David Rosskamp

Software, Scale, and Sovereignty: Europe Must Embrace a New Technological Paradigm

Europe’s productivity struggles are not merely a matter of lagging behind the United States or China in innovation. They represent a slow, painful unraveling of the continent’s ability to shape its future, welfare, and security. And much of this is not just about markets or metrics; it is about cultural inertia and the failure to embrace a narrative where Europe plays a decisive role in the defining technologies of the 21st century.

As I reflected on Andrew McAfee's recent thoughts on incumbent competitiveness, I was reminded of a persistent truth: Europe’s challenges stem not from a lack of resources or talent but from a deeper cultural, strategic, and intellectual failure.

1. The Digital Value Divide: Europe’s Industrial Blind Spot

The economic engine of the 21st century is digital technology. Take a look at Andrew's chart and analysis of the top 50 US company incumbents by market value over the decades. The world’s largest, most impactful and most valuable companies today are young and driven by software, data, and often platform economics. And more importantly: the digital revolution doesn’t just create big companies, it builds much bigger and more valuable companies than ever before, faster and with higher geopolitical importance. Decades ago, Brian Arthur elucidated the concept of increasing returns to scale in software-driven systems. Unlike traditional industrial models with diminishing returns, these systems experience exponential value growth as they scale.

Yet Europe ignored this and continues to glorify its industrial champions, imagining a future where legacy players remain at the center of value creation. They are not -- the US example shows a logical rejuvenation of large companies. Manufacturing will indeed stay relevant, but software-driven systems (or culture) with their speed and increasing returns to scale now run the show. This fundamental misunderstanding of modern economic dynamics—one that predates energy crises and disrupted supply chains—leaves Europe at a strategic disadvantage. The value differential between digital-first companies and traditional industrial players will only widen. I wrote the same thing in 2019 and have seen little change since.

2. Consumer Platforms as Launchpads for Scale and Revolutionary Technologies

Europe has also failed to recognize the role of consumer platforms as incubators for transformative technologies. From AI to quantum computing, many of today’s revolutionary technologies emerged from consumer-focused companies like Google, Amazon, and Meta. These platforms operate at unparalleled scale and economics, generating the data, capital, and ecosystems necessary for breakthrough innovation.

Their success is not accidental; it stems from the creative and entrepreneurial intelligence that enables them to expand across markets. Scale is central to this phenomenon, yet European technologists and policymakers continue to ignore that or play on the margins, focusing on incremental progress rather than building the foundational platforms needed for the new age. You simply need massive scale as an enabler for playing big and across markets – however you get it. Identifying a scale playbook will be key for any European technology contender; and simply promoting isolated "deep technologies" without such is doomed to fail.

3. Europe’s Cultural Blind Spots

Which leads me to the real thing: At the heart of Europe’s decline is a profound cultural and intellectual blind spot. Policymakers, investors, and business leaders fail to grasp the economics of software and the strategic importance of assertive scale.

a. The Need for New Industries

European debates often center on retrofitting the continent's traditional "metal-bashing" industries with new technologies rather than forcefully building out entirely new ones. Just open the business section of any newspaper and look for the omnipresent "digitization" theme. Observers like Wolfgang Munchau have astutely pointed out that that this entirely misses the point: resilience and competitiveness require diversification, not concentration.

This is what makes Germany’s economic decline a structural slump, rather than a normal economic crisis. Right now, the policy is to double-down on what they did before. No one in Germany talks about diversification, the only known remedy for excessive dependence. - Wolfgang Münchau

Yet, within core Europe—particularly Germany—the focus remains on sustaining legacy sectors. True economic resilience comes from creating industries of the future, not merely optimizing the past. This is not how you play competitively and with ambition. Contrast this with the United States, where decision-makers, media or politicians understand the strategic game, assertively. Leaders articulate a vision that links enabling technologies with national priorities.

b. The Power of Scale

I said it above: scale is everything. Competing globally requires serving hundreds of millions, if not billions, of users. This demands not just software but a mindset shift to embrace the network effects and exponential growth dynamics that define modern technology. Europe’s failure to prioritize scale leaves it uncompetitive on the global stage.

4. Strategic Technology Assertiveness

Energy policy illustrates Europe’s strategic myopia. While the continent focuses on climate change—a critical priority—it neglects the broader role of energy in enabling advanced technologies. AI systems require enormous computational power, which in turn demands massive energy resources. Similarly, transformative technologies like decentralized drone networks and quantum computing systems depend on abundant energy supplies and robust infrastructure. None of this features in European energy agendas or in the wider press.

The U.S. and China are investing heavily in these areas, linking energy policy directly to technological ambition. Both understand the mid- to long-term value flows (vs. just technologies) and act to capture as much as possible. Europe, by contrast, lacks a coherent strategy, confining its debate to environmental concerns while ignoring the broader implications, and opportunities.

5. What Europe Must Do to Reverse Its Decline

Europe’s path to relevance in the global technology race requires bold action on two fronts:

a. A Cultural Revolution

Europe must embrace the reality that software dynamics drive modern economies. This means moving beyond the romanticism of the “Mittelstand” and industrial nostalgia. It has been denying this reality for close to 30 years. Foundational tech players at massive scale are not optional—they are essential for global competitiveness. This requires top-tier talent, abundant energy, and an unwavering commitment to technological excellence. Getting there might mean a serious re-education and re-orientation of the economic caste and the wider populations. A certain intellectual assertiveness will be key to understand and act (after all, Brian Arthur's popular piece on software was published in 1996 and didn't feature widely in Europe).

b. Scaling Ambition: Europe’s Path to Technological Sovereignty

Europe doesn't lack early-stage capital; it lacks consistent world-class entrepreneurship fueled by strategic intelligence and ambition. It also lacks the customer and exit markets needed to support bold visions and ignite the flywheel of growth, by funneling returns back into the venture system. Simply injecting more venture capital into the ecosystem won't suffice, as David Clark of Vencap has consistently argued. It's the quality of companies behind the money that truly matters and, in line with my other comments, that quality must mean assertive, strategic ambition. For "deeper" tech, governments must act as anchor customers for emerging technologies, providing the initial demand that enables scale. This requires a level of assertiveness and urgency currently absent from Europe's technology landscape. Simply put, we need markets more than capital.

6. The Opportunity in Crisis

Complexity risks create large moats – exemplified by simulation software

A core tenet of my and Magnetic’s investment philosophy is backing complex transformations. For us, this goes beyond simply investing in individual companies or technologies or focusing solely on generating returns. It means funding larger, longer term, needed transformations that change how things are done in critical sectors.

The defining commonalities of these investments are:

They are complex, i.e. deal with intertwined technological and human challenges

They always need transformation, i.e. systems re-design, meaning they follow a strategic scope per company (or group of companies) that vastly exceeds single products or technologies

They take a lot of time

They often face substantial headwinds that make them unattractive at first sight, mostly because of their systemic ambition

There is a very fine line to be drawn between these constellations and moonshot-type, high-technical-risk investing. We are not speculating on outcomes or actual technical feasibility of far-off ideas, we are investing behind system re-design and lasting behavior change. Technical risk might or might not be high (often it is), but complexity always is. That plays a decisive role: when things work, the moat is substantial. In other words, complexity risk drives defensibility.

Mission-critical engineering software

One of those transformations has been in mission-critical software for physical designs. This type of software is an integral technology piece for our world – it covers the design, modeling, validating and simulating of anything from buildings to cities, semiconductors to machines. Gabriella Garcia and Eric Flaningam at Felicis recently covered the industry in a great piece.

Physical design software  is a classic case of complexity: the industry has seen total dominance by a handful of software providers for more than 40 years. Names like Autodesk, Ansys / Synopsys, Altair, Siemens or PTC have been controlling the markets for design and simulation, commanding some of the largest account sizes and highest valuations (and multiples) in all of software. No new entrants have been able to disrupt the technology experience for reasons of complexity: technical barriers, switching risks, human psychology. While technical barriers alone can and will be overcome by upstarts, human dependencies (i.e. customers) and stakeholder system designs (internal processes, dependencies) have created enormous hurdles for new entrants.

Yet, the possible transformation in physical design software is substantial: new entrants could upgrade the entire experience and introduce design collaboration, faster iteration, automation and an expansion of the traditional scope. That is what I have been investing in since leading SimScale’s first (and third) institutional funding round. SimScale remains the only cloud-native contender in simulation, delivering all the capabilities we would expect from modern software.

While SimScale is as complex as any deep tech company, its market constellation presents a tremendous complex transformation opportunity, one that we have been committed to supporting with considerable patience and energy. The payoff potential is off the charts: Gabriella and Eric call it the “only moat in SaaS” (though no one in simulation actually is full SaaS, so that prize would fall to SimScale). Such is the beauty of transformations. SimScale alone could be one of the most significant venture opportunities in all of software, driven by a team with the utmost dedication and patience. It gives me great energy to know that similar constellations exist in complex markets like healthcare, defense or financial services.

Complexity moats

So what wisdom can we read into all of this?

For me, it looks like this:

Complexity constellations like physical design software (or defense technologies or healthcare tech) have always been centered on the complete service, not just the software piece — a major differentiation to low-complexity SaaS where the basic software is the central concern (thus “software as a service”). Complete service mostly means highly individualized and fine-tuned total deliveries.

This gives these constellations a much higher total product risk than your standard SaaS: upstarts would have to show that they can deliver at the same (or better) total product quality to an incumbent, on all accounts, from features to actual technical results or outputs. This is the opposite of other software domains; obviously MVPs are not an option to begin with.

By definition, this is a vastly different standard than simple cloud software or point technology (or even modern AI service deliveries) as failure tolerances are zero and delivery expectations at 100%. It also goes against conventional disruption theory which used to rely on a "good enough" product to disrupt inert incumbents.

It also needs significantly longer time horizons to get to gold. But the patient entrepreneur is rewarded by real, enduring, systemic moats for those who succeed.

So this is where complexity risk therefore leads us:

💾 Low complexity risk —> simple software (or technology) provision often is enough —> low moat (and fast replacement or commoditization)

🤖 High complexity risk —> total service provision and quality are key —> high and enduring moat

This simple framework helps me to navigate such constellations, irrespective of sector or technology. It also helps to avoid falling into technology traps (difficult technology risks with little complexity in their markets) that we often see. Ultimately, it is the system that matters for true and lasting value.

It also turns conventional venture wisdom around. We used to assume that modern software comes with low technical risk and high market risk; we knew what could be built but we didn't know who would buy it. Complex transformations are different: they carry high technical risk AND high market risk. Thus, it’s a natural consequence that substantial moats follow those that succeed. This ultimately makes them worthwhile pursuits, even if the playbook and determination are vastly different.

I was going through some of my recent notes to our investors and thought that these might be an interesting high-level summary of the state of public and private technology markets. So here they are, with no claim to exhaustiveness.

We are nearing the end of a record-long growth cycle in markets, public and private alike. Historical realism, or the inverted yield curve, call for a gradual reversion to the mean in the coming year(s). In our world, this is most directly felt through multiple compression, an increased eye on cash and the primacy of sustainable business models or profitability. Private markets historically lagged their public peers when it comes to cycle corrections but will eventually feel a similar impact. Often, this comes hardest onto the earliest companies. Not surprisingly, we are seeing a rush of public offerings in 2019 that want to capitalize on the top-of-cycle momentum and the last innings of the present age of technology. In private markets, large financings have become ever-more present and Europe in particular has shown some substantial dynamic in the last 18 months, adding to its financial firepower for serious innovation finance.  Cases like UIPath, Deliveroo, GetYourGuide or N26 are a testament to the sea change in venture-stage financing, one which should generally be welcomed. The most significant development of the last decade, the primacy of private technology markets over public ones, is thus further confirmed. There has been an influx of seed-stage finance, leading to a vastly greater number of projects being financed. At the same time, however, companies stay private for a long time and most of the early value capture is not shared adequately. 

As much as the general trend towards (European) entrepreneurial finance should be welcomed, there are a couple of issues that stand out from our view, in no particular order:

First, it is a direct product of unprecedented easy money policies. We are seeing a hunt for yield across the board and quite naturally, early technology finance has been an attractive destination.

Second, it is largely driven by North American and Asian capital markets - a clear imperative for change to European law-makers if the continent wants to play its role in globalized, borderless, digital markets. 

Third, it has created a changed perception of the financing of venture-stage projects, one of easy money and visionaries over analysts. This, however, is not how professional technology finance works.

Fourth, while it feels different, it is just the end of the beginning. New technology platforms (from decentralization to open source to vertical AI) will fundamentally alter the workings of entire markets, one after the other. Any economic downswing will only slow this process but not materially change it. Our long-term approach provides sufficient cushion against short-term swings and we feel comfortable to invest counter-cyclically. 

Fifth, receding capital markets will reveal bubbles and inconsistencies. This will most likely hit late stage finance hardest given the flood of new capital and the flurry of aggressive valuations in technology markets (which nowadays are all markets). It only makes the search for defensible, differentiated and sustainable business models all the more important, at all stages of investing. In case you ever wondered why we are not invested in some of the headline-generating business models of our day, this is why. There will come a point in time, not too far away, when capital markets start to readjust growth prospects for entire sectors. This will come down as a hammer onto some of the most capital-intensive new businesses of our generation. We tend to look towards the public markets as guidance and guidance they will provide. 

I am no imperial Brexiteer, nor British in any form, so I only recently stumbled upon Rudyard Kipling’s poem “If” again (please forgive me for that). But it struck me how full of wisdom it is: for life, for entrepreneurship, for stoical clarity, for morality and character. It is as timely as ever. So I just want to leave it here.

***

If you can keep your head when all about you      Are losing theirs and blaming it on you,   If you can trust yourself when all men doubt you,    But make allowance for their doubting too;   If you can wait and not be tired by waiting,    Or being lied about, don’t deal in lies, Or being hated, don’t give way to hating,    And yet don’t look too good, nor talk too wise: If you can dream—and not make dreams your master;      If you can think—and not make thoughts your aim;   If you can meet with Triumph and Disaster    And treat those two impostors just the same;   If you can bear to hear the truth you’ve spoken    Twisted by knaves to make a trap for fools, Or watch the things you gave your life to, broken,    And stoop and build ’em up with worn-out tools: If you can make one heap of all your winnings    And risk it on one turn of pitch-and-toss, And lose, and start again at your beginnings    And never breathe a word about your loss; If you can force your heart and nerve and sinew    To serve your turn long after they are gone,   And so hold on when there is nothing in you    Except the Will which says to them: ‘Hold on!’ If you can talk with crowds and keep your virtue,      Or walk with Kings—nor lose the common touch, If neither foes nor loving friends can hurt you,    If all men count with you, but none too much; If you can fill the unforgiving minute    With sixty seconds’ worth of distance run,   Yours is the Earth and everything that’s in it,      And—which is more—you’ll be a Man, my son!

I recently came across an interesting post that highlighted traditional fashion retailers’ problems with a changing consumption landscape. Many of the old guard struggle with ecommerce and its implications on consumption and choice. I’d encourage everyone to read the article here.

The underlying dynamics, however, reminded me a lot of the development that information industries have gone through in the last two decades. To take newspapers as an example: curation privileges (what gets mentioned? where do we show it?) of local newspapers have been supplanted by a broad, democratic access to information. Local monopolies for information provision (fueled by advertising revenue) have become obsolete. Readers have taken over, infinitely decentralized, and dictating a completely different news cycle.

The same is now true in classic retail, an industry that has relied in equal measure on its supply and taste privileges. Retailers, just as newspaper editors, have dictated a curated offering in the past. They have also maintained geographic advantages in a pre-internet world. Today, that has been turned upside down: what we are observing is a decentralization of choice, driven by a large and distributed consumer base. Consumers see and create global trends in real time; retailers have to react. That is a fundamental reversal of the workings of such industries, similar to what information industries have gone through.

We are also observing a decentralization of production as a reaction to such dynamics. Companies employ more dispersed teams that work in faster cycles. Again, the parallels to the media world are striking. A demand-driven world is created where power and control have shifted and where the supply side gets increasingly fragmented.

Every now and then, I discover some counter-intuitive reality of the internet age. This time, it is the reality of journalism and journalistic content, in particular relating to digital “print”.

A lot has been written about the fate and future of journalism and of quality content in the digital age. Traditional media appears to be in an endless, and largely unsolved struggle between producing unparalleled amounts of content and seeking for a viable business model behind it. Long gone are the glory days of controlled distribution, curatorial privileges and hefty profits. Meanwhile, audience attention has never been more global, stratified and ambitious. That apparent predicament is the defining character of the written-word media industry in the 21st century.

The tech behemoths (Google, Facebook) are accused of being the only profiteers of the new age, and media houses won’t cease to demand a higher share of content monetization. Having realized that advertising revenues do not materialize as planned, news sites increasingly resort to paid subscriptions, micro payments or hybrid models in order to monetize “quality content”.

The interesting thing is that this debate seems to be entirely missing the point. As has been explained before (most explicitely by Ben), journalism has never monetized content. It has always been an advertising game - protected by geographic exclusivity and high hurdles for market entry. In so far, monetizing “content” is largely a new business model, that - on a grander scale - has not been tested for print.

Why is that relevant? Because in the internet age, most content is fundamentally worthless. With zero marginal cost, zero transaction cost and perfect competition (in the digital marketplace), the price for every new piece of “information" is essentially zero. In so far, it might be the cheapest commodity around - commodities like coal or iron can command higher prices given their marginal cost structure. The worth of most content is zero, winners are created around superior cost structures. That is the harsh reality of digital journalism. And one that is rarely discussed.

Newspapers and magazines have thus chosen an entirely wrong strategy in the past decade: increasing reach through distributing content. Perfect, global competition has lead to an erosion of advertising revenues per publisher. It is striking that it took so long to realize these realities.

Now, the consequence for publishers is counter-intuitive: they should create scarcity; they should produce less, not more. That being said, simple paywalls will not solve the problem. Neither will decentralized approaches or most reward systems - perfect competition will siphon off any short-term rewards. Possible strategies that come to mind are not far away from software businesses:

Closed system: highly valuable, highly focused and differentiated content for a specific audience

Hybrid: mixing free and open “generic” information content with highly focused closed parts. That seems to be the way many are going; yet they are already beginning to open up to aggregators like Facebook again, putting their major remaining monetization channel at risk

Open core: complementing an open core information part with services and additional products

Format innovation: producing content in a radically new way, for as long as it lasts

Nowadays, most insurers scramble to make use of data gathered through wearables or tracking devices. The insurance data revolution is in full force and seemingly aiming to end the ever-problematic information asymmetries in the market. “Lower rates for better insurees” can be heard a lot.

However, we tend to forget the interesting economic twist of that whole affair. As Diane Coyle at the FT has been right to point out, we all might not want an insurance system with full data transparency. In fact, there will be no insurance business in the classic sense if full information is achieved. Insurance is, by definition, the sale of pooled risk for a premium. If you take the risk component away, all insurance benefits are undermined:

The problem with this is that there will also be no insurance market if there is too much information. This is not for any clever reason to do with the role of information in pricing, or the incentives buyers and sellers face leading to adverse selection. It is because the insurance market is one for risk. The service insurers are selling is the pooling and pricing of risk, in the absence of complete knowledge about the future on both sides of the transaction. If the risk the insurer is taking on each individual policyholder is removed by gathering ever more nearly perfect information, and pricing accordingly, the customers would do better saving up their own money, and not paying the insurer’s costs.

Earlier in June, the European Securities and Markets Authority (ESMA) published a discussion paper on the applicability of blockchain technology to the securities world. That document is a rather good summary of the state of understanding of distributed ledger technologies (DLTs) for highly regulated financial markets. It demonstrates the regulatory or supervisory view de jour on the technology for securities markets. A range of things stand out and I will comment on a few.

First and foremost, ESMA is clearly seeing DLTs operating within the existing regulatory framework. This is a repudiation of the idea of fundamental systemic reform around blockchains. If just understood as another technological evolution that increases efficiency, the regulator’s challenges will be minimal and limited to making sure that full compliance is achieved. In other words, ESMA does not care which kind of “internal” market technology is used as long as it is compliant. Only if DLTs are geared towards replacing existing setups of market participants, oversight or infrastructure will there be serious regulatory challenges. To me, this points to a larger debate separating the various blockchain camps, and quite possibly the techno-blockchainists from the econo-blockchainists: “DLT as a system” vs. “DLT as a technology”. While the technologists (!) often stress the systemic implications of large-scale blockchain-driven upheaval and decentralization, the economic front sees immediate efficiency gains through a merely superior technology within the existing regulatory confines. Technologists vs. market realists could be another description. Consequentially, and in line with a more econo-blockchainistic interpretation of the world, ESMA articulates its preference for private blockchains when it comes to securities markets.

The paper also gives a good summary of the benefits of DLTs (or the blockchain) for securities markets. These are applicable to other markets as well:

Clearing and settlement: reducing the number of intermediaries, speeding up reconciliation, over time clearing and settlement becoming almost instantaneous

Record of ownership and assets: creating a unique reference database that is an integrated part of the trade lifecycle, smart contracts

Reporting and oversight: better and immediate access to information across a security’s history

Counterparty risk: shortened settlement cycles substantially reduce counterparty risks, in particular for spot transactions

Efficient collateral management: with reduced counterparty risk for spot transactions comes a decreased need for collateral, and shorter collateral durations

Availability and ‘uptime’: a system operating on a continuous basis

Security: higher security as the system is decentralized and encrypted

Cost advantages: reduction of post-trading costs as middle and back-office processes are streamlined through partial automation

Meanwhile, ESMA sees challenges and shortcomings in a series of fields, some of which are going against the very principles of distributed ledgers: scalability of DLTs for large securities markets, interoperability with existing systems (and retrofitting DLTs), simultaneous settlement, a recourse mechanism for mistakes, possibility for netting positions or margin finance. There are also governance issues such as the need for rules on authorizing private blockchain participants and their conduct, liability for misconduct, supervision or different privacy levels (beyond private keys).

Such perceived challenges translate into direct risks for the technology in financial markets:

Cyber attack risks (including the risk of attack contagion)

Misuse of private or public keys

Illicit activities such as money laundering or terrorism finance

Operational risks of a fully automated system in case of anomalies

Code failures or glitches, or simply unforeseen edge cases - particularly for smart contracts

Market volatility through the interconnectedness of systems

Unfair competition in closed DLTs or through information advantages

Recently in asset management: Many managers of emerging markets funds are dropping the old BRIC hypothesis and radically reduce the concentration of assets in commodity-heavy economies (primarily Russia and Brazil). They are replaced by a grouping that the FT calls Ticks, focusing on technology-centric economies like Taiwan and South Korea. As one can see, it is not only a reallocation of fund investments towards tech-heavy economies, but also a shift of country-internal assets towards technology companies. In simpler words, technology companies take significant shares in individual country baskets.

While some argue, with some merit, that this reallocation is a cyclical response to the end of commodity super cycles, there is an interesting larger narrative here: the pairing of a structural coming-of-age of emerging markets with the digital age. EM economies are migrating from production towards consumption. While doing so, they are supercharged by the digital revolution. The effects are immense. On a larger scale, emerging economies now fully experience the effect of maturing consumer societies, even in commodity-centred countries. This is largely reminiscent of the industrialized world’s development in the past decades. Thriving middle classes bring with them the consumption of goods on an unprecedented scale. Standards, sensitivities and expectations have risen and helped to create large consumer-oriented companies.

However, the digital age gives this whole tale a new twist. First, the dissemination of innovation and products in the digital age is instant. Likewise, the speed of customer adoption gets faster and faster. The explosive growth of the large digital technology companies in the emerging world is the result, which seems to have caught some EM asset managers by surprise. Second, the digital economy is fundamentally consumer-centric. It breaks up information monopolies, disaggregates markets and creates immediate access. On top, software-ization supports an increasing degree of product individualization. Third, it does all of this on an international level, enabling EM companies to access global markets.

"Media” is a description that one reads or hears many times a day. Yet, the term seems so incoherently defined. I thought of this while reflecting on the meaning and importance of all forms of media these days - online media, digital media, streaming media, media consumption. Many of them appear in the context of radical change or industry transformation that nurture our investment predictions or industry gospel.

Traditionally, we understand media as the system or means of communication, or as an industry. Media can be communication channels or publications or a physical storage unit - quite a vast range. Consequentially, it is used or leveraged in discussions according to specific industries: “the revolution in storage media” or “changes in television media consumption”. Most often, it is looked at under this limited industry understanding. The same is true for people that we see as “working in media” or striving for a “media career”. We deliberately reduce our observations and mental models.

However, what strikes me is that at the end of day, everything seems to have a media nexus. Quite literally, I can’t think of many parts of daily life that do not touch “media” in one form or the other. I must have read it somewhere, but I love this definition:

“You sleep, you go to work, you drink and eat. The rest is media.“

Two rather uncorrelated regulatory developments made me ponder over established orthodoxies in business creation. While the ECJ repealed the existing Safe Harbor principles, the Basel Committee is working on a re-interpretation of Basel III (or for some: Basel IV).

As supply-side wisdom holds, capital-inducing reform (read: deregulation) should be key to driving enterprise creation and new opportunities. In fact, our industry is constantly arguing for pro-business reform and the lowering of financial, factual or legal hurdles. Both a new Safe Harbor regime and Basel III+/IV are an implicit taxation on this very capital, and stand against such thinking. In a similar vein, the European challenges to net neutrality change the underlying business dynamics, favor large players and handicap fledgling enterprises. Nevertheless, both cases by themselves provide business opportunities that should not be underrated. As a matter of fact, there is value creation within regulation. It just takes different forms that need a more subtle look.

The Safe Harbor case shows that European standards on data protection differ from the US understanding of privacy. Regardless of the individual position in the debate, full US corporate management of European data might be a thing of the past. In fact, it appears that the medium-term perspective for a new Safe Harbor ruling will be a ‘mediatization’ of data regimes, i.e. the management of European data for US companies by European providers. For startups and larger corporates alike, this provides a lot of potential. Microsoft and its partner Deutsche Telekom have spearheaded this - I would expect a series of smaller-scale data solutions to emerge as well.

As for strengthened Basel capital provisions, a similar logic applies. Tighter capital means more breeding ground for new forms of non-bank financial intermediation. I expect the surge in new marketplaces and capital providers to continue, despite recently cooled-off valuations in the space. This is particularly true for Europe which is facing a rather structural re-orientation of its banks. Quite interestingly, the regulatory aspect coincides with an ongoing financial services liberalization within Europe, much to fintech startups’ favor.

  Shake Shack is filing for an IPO. (See the S-1 here.) This should be welcome news to all burger aficionados out there. It also made me think a bit about the comparison to high-flying tech companies. Sometimes, a reality check comes in handy and the company’s filing at a supposed USD 1bn valuation shows a remarkable similarity to any turbo-charged tech company success story. Despite not being tech at all.

  Granted, the investment inflow into Shake Shack will presumably have been higher than your average software play. But on all other accounts, its key IPO metrics are on par with any SaaS filing, and largely outperform anything in the ecommerce world. With its 2013 revenue run rate, it will be valued at a revenue multiple of 8.5 to 9, and will have filed for IPO within 10 years. This is perfectly in line with most SaaS ‘unicorns' that went public in the last ten years:

  What does this tell us? Foremost, it puts the “tech trumps everything” theme a little bit in perspective. Yes, cloud technology companies operate at incredible capital efficiency and enjoy exponential distribution capabilities, riding the wave of the digital revolution. Nevertheless, burger joints in extremely competitive - and to a technologist seemingly undifferentiated - markets can come up with similar success stories. That is if they show strong growth and a healthy profit contribution structure. Shake Shack does and demonstrates it through its "shack-level operating profit margin”. Markets will reward these factors in any industry. Lastly, it also confirms the notion that revenue growth is the single determinant of IPO valuations, be it in software or beef patty "hardware":

Within the world of venture investing, there are many approaches. Some act opportunistically or event-driven, others follow a set of theses or fixed beliefs. While the latter group has shown to be more vocal (a natural outcome of its doctrine-esque approach, I suppose), many roads lead to Rome. Regardless, it is about time to classify investment methodologies a bit - I have therefore tried to come up with a meaningful ontology of approaches.

One important caveat: I deliberately do not call those approaches investment “strategies". I see the overall strategies of most venture funds as somewhat similar, focusing on venture-stage equity investments. It is rather the underlying doctrine or thinking that is of interest here, driving which company (and not which broader asset class or stage) an investor will be considering.

1. Opportunistic investing

Opportunistic investors act event-driven and without a fixed set of beliefs that would limit their activities. While each and any investor will always use a healthy dose of opportunism, the main reason to list them separately here is that they, by definition, will not stick to a set of topics or theories. It is therefore best to define them in a negative way: they invest in the absence of an underlying belief. They will go for all industries, all companies, all business models given that return expectations are large enough.

2. Thematic or topical investing

Thematic investing might be the most common form of venture investing. Investors will focus on “e-commerce” or “SaaS” or “mobile” or “advertising technology” or ”Asia", i.e. they operate within a chosen industry or geographic domain. To be fair, most venture investing is thematic in some way as almost all VCs have picked the broader theme of “technology” as their playing field. Nevertheless, the pure thematic investor will attempt to cover a sub-industry from a rather broad angle. He will closely examine potential investments and go for the most suitable combination of team, competitive scenario and geographical scope. The pure thematic investor will stop here, while many of the more thesis-driven investors use the ‘topic' as a starting point for further intellectual refinement.

3. Thesis investing

Thesis investing means that the investor has an overarching intellectual foundation around the investment activity. This will shape the type of investment within a certain theme (be it the grander “tech” theme or a specific subset). I would differentiate between inductive, deductive and combinatorial approaches (or better: components) of a thesis. They all share the characteristic of a strong doctrine that underpins the choice of investments and that has been formed in the conviction of greater returns over time. While themes are the macro level, theses are micro.

Inductive theses

Inductive thesis investing starts with the company itself. Investors have an idealized concept of the enterprise and will pick accordingly. Examples could be margin requirements, business model types, user experience or the type of management team. These tend to be present, or near-future, characteristics of a company which define the choice of investment within a theme. Inductive theses have been formed around a conviction of superiority in scaling up the company or in withstanding competitive threats over time. I would argue that most venture investors have some form of inductive thesis, yet they might not officially postulate it as core factor of investment decision-making.

Deductive theses

Deductive thesis investing starts with a vision of the future. The investor will formulate a narrative of a target industry’s development and map out the individual elements that will be needed to spur that narrative. Each potential investment is then measured against these elements. Examples for such theses are the belief in “networks” or “the cloud economy” or “a broadband-enabled future of TV”. Each thesis can be dissected into individual components, and there is some overlap to inductive approaches (e.g. when you talk about “software is eating the world”, you inherently assume “software” as your preferred business model). Yet, the deductive thesis investor will always use his thesis as the basis of all thinking around investing.

Combinatorial approaches

Combinatorial thesis investing combines both types of theses. Deductive parts can be complemented by an inductive qualification. A prime example would be the decision to invest into “mobile networks” (deductive) that are “defensible” or have a "differentiated user experience” (inductive). To me, this makes most sense as both elements go hand-in-hand anyways. Quite evidently, inductive elements are most often the individual parts of a larger vision of the future.

A recent interview for an HBR article on crowdfunding and investment platforms made me think a bit about the democratization of VC and enterprise finance. Friend or foe, crowdfunding or crowd (in)vesting are a logical evolution of the digital revolution and its most prominent foray into the coveted space of private sector investing. To shed some light on the issue, I have gathered a few interpretations - from a company, VC and lender perspective. They are nowhere near complete, but could be good discussion points. For the sake of the argument, I am mixing debt and equity platforms, so please forgive my inaccuracies here…

The company view

Companies should welcome crowdfunding as the missing piece towards the democratization of enterprise finance in early stages. It opens up direct participation in innovation, enabling a more equal dissemination of progress and its rewards. In so far, it contributes to creating open, transparent and competitive markets for financing. This is true regardless of equity platforms (think Kickstarter or Crowdcube) or debt marketplaces (think Funding Circle).

For SMEs in particular, it fills the gap that has been created by even tighter lending and risk assessment standards put forward by established lenders. Crisis-induced financial reform of banking regulation (Basel III and the like) has triggered a significant rebalancing of asset positions. While it was difficult to obtain (risky) debt financing before, it is almost impossible now. This becomes particularly important in a bank-based system like most continental Europeans. Unlike the US, companies and innovation have traditionally relied on bank finance and close or intertwined bank relationships, while other (non-bank) capital markets have occupied a significantly lower share of enterprise finance. Crowdinvesting makes up for some of the lost financing opportunities and could become a standard form of corporate finance in the next decades.

The VC view

For a VC, the democratization of corporate finance creates an interesting new situation as it challenges - and helps - the existing model on various fronts:

It increases access to venture finance, a traditionally rather “elite” sub-sector within finance. This holds true for both (private) investors and companies

It makes the overall industry much more transparent - a good and to-be-welcomed development

It thus moves VC closer to a “perfect” financing market: prevailing informational asymmetries are reduced, market liquidity is increased, measurability and competitive analysis of VC performance is greatly enhanced

It adds credibility to venture capital as an asset class

Now what are the risks from a venture investor’s angle?

The “dumb money” argument: Institutional venture investors are industry experts. Unguided mass crowdfunding does not have this quality and might risk to fall for subpar investments. A “mediating” level (à la AngelList syndicates) might help here.

The company building argument: VCs provide fundamental operational assistance in the build-up of a company. This function cannot be substituted for by crowdfunding.

The cross-fertilization argument: VCs facilitate spillover effects and cross-fertilization between companies and industries - again, this cannot be undertaken by crowdfunding. The “institutional” role of a VC should not be underrated and is the main value add to “plain” finance.

To me, and despite some obvious risks attached, crowdfunding is an important development and for a historical parallel, it largely resembles the development cycles towards public markets over the centuries. Small clubs were broken up, access to and participation in industrial progress was enhanced, investment criteria became more transparent, performance could be measured in a clear fashion. The asset class in general will greatly profit from this; particularly in Europe, where VC exists only on the margin.

Not to be missed: The lender view

The situation for debt finance providers is slightly different. As they are the object of increased regulation and supervisory scrutiny, “giving in” to crowd platforms seems like a logical consequence.

One can expect a “flight to quality” when it comes to lending practices. In other words, large chunks of riskier SME finance might be taken over by new forms of finance providers. Banks will most likely position themselves in the larger and more secure tranches of corporate debt financing

Likewise, a “flight to size” is highly probable, to the detriment of smaller companies. Here, the true promise of crowdinvesting platforms comes into play and all signs point towards an ongoing trend.

Overall, the portfolio substitution towards higher quality / better risk assessment is in full force and will permanently change the nature of corporate debt finance.

One might see an interesting return of SME debt to the banks’ balance sheets if and when investing platforms become a viable asset class for banks’ asset management divisions. If materializing, that will be an interesting turn - asset managers turning into corporate financiers, i.e. banks intermediating themselves.

If there is one recurring theme I come across in talks with entrepreneurs, it is the defensibility question. How do you make your product defensible, how do you keep your customers or users for the years to come, how do you stand out and build up these unsurmountable walls of product defense?

I strongly believe in defensibility as an essential value proposition of our investments. In other words (in Fred Wilson's, to be precise), the software in itself is (or will become) a commodity over time. The real beauty lies in the added value that goes beyond pure software features or functions. Only if we see this sort of value will we consider an engagement.

Below is an excerpt of Fred's seminal post on the topic, the Dentist Office Software Story, which I encourage everyone to read. The story represents developments as they have taken place in many established industries, yet it also shows the imminent risk of relying on features and functions alone. Instead, added values should be generated that form the foundation of defensibility. Some of these are induced by his beloved network effects, others can be found in industry dynamics or supply- / demand-side lock-in.

    An entrepreneur, tired of the long waits he is experiencing in his dentist’s office, decides that dentist offices are badly managed. So he designs and builds a comprehensive dentist office management system and brings it to market. The software is expensive, at $25,000 per year per dentist office, but it’s a hit anyway as dentists realize significant cost savings after deploying the system. The company, Dentasoft, grows quickly into a $100mm annual revenue business, goes public, and trades up to a billion dollar valuation.

Two young entrepreneurs graduate from college, and go to YC. They pitch PG on a low cost version of Dentasoft, which will be built on a modern software stock and include mobile apps for the dentist to remotely manage his office from the golf course. PG likes the idea and they are accepted into YC. Their company, Dent.io, gets their product in market quickly and prices it at $5,000 per year per office. Dentists like this new entrant and start switching over in droves. Dentasoft misses its quarter, citing competitive pressures, churn, and declining revenues. Dentasoft stock crashes. Meanwhile, Dent.io does a growth round from Sequoia and hires a CEO out of Workday.

Around this time, an open source community crops up to build an open source version of dental office software. This open source project is called DentOps. The project takes on real life as its leader, a former dentist turned socialist blogger and software developer named NitrousOxide, has a real agenda to disrupt the entire dental industry. A hosted version of DentOps called DentHub is launched and becomes very popular with forward thinking dentist offices that don’t want to be hostage to companies like Dentasoft and Dent.io anymore.