Spotting the next big thing
Finding the next big thing in the tech industry isn’t easy. With thousands of start-ups clamouring for capital and investors’ attention, how do you know where to put your money? Klaus Hommels, one of Europe’s leading venture capitalists and a regular on the Forbes Midas list, shares his thoughts on VCs, spotting winners, and the European start-up scene.
As an investor Klaus Hommels started young. When he was a teenager, his grandmother gave him USD 20 000 and told him to buy shares. Any money he made, she said, was his to keep, while she would absorb any losses. The idea was that, at the very least, it would make him sceptical about banks and the financial industry. However, he wound up investing in the sportswear Manufacturer Puma’s IPO and tripled his investment – not a bad boost to his DM 10 per month pocket money.
He was hooked. Having been bitten early by the investing bug, over the next few years Hommels developed an interest in technology. In 1994, he joined AOL as its fifth employee. He was a main board member when he left AOL in 2000 to become an independent investor – just a few months before the dot.com bubble burst. He suddenly found himself unemployed with three children and a mortgage. It was touch and go for a while but, a few years later, his bets began to pay off. Early stage investments in companies such as Skype, Facebook, and Spotify helped to boost his profile and now, 15 years down the line, he is one of Europe’s leading venture capitalists (VCs).
How do you see venture capitalism developing over the coming years?
Venture capitalism is driven by innovation, and innovation is driven by Moore’s Law, which states that the number of transistors on a chip doubles roughly every two years. This means that for the first few years growth is slow, but then the exponential curve kicks in. If you think of the changes that took place between 1995 and 2005, they were fairly small, but the changes that occurred between 2007 and now, particularly with devices like the iPhone and the opportunities they have opened up, have been huge.
If Moore’s Law holds, by 2030–2035 an iPhone will be as smart as all human brains on earth put together.
We are now on the steeper part of the Moore’s Law curve. Mobile phones that are currently available have a processing capacity that is somewhere between the brain of an insect and a mouse. By 2023, or thereabouts, we’ll probably see devices that will have the capacity of a human brain. If Moore’s Law holds, by 2030–2035 an iPhone will be as smart as all human brains on earth put together. This is the underlying reason why the speed of innovation will only increase – and this amazing development will continue to fuel the growth of venture capitalism.
Considering the speed of innovation, how do you spot emerging growth industries?
I think there are big trends, but I don’t believe you can construct an intellectual model to help you identify growth areas or companies. If you could, then there would be huge numbers of smart people investing more successfully than me or my fellow VCs. When it comes to finding growth, it is less about applying a model and more about gut feel and imagination – you need to be able to imagine where current developments might go.
When you’re looking at growth industries, how do you identify the company that will become the next big thing?
You look at growth sectors like drones or mobility and then you try to understand the value chains of the companies within these sectors. Once you have achieved a good understanding of this, you identify your favourite part in that value chain. Next, you try to meet everybody who has some sort of business idea in the area of the value chain that you like.
The entrepreneurs who build great companies are always the ones who are on a mission to solve problems.
The overall goal is to find entrepreneurs who are on a mission to solve a problem, a problem which they are totally passionate about. Nobody who founds a company just because they want to get rich, gain social status, or look chic will ever succeed. The entrepreneurs who build great companies are always the ones who are on a mission to solve problems.
When it comes to investing in promising new businesses, what is the relationship between an initial high valuation and long-term success?
With internet businesses, entry valuation doesn’t really matter. It is simply the means to find a hygienic formula to integrate people who help you into your capitalisation table. As a VC, it doesn’t help to give low valuations and small amounts of money because then the entrepreneurs can’t do their magic. If you do this, you strangle them twice: first, because they lose so much of their own equity that they are no longer motivated, and second because you will probably have to give them a boost through stock options later anyway. The art of valuation is to understand the scope of the product and then give them enough money so you hit the sweet spot for developing the company.
You need to ensure that you give a good entrepreneur enough so that they can run for longer, hire stronger people, and achieve more.
In the US, companies tend to have higher valuations and VCs invest more. While it doesn’t really matter what the entry valuation is, you need to ensure that you give a good entrepreneur enough so that they can run for longer, hire stronger people, and achieve more. This will mean that the next valuation is much higher and underpinned by a better business and, it will overcompensate you for being a little bit over-generous in the early stages. And if we don’t give start-ups in Europe more money, American competitors will always be better funded and we will never be able to create a level playing field.
Switzerland is ranked number one in many innovation indices. Do you think this is reflected in the start-up scene?
I believe Switzerland is lagging behind when it comes to tech in general, but if FINMA (the Swiss Financial Market Supervisory Authority) is smart we could create a ‘Crypto Valley’ in Zug. This would change the face of Switzerland as far as the tech industry is concerned.
Obviously, there are regulatory issues that need to be tackled, but this is a new sector and one where Switzerland is perfectly positioned to become a global hub. There’s structural support and, because it is an intermediaries business, companies will be prepared to relocate here. You don’t need to be physically close to big markets to make investments and Switzerland has a number of advantages, including the ability to create a great legal environment. It’s a huge opportunity.
What challenges will businesses face in the coming decades?
When it comes to business in Europe, we have to take back control of our digital destiny. We can do this by becoming stronger on the regulatory front, or by becoming better when it comes to actively taking part in the development and financing of the businesses of the future. What we need to do is both.
In the past, 20–25 years ago, you could buy shares and take part in tech value creation. But now, high IPO prices mean the value creation happens mainly in private markets. Swiss private banks have been pretty good in this area and are helping to make these asset classes accessible to their customers. But still, Europe as a whole has a long way to go.
When it comes to business in Europe, we have to take back control of our digital destiny.
To give you an idea of where we are today: the top 30 non-listed digital companies in the world have collected some USD 60 billion in financing over the past eight years. European money took part in just 14 per cent of the rounds, invested 1.9 per cent of the capital, and is represented with a mere 1.4 per cent in the cap tables of these companies.
This is basically an insolvency declaration. When you look at Europe’s place in the world in terms of population or GDP, this figure should be between 20 and 25 per cent, not 1.4 per cent. We need to address this issue very quickly in Europe – otherwise we will become slaves to the big platforms which will be run from the US and China.
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