When Skyscanner was sold to Ctrip for $1.8 billion at the end of 2016, it drew attention to a startup ecosystem that up until that point had been rather overlooked. London and Dublin were the main tech hubs. Edinburgh was known for asset management and financial services and had a more conservative reputation (at least financially).
Fast forward to 2021 and the Scottish tech ecosystem is booming. According to Tech Nation, Scottish startups raised £345m in 2020 and Scotland is home to nearly 2,500 startups. Investors are taking note and excitedly forecasting hockey-stick growth.
The Fanduel Saga
However, against this overwhelmingly positive backdrop is the saga of Fanduel. For founders everywhere, the story will rightly bring them out in cold sweats.
The outcome is not disputed – the four founders, as common shareholders, ended up with nothing. This was on the basis that the company sold to Paddy Power Betfair in 2018 for $465m with the preferred shareholders entitled to the first $559m.
What is disputed, and remains subject to ongoing legal proceedings, is whether the private equity firms that held the preferred shares acted lawfully. The founders argue that Shamrock Capital Advisors and KKR & Co colluded to wipe out the common shareholders and “enrich themselves”. The private equity firms strongly deny this.
The Ongoing Impact
As chilling as the Fanduel story is for founders, there is a risk that the Scottish ecosystem has overreacted to a single, high-profile story, which is slowing growth.
The narrative has broadly been cast as angel investors are good whilst venture capital firms are bad. This serves angel investors well, allowing them to get into more opportunities uncontested, but does not necessarily deliver the best outcome for founders, who may suffer excessive dilution, upfront and ongoing fees, and overly populated and cumbersome boards. It is also anathema to the highly collaborative investment ecosystem we enjoy in London and elsewhere.
For founders trying to put together a strong early-stage investment round they should be mindful of the Fanduel story, but also be aware of the wider market context.
The Relevant Lessons
First, founders should resist participating preference shares. Anything more than a 1x non-participating preference at the early stages is, in most circumstances, considered off-market. Investors should be looking to create economic alignment with founders and not trying to get ahead by tilting the economics in their favor in the round structure.
Secondly, a trusted legal advisor is a key ally in a funding round. They should be advising you on what is market as well as black letter law. Building trust with your investor is key, but you should still be validating what you are being told. Too much trust in investors can result in an off-market round that is both detrimental to founders and sends a negative signal to prospective investors in subsequent rounds.
Thirdly, there are some wonderful angels and some poor ones. Equally, there are some wonderful VCs and some poor ones. In each case, founders should take extensive references to understand who they are going to be taking money from. The idea that different investor types are inherently good or bad is misleading.
Finally, carefully calibrate how much capital you need to raise and the associated risks of doing so. Fanduel raised over $400m before it was acquired by Paddy Power Betfair. More capital allows you to grow faster, but it also comes at a price if you fail to meet the growth objectives you set or the market changes against you.
The future for Scottish startups is incredibly bright, but ensuring that founders put in place strong foundations is key to their success. They should do this by ignoring scare stories and other tactics, and focus on securing the right investors on the right terms.