wholly-owned subsidiary of East Coast industrial company Fairchild Camera & Instrument. Later, the impossibility of working in such a setup led to the decision by Robert Noyce and Gordon Moore, two of Fairchild Semiconductor’s co-founders, to leave and start Intel. Fairchild didn’t become much, but at least the investment served as a major learning experience, launching the highly consequential career of Noyce and Moore.
Given an immature ecosystem, there are two options. One is that you can lure rich people into venture capital and let them waste some money so as to contribute to starting the local ecosystem. But I’m not sure that works: after all, rich people are usually either smart themselves or they have smart advisors, which means they won’t stay long once they realize they’re losing money trying to kickstart the still-immature local ecosystem.
The other option (one that I think is much more preferable) is to have these rich people do their thing, as in restructuring and repositioning their family businesses (see the case of Bertelsmann, as described in my Can Legacy Industries Survive? The Case of Music), without interfering too much in the lives of tech founders—who, in turn, should learn to rely more on foreign capital than domestic (like was once the case in Israel and is becoming more and more the case in Europe).
Only after the local entrepreneurial ecosystem shapes up can these rich people be invited to deploy capital in startups. At that time, it will happen on the startup community’s own terms rather than the ones imposed by people who don’t have a clear understanding of what they’re investing in. (In the meantime, rich people can become LPs in VC firms that invest in Europe since, as suggested by Hussein, it’s better to leave the pros in charge.)
Let me mention two additional dimensions to this discussion:
Here is investor Fabrice Grinda making a fascinating case for why everyone with at least 10M in wealth should spare a fraction of that to invest in startups: Nontraditional approach to wealth management (June 2017). Alas what we’re lacking there are wealth managers able to guide their clients into that world and secure good deals for them. About that, read my The Future of Wealth Management (April 2019).
And then there’s also the considerations about intra-elite competition and historian Peter Turchin’s idea of “elite overproduction”(about that, see Odin’s Patrick Ryan here and Entrepreneur First’s Matthew Clifford here). Remember what Dominique Sistach said about Perpignan above: rich people prefer not to see too much competition, which could weaken their grip over the local economy—and the problem is that startup founders are definitely emerging competition.
So rather than investing in new, innovative ventures, wealthy people clearly prefer to make them understand that founding a startup requires moving away for good.
By the way, in the thread below, Dr. Sarah Taber, a popular Twitter user on everything related to agricultural economics, makes the same point—highly recommended:
No wonder why rich people prefer to invest in stupid hotels (or in the US stock market) rather than risking their wealth in the still-immature entrepreneurial ecosystem that is Europe!
What do you think?
😀 More European controversies! My Sifted column about the EU investing in startups has attracted quite a lot of reader feedback, which Michael Stothard compiled in this article: Sifted readers respond: Should the EU put money into startups?
🙂 More DeepTech! We now have quite a streak of contributions on the topic of DeepTech startups in Europe—that includes me, investor Zoë Chambers, Bill Janeway, and now Dealroom Yoram Wijngaarde, who published this thread on their latest report on the topic (to which I contributed):
😏 Lots of writings these days about Jim Simons, the legendary founder of Renaissance Technologies. Noah Smith’s recent column in Bloomberg reminded me of Marc Rubinstein’s excellent Zuckerman's Curse and the Economics of Fund Management. Yesterday I ordered Gregory Zuckerman’s The Man Who Solved the Market, which I look forward to reading!
😐 Only a few days left before Trump leaves the White House. He might eventually be convicted by the Senate, but that won’t prevent him from issuing one last string of pardons. But then many problems are waiting for him: It’s Trump’s Money, Not His Brand, That Should Worry Him.
😒 I haven’t really caught up on the discussion around free speech, moderation and censorship triggered in the aftermath of what happened at the US Capitol 10 days ago. But I can only encourage you to have a look at what Ben Thompson and Benedict Evans have to say.
😖 Noah Smith is pessimistic about America’s ability to vaccinate its population. It stands in sharp contrast with Bruno Maçães’s view that the US is still doing much better than Europe on that front. Specifically, Noah’s vision that the US looks more and more like the Soviet Union was inspired by this:
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From Munich, Germany 🇩🇪
Nicolas
