Networking on the move:  Jacob Bratting Pedersen and I met whilst riding our bikes home from a Connect Denmark event!  Jacob is highly  approachable and is close the Danish start up scene.  He and I spent some time chatting with on Skype in July 2008.

How to spot an entrepreneur, how VC’s make their money, the difference between the ‘East coast’ and the ‘West coast’ approach to investment

Alex Farcet (Q):  What’s your background, can you describe your job and how did you get to this position in the first place?

Jacob B. Pedersen (A):  I got into venture capital in 2000 after spending 3 years in Tel Aviv, Israel during the happy dot.com days. I have always been very entrepreneurial,  interested in new technologies and focused on investments and finance and I saw that venture capital combines this in a unique way.

(Q):  How did you get into the company?  I don’t see many jobs such as your advertised, is it all network based?

(A): I was fairly focused and wanted to get into the industry after seeing the great success of venture capital in Israel. It all happened by chance, when I sent an unsolicited application to one of the new players in the VC industry back in 2000.

(Q):  Did you receive specific training when you started?  It seems to me the typical profile for your kind of position is a finance background.

(A): Finance was one of the areas where I needed some “upgrading” so I followed finance courses on INSEAD and entrepreneurial/VC focused courses at Harvard Business School. In the early phases of the VC industry in Denmark it was very much a trial and error approach since almost no one in Denmark had very much background from the industry.

You basically have two different approaches to venture capital. The “East coast” approach (US East coast) where the industry is dominated by people with financial backgrounds and then the “West coast” (Silicon Valley) approach where VCs typically have an entrepreneurial and operational background. The latter seems to work best and in particular in Denmark, where most of the start-ups don’t have a size that makes financial engineering make much sense.

(Q):  Is 2000 considered the early phase of VC in Denmark, or are you refering to earlier?

(A): Yes, I refer to 2000 as the early phase of the VC industry in Denmark. Prior to this you almost only had 2M Invest and Dansk Kapitalanlæg – and Vækstfonden of course.

(Q):  Can you describe your company, Northcap Partners?  Where are you positioned in investment spectrum? Any special focus areas?

(A): At NorthCap Partners we are stage agnostic meaning that we invest in both seed stage and later stage technology companies. Our primary focus in on companies in Scandinavia. Technology wise we currently have strong focus on digital media and online services, enterprise software (in particular SaaS based models) and on mobile systems and apps.

We have a strong focus in NorthCap on internationalising our portfolio companies. Basically the path for the 4 successfull exits we have made over the last 2 years have been the same. Invest at a fairly early stage where there is proof of the business model and some customer/market traction (basically that there are customers willing to pay for the service or product), start focusing the internationalization strategy and execute it together with competent local management and in the end exit the company to one of the main competitors.

(Q):  Are you jumping on the cleantech bandwagon?

(A): NorthCap Partners is part of the BankInvest Group, which has a cleantech arm, so we leave it to them – they are the specialists in that area, and I do not believe much in VCs jumping to a completely new business area, just because it may look more promising than the area they are currently focused on. I have seen VCs chasing the wave all the time without ever getting onto the real surf.

(Q):  How is your company linked to BankInvest?  Are they funding the investments or are you completely independent?

(A): We raise our own funds and work as a fairly independent entity in the BankInvest Group. At the same time we have all the advantages of being part Scandinavia’s largest venture capital investor like shared services (legal, accounting, administration etc.)  BankInvest has a total of 4 different venture capital areas.

(Q):  How do you differentiate from other VC’s?

(A): Mainly by having a very strong focus on the business model and on internationalising the companies very rapidly. We have a strong and international network just as we have some of the most successfull Danish entrepreneurs in our advisory board. Our network to international VCs is also very strong and all of this benefit the companies to a very large extent. [pagebreak] (Q):  Typically Advisory Board members are not compensated (as opposed to ‘official’ board members).  Is that the case for your company?

(A): In our case they are compensated and most of them are also investors in our funds giving the additional incentive to help the portfolio companies succeed.

(Q):  To conclude on the VC company discussion: are Danish VC’s any different than elsewhere in the world?  Any specifics to this market?

(A): Since we only have a very small home market in Denmark, Danish VCs have to be very internationally oriented. E.g. US or UK VCs can easily create great companies just based on their local markets. But most VCs tend to be very internally focused, so I don’t see any major differences.

(Q):  I’d like to focus on you now.  What does an average day look like?

(A): We screen about 100 business plans every quarter, so much of the day is spent on meeting with and analysing start-ups. One of the most important aspects for whether a company will succeed or fail is the management aspect, so we always meet with entrepreneurs that have a somehow promising business concept. We have many examples of great teams succeeding with mediocre ideas, but never the other way around. Besides from this I spent time with the portfolio companies helping them in business development, strategy planning, refinancing and exiting.

It is important to have a huge network in order to also add value to the portfolio companies by connecting the right people to the company. This is not as such a “work task”, but rather something you need to have in the back of your head all the time in order to make sure that people that can benefit from each other are connected.

(Q):  How do business cases end up on your desk?  Do you get lots in the mail (and do you read them) or are you personally scouting out there?

(A): Most of the cases we get through our network and I would say about 20% are unsolicited. We are constantly scouting for interesting cases at venture capital and start-up focused conferences both domestically and internationally. Fortunately most start-ups initially approach us with an abstract of their business plan, so it is not necessary to read 50-100 pages on every case

(Q):  What’s on your plate at the moment?  How many investment cases do you typically handle at any one time?

(A): I handle about 8-10 cases at the same time. We try to make the process from initial contact to investment as short as possible, but in the end it takes some months to analyze everything, negotiate terms, interview customers and partners and perform due diligence.

(Q):  I want to get into the process of a typical investment.  You mentioned that the quality of the team is a key factor.  Do you bring them in and do they go through some specific steps or is it more a subjective evaluation based on talking to them?

(A): We always bring in the management teams to present to our entire team (6 people) at a fairly early stage in the process. This gives everybody some indication of their quality – at least as presenters and sellers of their own idea. Besides we take lots of references on the team members and look a lot at their traction. Have they built a successfull business before? Do we believe they can take the psychological stress of being an entrepreneur and knowing that the company may be out of cash in 3 months unless they succeed?

(Q):  What’s the approach if the product or service is highly complex technically?  Do you bring in outside experts to do a technical due dilligence?

(A): On the technical side we typically bring in outside experts. We invest in many different technology areas, so it is basically impossible for the same person to have a deep knowledge in all areas.

(Q):  The million dollar question: can you spot an entrepreneur?

(A): It is not that hard to spot an entrepreneur. Typically it is people that have started their own business at a fairly early stage like e.g. when they were studying. The difficult part in particular with Danish entrepreneurs is to spot their true level of ambition. Danes have grown up in a small country and are not used to thinking “we will concquer the world” with this product, but it is the approach and attitude necessary for building a truly successfull technology business today.

(Q):  Do you care where the entrepreneur is from?

(A): Not at all – as long as they have an entrepreneurs mindset.

(Q):  Switching gears:  Are you incentivised based on the success of investments in your portfolio?

(A): That I can not tell;)

(Q):  What does ‘partner’ mean, do they have skin in the game (their own money) in investments or are they simply getting a cut of the returns?

(A): Partners typically have both their own money invested and do also take part in the carried intererest (the upside from an investment).

(Q):  Can you be more precise on ‘carried interest’.  I’ve heard the expression 20 + 2, is that your approach as well?

(A): Typically the management company gets 20% of the return above a certain treshold (that’s the carried interest)..

(Q):  So you invest x mio. DKK, which buys you a percentage ownership (equity).  And you’ll pre-agree a carried interest on top.

(A):  Basically – if you invest 100 kr and get 200 back the 20% of the 100 profit would be the management teams compensation.

(Q):  Sorry to be thick:  you invest 100 kr., that buys you, say 25% of the company (assuming it’s valued at 400 kr.).  Then they sell to another company for 800 kr, you should get 25% of the 800 kr.  And carried interest on top?

(A): The 25% of the 800 kr is worth 200 kr. You originally invested 100 kr meaning that you have a profit of 100 kr. This profit is typically split with the investors to the venture capital fund (the limited partners) in a ratio of 80% to the investors and 20% to the management team. There are many variations, but this is the basic formula.

(Q):  OK got it. So for the 4 succesful exits, how many failures and how many ‘just break even’?  What are your expectations in terms of hit rate?

(A): The general expectation to a VC fund is that for every 10 investments there will be one big time home run (more than 10xreturn), 5 cases with decent returns and about 4 that are just giving money back or a loss. Of our 6 exits 2 of them have been with more than 10x return, so I guess we are a little in front of the statistics.

Jacob, many thanks!