Munich-headquartered Earlybird Venture Capital has become one of Europe’s leading digital investors in recent years, with 16 locations and investments, on average €2.5 million ($2.68m) in dozens of companies worldwide. A steady stream of exits has allowed Earlybird to scale hugely in its 20-year history. However, co-founder and partner Hendrik Brandis tells Red Herring that success has not come without considerable mistakes–one of which was underestimating the human aspect of the industry.
How did Earlybird’s founders’ experience push its early investment model?
We’re a set of founders with different backgrounds. Rolf (Mathies, partner) came from Bain Capital, so he had both Bain Capital and Bain consultancy experience. Christian (Nagel, partner) worked at McKinsey and small private equity firms helping with the privatization of East Germany.
I was coming from McKinsey as well, but private equity investment. That was our collective investment history. The experience of true venture investment was fairly limited when we got started, which needs to be admitted. And we learned our business as we went.
What mistakes did you make back then?
We committed a series of typical beginners’ mistake in the venture business: we invested in way too many companies for way too small a fund. We did not keep sufficient reserves for follow-on funding. And we didn’t anticipate what would happen with the burst of the first dot com bubble in 2000. I think that is a very classic mistake of unexperienced investors.
Have the things you look for in a prospective portfolio company changed?
Yes. Everyone knows that people make the difference, and you can read and hear that wherever you go. But at the end of the day, having seen to what extent it is decisive has changed our minds quite a bit. In former days, we said that if the technology was really interesting, we may have overlooked a management team that wasn’t as strong a little bit.
Nowadays we would not do that. We have learned that people really make the difference, and very strong technology can turn very quickly into something outdated if it is not managed strongly.
What other aspects of Earlybird’s investment plan have changed over the years?
I think we’ve narrowed down our investment focus over the years. Initially we looked at everything–even vendors to automotive companies–but we gave that up relatively quickly because experience told us there was nothing that could be scaled within the timescale of a venture fund. We have similarly given up biotech and semiconductor investments.
We have learned to look at capital efficiency in relation to scalability: scalability in terms of absolute perspective, but also in speed.
Is there any particular way how a fund like Earlybird has to scale, compared to a startup?
First of all, Earlybird has been a startup in itself. And, at the end, the development of a venture fund is best indicated by the development of the size of the management. If you’re not reaping serious returns in your industry you’re not going to collect money again. Because companies have the freedom to choose those managers who’ve come up with major returns in the past. Venture firms typically silently, because what’s happening is that they simply don’t get new money, manage the old money, then that’s it.
Do you think European attitudes towards less risk-taking are loosening?
I do think things are changing, but there are long ways to go. Is it becoming equivalent to what we’re seeing in the US? No, not any time soon. But entry valuations are so much lower in Europe, that the prospective returns for a venture fund are at least as good as they are in the US, combined with a significantly lower risk.
What have been the most important factors in Earlybird’s success?
I think it’s about an openness to learn, and to change the processes, to adapt, to be dedicated to the portfolio and to help entrepreneurs become successful. It’s about rigorous follow-on investment decisions–which are often tough.
There are two VC mantras, which are simple and broadly followed. The first is that Lemons Ripen First, meaning you have to weed out the portfolio relatively early, and cut the ropes for investments that cannot prove their perspective and their validity within a limited space of time and capital.
The second is Ride Your Winners. If you do have a winner, the problem is that these are the companies you can sell first. It is decisive not to sell early. This is a commonly-shared mistake of European venture firms, since fundraising in Europe is so difficult, and people are desperate to show performance, that they are tempted to sell things off too early.
At the end of the day as a venture fund you are always dependent on a low, single-digit number of deals which make the difference. If you do sell them off too early, you have a hard time coming up with decent performance.