This is part two of our exclusive interview with Joe Schorge, Founding & Managing Partner of Isomer Capital. Read part one here.
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A little bit about Joe Schorge
Joe Schorge is the founding and managing partner of Isomer Capital, one of the most formative Fund of Funds (FoF) in the European ecosystem. Joe started his career in technology management positions that got him up close with M&A which led Joe to a whole string of accomplishments in PE & VC doing direct as well as fund investments. To top it off, Joe has also made Angel investments. This is the second part of a two-part interview and focuses on Joe’s views on disruption in the VC space, the current state of the European ecosystem and how he assesses emerging managers. As a bonus, Joe left us with some clues of what’s coming next for him and Isomer Capital.
Some things you’ll learn from Joe Schorge:
– What it takes to start a VC firm and get interest and money from the best LPs.
– Just wanting to start a firm isn’t enough, so how can new VC firms spike Joe’s interest?
– What answers should new VC firms be looking for to ensure they have a bright future ahead.
– Why it is smart for an LP to invest in a FoF instead of investing directly.
If you’d like to listen to more of these meetings with European VC champions, follow the EUVC Podcast.
David Cruz e Silva (David): Joe, you have the view that fund management is a product that managers have to think about how they can best deliver to their LPs. While there have been some incremental innovations in VC, we haven’t really seen a disruptive cut in the scene, yet. I’m curious, do you think VC is ripe for disruption?
Joe Schorge (Joe): There’s a lot of ink spilled on disrupting the VC model, but I’m not interested, to be really frank. I think there’s a reason the VC model is broadly standardized on a GP–LP format with the type of portfolio constructions that we see. And the reason is, predominantly, it works.
There are 40 years of history into why that works, despite the continued existence of problems and issues to deal with. But fundamentally, it is the best structure we know to do this kind of investing. So to be honest, disruption for its own sake is something I’m not interested in.
Sometimes you meet people who say they hate the VC model and are doing something different, but usually, it’s not something I can get excited about. What I can get excited about is when someone talks of a certain investment scenario, or company builder scenario, that is not well served by the traditional VC model. If there’s something else that could work better, that’s something I want to hear about.
I’ll give you a real example: Entrepreneur First (EF). My partner Chris Wade was a mentor there before they had any funds, and they were creating a place where founders could meet and work on a project before there even was a company. And at some point in the journey, either the founder would found a company or leave the program. This is a case where the traditional VC wouldn’t make sense – you must give people money before there’s a company formed. In that case, there’s no equity to buy and it’s not really an investment, so you need a different model.
That was interesting and caught my attention and we started to investigate how that would work. We actually worked with them on building their very first fund, to understand how to approach this idea by using what we knew about traditional fund investing and what they knew about building companies, and I think that’s been a great success. Matt Clifford and Alice Bentinck has now pioneered a new method and approach. But all this arises from them being first principles thinkers. They weren’t asking: “How can we disrupt VC?” They were looking for a solution to help these entrepreneurs build companies and give them the support they need. Part of that support is capital, but they need other forms of support as well, and before there’s a company. And thus the Entrepreneur First method.
Trends in VC
Andreas Munk Holm (Andreas): Joe, There are some interesting trends in VC these days: on the strategy side we have private equity firms starting to come into venture, and Tiger Global coming from the growth stages and making crazy fast investments – to the point where they’re now averaging a whopping 1.3 investments per day. What are your views on all that? And maybe also touch on the resurgence of the smaller IPOs?
Joe: I guess I have a comment on the market in general, yes. But at Isomer we have a focus; we want to be there early. We spend our days thinking about how to find the next exciting company through our partners and help it as it grows, which means co-investing in secondaries and so on. And players like DST Global, Tiger Global, hedge funds and pre-IPO investors tend to come along quite a bit later, so we primarily encounter them joining late-stage rounds. And I have to say that we observe more than we opine on them. We have co-invested with Tiger Global, we’re doing it right now actually, and they’re very impressive so we take their involvement as a strong sign. I don’t have a fixed view on how their strategy will ultimately work but, from what I can tell, their company selection is good. Returns are all about money in and out, so… if you’re able to buy significant ownership at a good price and you drive big outcomes, you’ll have a great return.
My investment strategy in contrast to these guys is based on small funds. It’s easier to turn 50 or 100 million into three, four or five times the invested amount than doing the same with 500 million or a billion. I think that’s statistically true in general but in Europe, it’s even more true. While we have more unicorns than ever, it’s been a record Q1 in unicorn generation, I don’t necessarily want my investment strategy to be based on the requirement to generate unicorns. I’d rather enter a company at a 50 or 100 million euro valuation where, if you have the small IPO, the 500 million to a billion euro IPO, you get your 10x or 20x. On the other hand, if you’ve entered at 500 million and you have the 800 million IPO, you’re not going to get the venture return we’re looking for.
I know I’m expressing my personal bias and, again, I have been and will be wrong, and pre-IPO investors are very active these days. They want to own the shares after they go public, so coming in these late-stage rounds is an interesting strategy, but it pushes up valuations quite a lot. Those companies have realized that private companies stay private much longer, so they need to buy in while they’re still private. This is something they didn’t do before, and that’s a whole new range of investors that we’re seeing. Frankly, I’m happy with it because a lot of our companies need that additional capital to grow, and the VCs are largely tapped out by that point in time, so this is really just a continuum in the D, E and F rounds.
Tips for VCs & Emerging managers
David: Joe, you’ve had a lot of exposure to established VCs and emerging managers. I’m sure you’ve detected some patterns as well as unexpected stuff. Based on that experience, could you tell our readers what your best tips for VCs are?
Joe: Well, I always ask myself a question for my own fund, and I ask it to new VCs when they’re creating a VC firm as well: Why does the world need another VC firm?
You must understand; we have an active database of about 900 VC firms in Europe and there’s probably an equal number that we’re not actively tracking. So, if you come up with an idea, there’s a big chance that someone else also thought about it as well. So just wanting to have a firm is not a good enough answer. A good answer to my question is something along the lines of; “There’s a group of founders that needs the help and capital I can provide, and they’re not well served at the moment.”
Telling me you just want to have a firm doesn’t display how you’ll win. The kind of answers that I’ve heard from lots of our partners usually start with a story of a certain kind of founder they can serve better than anyone else. Here’s a real example: “There’s a kind of deep tech founder, in our target market, that is building really interesting technologies with high potential. They’re not well-served by existing VCs, because the VCs in their market are not able to help with the tech, and at that very early stage they don’t need growth hacking and brand building; they need product development.”
In this real example, we have a VC team consisting of coders and deep tech guys, and we can get in there and help. That makes it interesting. So what we did was that we then went to talk to some entrepreneurs, and they said: “We really struggled in our raise, we’ve approached 10 VCs and none of them could even understand what we were doing, never mind take a bet on it.”This is a good example of something that got me excited because that market needs help and small amounts of capital early but, more importantly, that value add that these guys are proposing. Another example is a geographically based thesis. Eastern Europe is a good example: It’s less mature than Western Europe; great companies are being built and fewer great VCs are running around. So, that market needs more great firms and it’s getting them.
The technological example that I just mentioned is real. That’s a deep tech example but there are lots of others. It really underpins the necessity to keep an open mind. What I do is listen to the thesis and when someone comes in talking about a market segment that’s highly generative, that can grow strongly but it’s not well served by current capital solutions, I always think about it as a supply and demand imbalance. That’s when I start to lean in and get excited.
And I think that for all private funds, VC or other, there are three big things you need to believe in, as an investor:
First – Is there an attractive market segment? However you’re defining your market, can you make that case to me – in a story but also quantified. So specifically; how many founders are there? How many companies? how do you define the market? What’s in it and what’s not? If I can agree with you that that’s an exciting segment to invest in, that’s step one.
Second – What would the strategy be to approach that? How big are the tickets? What sort of follow-on would you anticipate to fund these companies over time and, strategically, how would you approach that?
Third – A big question for every VC: why would the best entrepreneur take your money? Especially in a market where there are more and more options? If they have five or ten term sheets, why are they going to take yours over a different one? Every VC firm developing its secret sauce should be developing a range of answers to that. It should comprise things along the lines of having backed success stories like the company in question, the kind of support they provide, the specific skills of their team that can make a difference and so on.
So, I think that as the market gets more competitive and Europe gets more mature, as a function of having more competition, you’ll need to have a constant development of why a founder should want to work with you.
Andreas: Joe, I’m curious, what’s the single dumbest thing you see VCs doing when fundraising?
Joe: Well, one of my complaints about new VC-fundraising is these superlative statements: “We’re the only ones doing this. We’re the first one doing this.” Whatever “this” is. I don’t care if you’re the only one, or the first one, that’s not how you generate value. You generate value by being the best one. You have a lot of firms who are pitching in that way, and I don’t like that for two reasons:
One – It’s seldom true and it displays that this group doesn’t know about the group in another country doing the same thing. So I would always be really careful with that statement because there are very few new ideas under the sun and, again, that’s not how you create value.
Two: Don’t tell me you’re the only one, I want to back the great one! Tell me why you’re going to be great, how you’ll find great entrepreneurs, drive value in their companies, and help them build something great. If you say to an investor that you’re the only one doing it then the investor looks at you and says: “Oh, probably it’s not a good idea because if it’s a really great idea others will see it too and start doing it.”
Andreas: Why should LPs invest in a Fund of Funds rather than directly into a VC firm?
Joe: Oh, for lots of reasons! Europe, as I mentioned, is very fragmented and very diversified and I think that every year, it’s more unclear where the next big thing will come from. What our kind of FoF gives an investor, is a broad diversification to increase your probability of finding the next big thing, and then double down on it with co-investments.
For LPs, the way we operate a FoF gives them a partner they can learn from. They can leverage our research, our specialist expertise, and that’s how we view the partnership with our investors. They may not have spent a lot of time flying around the Nordic region, or Eastern Europe, or France, but we have. And our LPs benefit from that.
In addition to that, venture capital is, perhaps, the only area where a FoF can perform on the same level as a direct fund. And that’s partly because, in Venture Capital, you have the highest dispersion of returns. In other words, a great fund will be greater than in any other area. And a bad fund will be worse than in any other area. So, on a portfolio level for all investors, it’s really important to diversify. For those investors that can build their own diversification, select 10 or 20 groups themselves, fine. But they still need a team and a research agenda. Most investors, though, can’t start from that point, particularly with COVID – nobody’s been able to travel for a year.
So, what we do is enable them to have that diversification, we have a good look into the whole market, and we can take the risky bet that they may not. I think it’s interesting that we backed a lot of fund-I’s, probably more than I want to say out loud, and I’m thrilled to say they’re performing really well. They are hungry, exciting firms that are doing great stuff, but most traditional LPs are not able to take that risk because they’re not able to diversify that risk in a bigger portfolio. We balance that with some funds three, four, five and more mature groups. But it’s also exciting for our LPs that, when those fund-I’s start to grow, we connect our VCs directly to our LPs. So, maybe fund I was a bit too on the edge and risky, but the LP would like to back fund II directly. And that can bring a lot of great benefits.
The last reason is that we have several corporate investors who view a FoF as an extension to their corporate VC activity. Where a VC fund can show them 20 or 30 companies, we can show 800 and that’s a pretty powerful lever. For example, if you’re looking in the telecom sector you want to look everywhere, not just in the one or two funds that you’re able to back directly. So those very broad eyes, ears and access to the market are important.
Andreas: Final question, Joe. What is next from you and what’s next from Isomer Capital?
Joe: Oh, I couldn’t possibly tell you… [laughs] We’re cooking up some exciting stuff. We’re backing a lot of funds now: some of our partners who’ve come back with their new funds and some new firms as well, so quite a nice mix.
There are too many great funds to back in Europe now so, unfortunately, we’re turning down fantastic funds and that kills me. Sometimes I talk to my friends at the European Investment Fund (EIF) and I tell them that I’d love to be in their position and be able to back everybody. They reply that they’d love to be in my position, that we’re flexible and nimble, and we can do different things so, the grass is always greener on the other side.
But to answer your question, we will continue as we have and we’ll do more co-investing – that’s quite an important feature and it is logical as companies are growing and asking us for more. We’ve done a fair bit already, but you’ll see an increase there.
I’ll only hint at what else is coming, because it’ll take a little while. Our view for Isomer was not to be a FoF but to be a great tech investor, and if you follow the entrepreneurs on their journey, they need different things along the way. At the seed round, they need value add and risk capital but, as they go along, they need different things. They need liquidity options when a founder leaves or when an LP leaves a fund. We do a little bit of secondaries with our GP partners, but there’s a bigger need for that in the market than we’re serving, so we need to do more there. Sometimes companies grow up and need debt, particularly in business models where there’s an inventory component, or there’s a hardware component. One of our LPs is now offering debt directly to companies and so I think that’s an area where we need to do more. And so, at Isomer, we are looking at where we can be doing more for the entrepreneurs and the “fundpreneurs” of Europe, and the more we think about it, the more we can and should do. Without revealing too much, we have some half-baked ideas, some three-quarter-baked ideas and a couple of ideas that will be ready to show in the coming quarters!
David: Joe, I think you’ve hinted at some interesting and exciting things so hopefully, we’ll be able to talk about them when they are fully cooked. Thank you, Joe.
Joe: Thank you, David, thank you, Andreas! It was really nice talking to you and I’d love to come back anytime.
And this wraps up our interview with Joe Schorge, Founding Managing Partner of Isomer Capital.
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