An alternative approach (to financing innovation)

When we set out to create Anthemis Group, we thought long and hard about how it should be structured.

We wanted a structure that would:

• optimally support our core mission to build the leading “digitally native” diversified financial services group of the 21st century
• fundamentally and structurally align our key stakeholders: investors, management, employees and our portfolio companies and their founders
• create transparent economics that are clearly driven by long term wealth creation through capital growth
• be as simple as possible while remaining operationally and tax efficient

We wanted a structure that would avoid:

• misaligned economics – in particular any structure which would incent management to raise capital without regard to cost; we want to be in the business of investing and growing capital not collecting it
• misaligned horizons- in particular having our investment decisions driven by tactical (time-driven) rather than fundamental considerations; the tail should not wag the dog
• undue complexity – in particular where it might lead to reduced transparency or fundamentally drive management or investment decisions; as simple as possible but no simpler

And so we very deliberately – against the grain of many (smart) people’s advice¹ – decided to set Anthemis up as a company, or more specifically as a group of companies with a simple holding company at the top of the group structure. In order to give you some insight into why we made this choice, I’ve tried to distill what we believe to be the key advantages of this structure in the context of our business model, vision and goals:

Alignment

We have one clear, measurable and transparent objective: grow the value of Anthemis shares over the medium to long term. All of our management decisions – which can essentially be distilled into allocations of human and financial capital and assessing the opportunity costs of both – are guided by our best judgement as to how these choices will affect the long term value of our shares. We get this right and everyone is happy. We win (or lose) together with our people, our shareholders and ultimately our portfolio companies and their founders.²

Simplicity

All investors are invested in the group’s parent company: Anthemis Group SA, a Luxembourg Societe Anonyme. We have only three classes of shares: preferred (with a simple 1x liquidation preference), common (essentially arising from the exercise of employee performance options) and founder shares (which are economically identical to common shares but carry certain limited governance rights and more onerous vesting and transfer provisions.) Investors and employees don’t need an advanced degree in financial modeling in order to understand the value or performance of their holdings. Beneath the parent company we have a small number of both operating and holding entities all of which are 100% owned by the Group, the corporate form and domicile of these entities has been chosen to ensure a tax efficient and compliant structure that is also cost effective to run. It is exceedingly simple to understand which we believe has its own value.

Transparency

We have an enormous opportunity in front of us, one which requires our full attention and all our energies. Opacity is a tax on efficiency and productivity. It drains your mental energy. It increases entropy. Transparency sets you free. If nothing else it means that you never have to remember what you said to whom when. More importantly it builds trust which is the currency that fuels networks and ecosystems. Of course it is much easier to be transparent when your structure is simple and aligned across stakeholders. Paraphrasing Warren Buffett, “our guideline is to tell our stakeholders the business facts that we would want to know if our positions were reversed…and we believe candor benefits us as managers: the CEO who misleads others in public may eventually mislead himself in private.”

Evergreen

Building great businesses takes time. Typically at least 7-10 years in our opinion, sometimes longer. And having invested in and built a great business, why would you want to sell it? Or more precisely it would seem crazy to have to sell it. And yet that is exactly the constraints faced by traditional GP/LP venture funds. Sure a GP can ask for an extension, but that doesn’t change the fundamental truth that irrespective of circumstances, they have an obligation to exit their investments. Aside from the misalignment of fund terms with optimal venture capital investment horizons (which, to be fair, could to a largely be remedied if fund lives were 15 or 20 years rather than 10), the other disadvantage of being structurally forced into shorter, time-limited investment processes is that one inevitably risks being seduced by the siren call of high IRRs to the detriment of building real, tangible long term wealth which ultimately arises from actual cash on cash returns.

An evergreen – ie equity – capital structure is the simplest, most elegant solution. We also believe in robust and conservative balance sheet management: to use the trader’s vernacular, we believe in running a matched book. Equity financed with equity. If we do our job successfully, the last thing investors should want is to be given their capital back before they want or need it. If we are successful, there will be any number of ways to create liquidity event(s) as and when required by our investors. If on the other hand we are unsuccessful, quite frankly the structure won’t make a damn bit of difference to our investors’ outcomes. In fact they may well be better off holding corporate equity rather than distressed fund units, but almost certainly they would be no worse off.

Last week, the Kauffman Foundation published a very comprehensive and well written report concluding that “the Limited Partner (LP) investment model is broken” as “too many LPs invest too much capital in underperforming VC funds and on misaligned terms.”

There are more than simply structural differences between Anthemis and a venture capital or private equity fund; the most important of these is our ambition to build a coherent yet diversified group of companies that is perennial. This means that our investments (and eventual disposals) are framed in the context of optimizing our business portfolio and overall return on invested capital and are considered through a lens of corporate development rather than simply as individual financial investments. The fact that our current investments (we currently have 20 companies in our portfolio) have been entirely concentrated on “venture” stage companies reflects quite simply our thesis that the global financial services sector is at the early stages of what we believe will be a secular transformation of the industry as “industrial age” business models are disrupted and ultimately replaced by “information age” or as we like to call them “digitally native” business models.

Over the next 10-20 years, our plan is to initiate, grow and consolidate our positions in the companies that emerge as leaders in this new economy. At the same time we plan to continue to make investments in disruptive startups emerging on the “innovation frontier” in order to maintain a vibrant pipeline of emergent technologies and business models in order to retain our immunization to the innovator’s dilemma. We believe that the optimal organizational paradigm of the information age will be predicated on networks, not hierarchies and have crafted our approach to building the leading financial services group of the 21st century to be inherently aligned with this hypothesis. Our vision is to build Anthemis into a strong but loosely-coupled network of complementary businesses focused on financial services and marketplaces; not to build a monolithic, hierarchical conglomerate. We never want to become too big to fail, our clear aim is to become too resilient to fail.

Although our investment thesis is fundamentally different, from a structural or even philosophical point of view our approach is very much inspired by Berkshire Hathaway. (Spookily, upon founding Anthemis, Uday and I happened to be very close to the same ages respectively as Warren Buffet and Charlie Munger when they “founded” Berkshire Hathaway in 1965. Here’s hoping history repeats!) As an aside, Henry Kravis once called Berkshire Hathaway “the perfect private equity model”, though why KKR didn’t or hasn’t adopted a similar structure is interesting. (One wonders if it isn’t as a result of the relative risk/reward (fee-driven) profile for the GP in a traditional private equity structure vs. the (equity-driven profile) of a founder/manager in corporate holding structure…) Other examples of thematically or industry focused groups from whom we draw inspiration are companies like LVMH or Richemont (luxury and branded goods) or Naspers and DST (media and internet) but ultimately we have the sense that what we are seeking to build is somewhat unique, something new. An evolution in corporate organizational structure which is adapted to the emerging social and economic landscape of the global information economy.

(excerpt from LVMH Group Mission:) The Group’s organizational structure is decentralized, which fosters efficiency, productivity, and creativity. This type of organization is highly motivating and dynamic. It encourages individual initiative and offers real responsibilities – sometimes early on in one’s career. It requires highly entrepreneurial executive teams in each company.

For both Anthemis investors and for the companies in which we invest, our focus and approach provides an interesting and complementary alternative to traditional venture capital funds. Although it would be naive to pretend there is no competitive overlap, our conviction (confirmed by our experience to date) is that we are in fact a positive new entrant in the venture ecosystem that complements rather than competes against more traditional venture investors. Not “either/or” but “and”. For the startups in which we invest, we know that building an investor syndicate of diverse and complementary talents which includes the networks and company building skills that the best VC partnerships bring to the table is the best way to ensure their chances of success. Our portfolio companies are much stronger for being able to combine our (sector-focused) talents and resources with those of leading VC firms such as Atlas Venture, Bessemer Venture Partners, IA Ventures and others too numerous to mention. And it is equally clear to us that Anthemis is strengthened by the continuous learning and exchanging of ideas that comes with having the privilege of working alongside so many smart and seasoned partners and associates of these VC firms.

For our investors, we offer a unique and efficient way to gain intelligent exposure to the future of financial services. And while clearly there are some similarities in our risk/return profile with that of a traditional venture fund (given that a very significant proportion of our balance sheet is invested in early and venture stage companies), we are nonetheless not strictly speaking substitutable (in the way say traditional “bluechip” generalist VCs might be.) And as we grow – just as for the startups in which we invest – our risk profile will naturally evolve. Indeed one could think of Anthemis as a financial services “meta-startup”. That said, when considering Anthemis I suspect that many of our existing and potential future investors would characterize Anthemis as a direct venture-stage investment, with any allocation coming from within their venture capital (or private equity) bucket. As such, I thought it would be interesting to examine how Anthemis might stack up in the eyes of an investor in the context of the five recommendations of the Kauffman report.

(1) Abolish VC mandates

Not sure if this is directly relevant to Anthemis. However we would agree that anything that encourages a return to substance over form in the context of LP asset allocation is a good thing. A private equity investment process that focuses more on the “what” rather than the “how” strikes us as being more sensible given the heterogeneity and illiquidity of these types of assets.

(2) Reject the Assumption of a J-curve

Traditional venture capital theory (useful it seems when justifying reporting opaqueness!) states that investments in startups (and thus portfolios of startups in a particular vintage fund) go through a cycle by which their valuations initially decline before later increasing in the goodness of time as the big winners in the portfolio emerge (and are fed more capital) and the losers fall away (with relatively limited capital having been invested.) Kauffman however found that this theory while it sounds good, isn’t borne out by reality; rather most funds experience an “n-curve” whereby valuations increase substantially in the first 2-3 years (driven by follow-on venture financings at higher and higher – but generally unrealizable and almost always unrealized – valuations), only then to deteriorate over the remaining life of the fund. (ie Big winners often don’t emerge…) Unsurprisingly, they also found that these increases in (paper) value topped out at almost exactly the same time that GPs sought to raise their next fund, producing a flattering backdrop upon which their LPs could tick the track record/historical returns box. The reader can draw their own conclusions, but Kauffman concludes that “too many fund managers focus on the front end of a fund’s performance period because that performance drives a successful fundraising outcome in subsequent funds.”

Investors in Anthemis don’t have to worry as to whether there is a J-curve, an n-curve or an “any-other-letter”-curve…as they are owners of preferred equity in Anthemis. We don’t raise subsequent funds. The Anthemis founders and management are significant shareholders whose performance compensation is largely equity-driven. Any time Anthemis raises new equity capital (our analog to raising a new fund), both our focus and the new investor’s focus is on future expected returns on this capital. Full stop. If we go to raise new capital and investors think the share price on offer is too high (or at least too high to offer them the risk-adjusted returns they expect), they won’t invest. If the Anthemis Board thinks the share price offered is unattractively low (insofar as the cost of capital exceeds the company’s expectations as to it’s projected risk-adjusted returns and/or those available from new investments), it won’t issue.

Every smart entrepreneur and venture capitalist understands the intrinsic tension between capital and dilution which acts as a powerful aligner of interests. We simply embrace this dynamic, aligning our returns to those of our investors and removing path dependency and our ability to arbitrage the structure at the expense of our investors.

(3) Eliminate the Black Box of VC Firm Economics

I must admit that before reading the Kauffman report, I didn’t realize how little information VCs provide to their LPs. It’s pretty ironic given that most VCs spend more time negotiating (and are more dogmatic about) the nuances of control and information rights in the companies in which they invest than pretty much anything else, including valuation. The report highlights that “LPs seem to lack the conviction to require the information from GPs in the same way the GPs themselves require it” and apparently don’t use the leverage that they potentially have to force the issue, according to one GP quoted in the report “LPs never walk away.” Sure. Um, that sounds like a robust and healthy investment process. Yikes. But the boxes are ticked and the forms all filled in nicely…and so everyone’s happy.

Another perceived top-tier GP agreed with our view about the importance of transparent partnership economics and he admitted “no good answer” as to why LPs couldn’t receive the same information about his fund, except that the information is “never shared.”

Ok so you can get away with it, fine, but why? Why not be transparent? It sounds like a bunch of derivatives bankers that won’t share the model because they’re afraid the client will find out just how big their margin is and “won’t understand” all the costs (systems, people, capital – immediate and contingent) that this gross margin needs to support. (Irony alert: of course these same bankers usually hold up this gross margin to their managers as profit, blithely ignoring these same items in the pursuit of a “fair bonus”…) Imagine Joe Entrepreneur saying to Jim VC: “Just write the check and trust me. It’s complicated, I don’t want to cause you any unnecessary anxiety or have you misunderstand the numbers. That would be distracting. I’ll let you know when I need more. Thanks.” Come to think of it Jack Dorsey could probably get folks signed up on those terms…

So Anthemis is not a black box. We treat our investors like any startup would treat their VC investors. We have certain information and governance rights written into our articles and in general we respect and are open with our investors, doing our best to keep them informed and making ourselves available when they have ideas or questions they would like to discuss. We have audited financial accounts, a clear remuneration policy (overseen and approved by the Board including at least one Investor director) and quite frankly a pretty transparent and straightforward approach to investor relations. We can’t imagine having a conflictual, non-trusting relationship with our investors. What we are trying to build is hard enough as it is, we need our investors to be on board: not just financially, but intellectually and emotionally.

And so I hope Warren doesn’t mind if we adopt Berkshire Hathaway’s first Owner’s Manual principle as our own:

Although our form is corporate, our attitude is partnership. Udayan, Nadeem and I think of our shareholders as owner-partners, and of ourselves as managing partners. (Because of the size of our shareholdings we are also, for the moment and for better or worse, controlling partners.) We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.

(4) Pay for Performance

Our first hand understanding of how this principle was being misapplied in much of mainstream finance and asset management was yet another proof point for our thesis that financial services business models were ripe for disruption. It is the shield the industry wraps itself in: “we may be paid well, but we are a meritocracy and our pay is justified by our performance.” This may have been true once – and in some firms in some activities it probably remains true today – but these are too often the exceptions not the rule. It’s a whole other essay as to how and why this is and how it came to be so, but I’ll spare you the details and jump straight to the punch line: too many compensation models are structurally biased to favor human over financial capital and worse, compound this bias with path-dependent outcomes that reinforce the skew, sometimes dramatically so.

The standard 2 and 20 fund compensation paradigm is one of these. There is nothing fundamentally wrong with the principal behind it – you get a management fee to cover your overheads and a performance kicker if you generate returns (even better if there is a hurdle rate which should be based on the risk-free return plus possibly some margin for the extra risk or illiquidity depending on the strategy.) And frankly, this model can and does work, especially when the managers have a substantial stake in the fund (both in absolute terms and in terms of a % of their net worth) and when the fund has performance high-water marks and/or hurdle rates. Good examples of this model working are often found in the hedge fund world, where principals often own much or even most of the fund and their holdings represent a very substantial proportion of their total net worth.

In cases where these conditions aren’t met it often doesn’t work out so well. The fixed percentage management fee acts as an opiate, driving managers over time to focus their energies on asset gathering (not management.) The temptation to increase AUM to the largest (credible) size is strong as doing so essentially gives the managers a free upside performance option as the management fee alone becomes enough to pay themselves handsomely. Heads I win, tails you lose.³ This pathology is bad in any asset management context, but is particularly toxic with respect to venture capital given that it is an strategy that involves investing in a limited number of essentially illiquid securities.

If you are a macro hedge fund investing in FX and interest rates, the fact that you are managing $100mn or $100bn possibly doesn’t matter (especially if a big chunk of the capital is your own.) If you are investing in venture – or for that matter small cap public equities – a strategy that is highly successful with $100mn of capital can be a struggle to execute when you have $1bn or more to play with…) Unsurprisingly you often see some of the best VCs (who have easy access to capital) drift towards growth/private equity strategies where they can intelligently deploy larger sums. Done well this can be a good strategy (for all) but still we wonder why LPs aren’t more flexible and proactive in negotiating more tailored fee structures, either on a per fund and/or per firm basis.

In this context, our relatively simple, transparent “corporate” approach to compensation is an interesting alternative – it aligns management (who are also significant investors) with outside investors under all circumstances. First, not only is there no incentive for management to raise capital (grow assets) for the sake of it, there is actually a strong disincentive to do so: more capital means dilution. It has a cost. Raising capital is only interesting at a price that allows Anthemis to improve the risk adjusted returns of its existing and potential future portfolio of businesses. If the cost of raising equity is too high (ie the price of our shares is too low), it is financially more attractive for Anthemis (and our existing shareholders) not to raise more funds and to simply manage our existing portfolio of assets. To be clear – especially given the nature of our assets – I’m not suggesting that it is possible to create a spreadsheet that will spit out a definitive share price at which we should issue or not – there are too many subjective and uncertain inputs and pricing the opportunity cost of capital (which is essentially what I’m talking about) is as much art as science, especially at this stage of our development.

But what is clear – and structurally friendly to shareholders – is that there is symmetric risk and reward for management when raising capital. Just as there is for the founders of companies that VCs invest in everyday. You don’t see Jane Entrepreneur raising $100mn on a $1mn pre-money because she could then afford (to pay herself) a big salary; rather she is going to look first at what is the minimum amount (including a margin of safety) of capital needed to achieve her key value-creating milestones (while paying herself a reasonable salary.) If the price offered is unattractive, she’ll probably err on the side of raising less capital; if the price offered is generous, she’ll probably err on the side of raising a bit more. Simple. Valuation matters. Dilution matters. And most importantly, what is good for Jane in this context is (almost) always good for her existing investors. Alignment.

So how do the management and employees at Anthemis get paid? Basically there are three components, all of which are easy to understand and ultimately transparent to our investors:

• Baseline: We pay our people competitive salaries and annual bonuses based on their experience and market value; this gives us some flexibility and resilience with respect to managing operating cash-flow while allowing us to attract excellent people who don’t have to be independently wealthy to finance their employment with us. Note that a very significant part of our overhead costs including salaries and bonuses are actually financed by our successful advisory businesses which are profitable on a stand-alone basis. These businesses then give a decent return on capital to the group while more importantly enabling significant operating leverage vis-a-vis our investing activities. Under a traditional GP/LP structure, given the size of our balance sheet, we would currently only be able to align a small fraction of our professional resources to support our principal investment activities. (And we would not be able to leverage the extremely valuable strategic and informational advantage arising.)
• Performance bonuses (cash): With respect to our advisory businesses, insofar as our operating revenues permit, we accrue a performance bonus pool. The size of this pool depends on achieving a certain net operating margin target as set and is agreed by the board.
• Long term incentive plan (equity): Each time we raise new equity capital, we create an option pool equivalent to 20% of the amount raised; these are options on common shares and have an exercise price equal to the price paid by investors in that round and are subject to standard vesting provisions. The options are then allocated to staff over the expected deployment period of the capital raised, based on a number of criteria (skewed towards their respective contributions to the development and performance of our portfolio participations) – again all agreed by the board. Some are also held back in reserve for new hires and exceptional performance rewards. In our opinion, this option structure offers a competitive performance incentive to Anthemis management and employees with a payout profile that does a much better job (than traditional GP carry structures) of aligning the interests of management and investors. Unless we increase their value and create liquidity in our shares, we don’t get paid.

(5) Measure VC Fund Performance Using a Public Market Equivalent (PME)

Earlier I mentioned that we were inspired by Berkshire Hathaway; one of the elements of their approach that we most admire is their very simple but obviously relevant approach to creating value⁴:

Our long-term economic goal is to maximize Berkshire’s average annual rate of gain in intrinsic business value on a per-share basis. We do not measure the economic significance or performance of Berkshire by its size; we measure by per-share progress.

Intrinsic value is formed by three components: the value of investments, the value and growth of operating earnings and a third, more subjective element Buffett calls the “what-will-they-do-with-the-money” factor. In other words the efficiency with which management deploys cash (from retained earnings and new capital raised) in the future. This last factor unfortunately for those who love algorithms is extremely important to the determination of intrinsic value and yet unmeasurable, it’s a judgement call. As an imperfect proxy to intrinsic value, Berkshire Hathaway tracks the per share book value and it’s performance vs both the S&P500 and the S&P Property & Casualty Insurance indices, believing that over the long term this measure at least gives a reasonable indication (although understates) the change in intrinsic value of the business.

Obviously we are not Berkshire Hathaway and so it would not (yet) be meaningful for us to simply take an identical approach to reporting, but we are adopting the same intrinsic value-based approach to evaluating and analyzing our performance and valuation. And once we have enough data to be meaningful, we will certainly look to track and publish (at least to our investors) a similar proxy metric that will allow our investors to compare our performance to the relevant benchmark(s).

The Kauffman Foundation in their report suggests that the Russell 2000 is an appropriate benchmark against which to measure generic US venture capital returns. Given that we invest globally and predominately in financial services and related businesses, I suspect we will need to look at other potential benchmarks and/or perhaps a mix of 3 or 4 different indices. In the past two years since creating Anthemis, the S&P500 is up c. 11% and the MSCI World Financials index is down c. 10%, I’m happy to report that so far we’re doing better than both… As an aside, if there are any index geeks out there reading this who have suggestions as to which index or indices would be the most appropriate benchmark for Anthemis, I’d be happy to hear your thoughts.

For most of my career I worked in capital markets and investment banking and mostly found it to be an incredibly stimulating environment and felt privileged to work every day alongside so many smart and ambitious people. I was particularly fortunate to have worked in fixed income at Paribas for most of the 90’s where I serendipitously found myself at the heart of the birth of the Euro bond markets, with the opportunity to participate directly in building new markets, products and businesses. And once the Euro came in to being, I naturally looked for the next big thing to build, the next big innovation, only to realize (slowly, over the course of several years) that the Euro project truly was exceptional in every sense of the word and that – like most big successful industries – there was actually very little interest in change or disruptive innovation. That “if it ain’t broke, don’t fix it” was the overriding philosophy. (Actually it turns out to be worse, “even if it is broke, don’t fix it”…)

It is difficult to get a man to understand something, when his salary depends upon his not understanding it. – Upton Sinclair

And so I left. And when I immersed myself in the world of startups and venture capital, I was very excited to be leaving this mentality behind – after all venture was all about the new new thing, right? And although I found this to be true of the founders and companies financed by venture capital, and just as in investment banking was thrilled to find myself amongst another group of incredibly smart, ambitious and (new!) passionate people, I was surprised to find this didn’t extend to how VC partners thought about their own business and business models. In this respect, they were collectively just like the bankers I had left behind. (And given the context, this was even more cognitively unsettling…)

Uday and I (and our newest partner Nadeem) set up Anthemis because we were convinced that a very big opportunity exists to do things differently in finance. And while it wasn’t at the core of our mission, if you think about it venture capital itself is part of the financial services pantheon and without having set out deliberately to do so, perhaps we will play a small role in catalyzing disruptive change here as well if our model proves to be successful. Meta-disruption anyone?

Thinking about it, I suspect our model could work for other industries and sectors – especially for those where there are strong network effects and where companies and businesses form an interdependent ecosystem and/or value chain. For example an Anthemis for retailing? health? energy? As an investor, I would certainly be interested in building a portfolio of these. Think of it as the the equivalent of sector-focused ETFs but for disruptive, emerging growth companies. Until/unless they were listed, it would be hard to short these companies so it would be impossible to run a balanced long/short strategy in both directions. But a more adventurous or aggressive investor could at least express an even more aggressive view on industry disruption by shorting an index of the incumbents in each sector (against a long position in the innovation holdcos.)⁵

What is clear is that change is coming to the world of private capital markets, whether it is sector-focused holding companies like Anthemis, platforms like AngelList, CapLinked or even Kickstarter and others, private company exchanges like Second Market and SharesPost, new approaches to the VC model like A16Z, Y Combinator, 500 Startups and many other ideas I’m sure that will emerge. Given our nature, I guess it’s not too surprising to find ourselves disrupting on this dimension too! Interesting times indeed. Stay hungry. Stay foolish.

1. conviction: a fund structure fundamentally did not correspond to our vision, objectives and business model and would have forced us to make material comprises in all three which we were unwilling to do
2. ethics: having worked in investment banking and capital markets for many years, we had a clear and deep understanding of the traditional incentive models in the asset allocation and management value chain and we believed that in many cases these were fundamentally broken, causing (mostly avoidable) misalignments of interests with often toxic outcomes; we did not want to be a party to this – we wanted Anthemis to have a fully transparent and aligned structure
3. strategic: we wanted our shareholders to deeply understand and endorse our vision, to become truly our partners for the long term and be able to weather the good and the bad and intelligently hold us to account because they get what we are building and believe in the opportunity; it may sound crazy (for someone who wants to raise capital) but by making it harder for investors with a “box-ticking” or “herd-following” mentality to invest, we felt this would help us ensure that those that did were both smart and aligned with us as founders
4. pragmatism (or cynicism!): we believed that even with a plain-vanilla, consensus structure, we would struggle to tick all the boxes of a traditional LP who would rather invest in the 4th fund of a serially underperforming VC fund or even the first fund of a GP with years of junior experience at an established VC, than in a team of seasoned operating professionals with a clear vision, who’s track record of success wouldn’t however fit neatly into their approval grid; we weren’t IBM and we figured they probably weren’t going to risk getting fired by investing in us

² There are two main ways in which our performance can have a positive effect on our (minority-held) portfolio companies:

1. if our performance is good and our share price is strong, this gives Anthemis (greater) access to (relatively) cheaper capital which will allow us greater scope to support the growth ambitions of our portfolio companies as opportunities arise; their success drives our success which in turn helps us be an even better, stronger strategic shareholder to them
2. if our shares perform strongly, this creates an interesting currency that we can offer to the founders and executives of our portfolio companies, allowing them a mutually attractive third alternative to hold or sell if and when the day comes when they would like or need to reduce their holding in their company; we hope and expect that this will create a unique and powerful incentive that allows us to retain talented people within our ecosystem over the long term, which we consider to be the single most important driver of sustainable long term success

³ To be fair, as Kauffman points out in their report, LPs are enablers of this and if a manager can charge 2% (or more) of AUM and their customers (the LPs) are willing to pay this, there is nothing intrinsically wrong with this if it is justified by performance. I would however suggest a modification that would both allow great managers to charge whatever the market will bear and better align outcomes. For all management fees above the operating costs of the firm, the GPs could “re-invest” this surplus in the fund. Note this throws up some complications in a fund structure (in an equity structure such as ours, this would simply mean paying out surplus “management fees” as restricted equity) but I don’t think it would be impossible to come up with a decent solution. Even if not perfect, it would clearly drive a better GP/LP alignment. Indeed this is effectively what (most) of the best hedge fund managers do, essentially re-investing their surplus income back into their fund(s). Clearly this is easier with a hedge fund that will often have daily or at least monthly NAVs but again I don’t think it would be impossible to come up with a reasonable methodology to enable something similar for venture GPs.

⁴ (from Berkshire Hathaway’s “Owner’s Manual”):

“Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life. The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at the same set of facts, moreover – and this would apply even to Charlie and me – will almost inevitably come up with at least slightly different intrinsic value figures. That is one reason we never give you our estimates of intrinsic value. What our annual reports do supply, though, are the facts that we ourselves use to calculate this value…

…Inadequate though they are in telling the story, we give you Berkshire’s book-value figures because they today serve as a rough, albeit significantly understated, tracking measure for Berkshire’s intrinsic value. In other words, the percentage change in book value in any given year is likely to be reasonably close to that year’s change in intrinsic value. You can gain some insight into the differences between book value and intrinsic value by looking at one form of investment, a college education. Think of the education’s cost as its “book value.” If this cost is to be accurate, it should include the earnings that were foregone by the student because he chose college rather than a job. For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its economic value. First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that figure an estimate of what he would have earned had he lacked his education. That gives us an excess earnings figure, which must then be discounted, at an appropriate interest rate, back to graduation day. The dollar result equals the intrinsic economic value of the education. Some graduates will find that the book value of their education exceeds its intrinsic value, which means that whoever paid for the education didn’t get his money’s worth. In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed. In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.”

⁵ Indeed, I kind of regret not having done so with Anthemis by shorting one or two of the broad public financial sector indices at the same time as going long Anthemis. Although having been very long financials in 2006 (structurally as a result of my 16 years in banking), I can’t complain too much having sold down as quickly as possible my direct holdings and implicitly – by leaving my job – my ongoing embedded exposure… As an example, Weatherbill (now Climate Corporation) where I led the angel round in 2006 is now worth upwards of 9x where I invested, whereas Allianz (where I worked via DrKW) is down c. 40%! If you use Commerzbank as a proxy for Dresdner (RIP) it’s down by c. 95%!! And yet investors still consider public stocks like these less risky than venture stage companies…go figure.

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