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Why we don’t believe in tech ‘themes’

TechCrunch TechCrunch 27/06/2016 Tony Zappala

The tech hype-cycle works something like this: Some driver — perhaps a landmark company event such as the 2014 IPO for Lending Club in the fintech sector, or the spike in Bitcoin’s value, or indeed Facebook’s acquisition of Oculus in VR — triggers a flurry of investments in a particular “theme,” which in turn feeds news flow, panel discussions at conferences and a procession of expert “talking heads.”

This febrile atmosphere all too often results in companies that are more noise than substance and an increasingly congested marketplace, which makes it harder for distinctive startups to emerge. As the clamor continues, yet more founders start to pivot their businesses specifically to include the buzzword-of-the-moment (e.g. big data, AI or VR), seemingly no matter how tenuous the link, only to reverse pivot again afterwards when things don’t work out.

From an investor’s point of view, meanwhile, it’s a pretty good rule of thumb that by the time a tech “theme” starts to attract buzz, most of the best investments in that sector will have been made.

Granted, in and of itself, hype doesn’t necessarily mean that a particular company or new technology is good or bad. Nor is it indicative of quality or sound business fundamentals — and it probably won’t incline investors like me to prioritize them. In fact, if anything, I would have a slight negative bias against startups in supposedly “hot” sectors, if for no other reason than the sense of overinflated expectations they carry.

Born entrepreneurs, of course, are far more likely to spot an opportunity that others have overlooked.

Of course, the later stage at which we at Highland Europe invest means that we are inherently skeptical about tech “themes,” and see them as little more than a layer of branding. Despite our backgrounds in tech, we’re not looking for the latest cutting-edge tech companies, the startups at the eye of the storm, if you like. Instead, we seek teams that already have a proven business model and revenues — which is why we set a minimum threshold of €10 million in revenue run rate, and a 50 percent growth rate before we invest.

And because we’re looking at companies that have real products and customers, what wethink about a particular sector comes a distant second to asking ourselves what it is about a team that is actually working. That enables us to keep an open mind, and leads us to unexpected, almost counter-intuitive places; toward industries we wouldn’t necessarily have considered or that wouldn’t have come across our radar if we’d been driven by themes instead. We wouldn’t have thought, for example, about investing in a recycling and waste management software company or a fitness equipment and connected services firm.

Born entrepreneurs

These were companies in sectors about which we didn’t have strong convictions, or indeed particular knowledge of. But upon seeing their products, and meeting the passionate founders behind them, we asked ourselves how they fit into the consumer or enterprise tech worlds, and whether they could become very large companies, irrespective of their sector?

By contrast, with the buzz-led, and I’d argue more cynical, approach, an investor, without prior views on a particular industry, would pounce on a thesis because it sounds on-trend and work backwards from there, searching only for businesses that fit those categories.

Take Bitcoin, for example. The digital currency had been around for a while when its price started to soar about two years ago. All of a sudden there was a great deal of excitement, with some commentators gravely declaring Bitcoin to be The Future of Money.

By the time a tech “theme” starts to attract buzz, most of the best investments in that sector will have been made.

Investors scrambled to invest. We, too, looked at a number of companies branded “Bitcoin” — some of which were even profitable enough to have fit our investment criteria. But while the theme was red-hot, we never felt that we understood the industry, and its underlying dynamics, well enough to be able to develop a strong opinion, and therefore decided not to invest. (Of course that might change in the future; as I said, we always try to keep an open mind.)

From a founder’s point of view, techthemes often represent something of a siren song, too. If you decide to build a startup in a certain area about which there is a great deal of froth, by the time you have created a business model and a minimum viable product, you’ll almost inevitably be a couple of years behind the curve — and that’s if you can beat the competition before you get there.

Born entrepreneurs, of course, are far more likely to spot an opportunity that others have overlooked — an industry that’s lagging or a problem that people or businesses need to solve (even if they didn’t know it). By using that route to starting a company, such founders have a decent shot of being far down the road long before any bandwagons begin to roll.

And by the time we come to invest in their companies, they’ve reached the point in their growth where themes are far less relevant anyway. Indeed, the founders we back aren’t looking to us for deep expertise in theme X or Y, but rather for “big picture” help scaling a business, because the issues they face — such as growing a team, adding organizational structure and scaling internationally — are more or less the same, no matter which branch or niche of tech they happen to be in.

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