A early Facebook-style investment is the ultimate venture capitalist fantasy.
An investor who gets in on the ground floor of an explosive startup can see unimaginable profits — returns of 10X, 100X, or even 1,000X on their initial outlay
Peter Thiel, Facebook’s first outside investor, for example, bought 10.2% for $500,000 in 2004 — cashing out most of his shares following the 2012 IPO for more than $1 billion in cold, hard cash.
But not everyone thinks these kinds of deals are worth chasing. Fergal Mullen, a partner at European venture capital firm Highland Europe, said he would almost certainly choose not to invest in an early-days Facebook — because it just doesn’t fit his firm’s investment style.
“I’m looking for what’s actually working today, that needs scaling,” Mullen told Business Insider at Highland’s London office in June. “You’re not gonna get any money from us unless you can actually show us that you’ve hit at least 10 million in revenue, that you’ve got a growth rate of — at that scale — typically north of 100%, that your economic model makes sense, that you’re being capital efficient, that you’re a group of people that we really want to be involved with.”
“We buy the reality.”
This is in stark contrast to the model that Facebook (and many other, less successful businesses) pursued in the early years: promoting growth ahead of everything else, and worrying about monetisation later. Similarly, many VC firms in recent boom years have been happy to pump tens of millions of dollars into businesses with impressive growth metrics, trusting that cashflow and profitability will come in time.
“If somebody comes in and tells me ‘Oh, I’ve got tens of millions of viewers and I’m building audience and I could be doing revenue, I could switch it on next month’ … My response is ‘I’ll see you when it’s switched on,'” Mullen says.
“I don’t buy people’s dreams. We buy the reality. I think if you could be doing revenue, in most cases, you would be doing revenue.”
Instead, Highland takes a different route, focusing on growth-stage investment in internet, software, and mobile companies, and typically investing between $10-30 million in a company each time. It launched in 2012, and has €580 million (£444 million, or $652 million) under management across two funds.
“I would have missed [Facebook],” Mullen said. “Because it doesn’t fit our criteria, and it might have been that it went nowhere, but they went to the moon — awesome.”
It’s the fundamental distinction between early-stage and growth-stage investments.
Why take this cautious approach to investment? It’s all about having more guaranteed returns, from more proven businesses.
“At the end of the day, we have investors who are looking for a return. They are pension funds, they are university endowments, they are sovereign wealth funds, they are very large family offices …. so we take their mandates and their money and their requirement for return very seriously.
“They expect a certain return from us, and there’s multiple ways to get there. Early stages guys get it by …. take a typical 100 million portfolio. They will invest 100 million, and on average the industry should be able to generate, 2.5, 3X return on the fund over 10 years. And they will get that even though 40%, in some cases 50% of the 100 million will go to zero. The ideas just won’t work. Which means the remaining 50 million has to generate more than 6X to get a 3X return on 100 million. We take the same 100 million, we back a number of companies with that 100 million, and currently we’ve got a loss ratio of way less than 10% — compared to 40% or 50% for an early stage.”
In short: Slow and steady wins the race.
The promise of Facebook-style returns are attractive — but also incredibly risky. Highland is betting its method will get to the same place in the end, with much less unpredictability.