E516 | Lorenzo Franzi, Italian Founders Fund: Founding with Focus: Why Italy’s VC Moment Is Now

28:07Now I want to ask you about the arena in which you play. So you described it in the beginning when we talked to Thesis, right? It's Italy, it's Italian diaspora, and it's foreign companies that want to enter the Italian market and where there for some reason is an opportunistic fit with you. But I want to ask you to just describe to me as clearly and as data-based the opportunity that we're looking at here. In our framework, I'm hearing the venture market maturation framework from Foundamental, where they're saying, well, we've been looking at different verticals across the world and across the venture.

28:47and said, okay, so when it started, when this sector got started, FinTech as an example, when it got started, it took two years to go from 5 billion to 10 billion. And then from there, it took six years to go from 10 billion to 50 billion. And now today we have 490 billion of total VC funding within FinTech. So that means eight years there. It took eight years from when it really, started and was a small thing to really become a large investable segment within venture. And then what they did with this framework, they went through a bunch of different verticals and found that there is some magic around this inflection point that happens in industries that it takes oftentimes a good venture industry will mature from being very small and non-investable to being an incredible opportunity.

29:45takes those eight years. And if you then hit that market at the right time, you're at the perfect place to dominate this sector, right? So my question to you is then looking at the market you described before, Italy, diaspora founders and foreign companies wanting to enter Italy, how would you describe that from a numerical perspective? Why is it that there's enough now, whereas there was maybe too little before? Or if you just said B2B SaaS in London, I'd say, well, isn't that pretty filled up with good investors already? So my question to you is, how would you describe the opportunity that's right now in your arena?

30:28Yeah. So I think there is a certain moment in time element as well, right? So I think if you look now in 2024, if you start to look at most likely around 2020 is when also way more capital started to be deployed into Italy, right? And I think the amount of money invested in Italian venture, you know, passed the one billion mark and reached around the two billion mark. And that's been a very step change versus what was ever done before. Part of it is a lot of public money, right? So through its arm, GDP, the Italian government decided to invest way more in innovation and support. And I think for us, that's been an amazing component that supports.

31:11I mean, we don't benefit from it, but we see a lot of our portfolio companies and ecosystem members benefiting from it, which the main benefit is also attracting talent in bigger waves. So we think that's a very big element. The other data point we look at is similar ecosystems and their progress, right? So as I mentioned, I was lucky to sort of be in France in 2012 at the end of it when you still had François Hollande as a president. It was still quite hostile as a startup ecosystem, but it was accelerating. Criteo was doing really well. Algolia was born and quite a few others. And we're now around 12 years later and we are at a huge acceleration since a few years.

31:59So that matches, I think, the years you mentioned, that it takes a whole cycle of at least eight years to really start to see some of the results. So we think Italy started that acceleration wave a few years ago. And now it's accelerating. We are part of it. We see a lot of foreign investors coming in. I don't have the exact number, but if you were to track how many of the sort of seed and series A Italian companies received foreign capital, it's been exploding over the last even just two years, I would say. Again, for us, this is an important data point on the acceleration component. So we see the local ecosystem benefiting from increased funding, increased attention, more companies being created and good quality profiles deciding to be founders.

32:55And that's all now starting to materialize in the numbers, but it will take time and we see the same sort of horizon needed. And most likely we will also see a lot of failures first, right? So I think that's already an important data point as well, is it takes most likely only one to three, four years to see the losses on a pre-seed or seed investment that doesn't go through. It takes way longer to see the result. And that's part of the education we also want to share with RLPs is, you know, get comfortable by losing companies early and have to wait for the winners to take more time. Now, and this is the contentious part and one that might be harder to answer on the open air, because I'm asking you now to comment on the players in the market.

33:43Yeah. Which means I want to ask you about, are you materially different from the other players that are active for the founder profile you're targeting? Yeah. So I think we learned it the hard way of why there is no small funds in Italy. When I mean small funds, I mean sort of your 15 to sort of 50 million. It's extremely hard. The regulations are not made for it. So at the pure pre-seed stage, let's say the 200 to 500K ticket, it's very hard to have an institutional vehicle or a fund to operate. And you have a lot of great angel groups, communities doing really well, and then a few corporate players doing well.

34:26but it's very hard structurally compared to some other markets like the UK or the US where the barriers of entry are the small side. Tell me, do you mean here from the complexity of doing deals as a fund with its time? No, I'm more setting up the fund. So setting up a fund, the time it takes, the cost it comes, the regulatory complexities, the thresholds. And I just set it up in Delaware or London or Lux or Holland as so many others. So I think there's still a local feeling of local appetite, right? So I think people want to see that. We also see it with the regulation to bring in foreign capital.

35:13It's even harder for us than to bring local capital. So there is more friction. We would be a big supporter of, at least on a European level, a much more integrated market. But it's the reality. It's quite culturally and maybe even tax-wise, I'm not sure, but for Italian investors to invest abroad. So it remains people want to see local investors. That's what they're used to. That's what they know. And then to execute deals, you need to be somehow used to the language, et cetera. Your articles are going to be written in Italian and those sort of stuff. But that's true in every single European market.

35:49But it's really on the fund setup. So, you know, I think what we've been able to do is on the smaller side, the smaller end of things, bring in a fund structure with all the support and then the follow on capital depth, etc., that a fund can bring. And that's something quite new, which hadn't been done before. I asked a stupid question by design when I asked you, why not set it up somewhere else? Because many, many LP ecosystems are very patriotic, especially with their startup money. For many of them, it's kind of seen as a way of supporting the ecosystem. And if you're super financially literate and used to doing stuff across borders, you're like, well, if it's structured in Luxembourg or here, I don't give a fuck.

36:38But if you're a local guy and you're not used to doing that, it's kind of like, why are you putting it in that tax haven? I'm not doing that. I'm not telling my wife or my friends that I'm investing in this shady thing happening in Luxembourg. Absolutely. And a lot of the capital we raised is to give back, right? I mean, I think people are really willing to support and they see it as a way to give back to the ecosystem and where local angle matters. I agree with you. The more sophisticated investors we talk to wouldn't care and they speak way more around your expected returns and all that rather than the impact you have.

37:16But the majority are all entrepreneurs and they care, how will we engage them? What impact will we have? How are we going to really help increase innovation and entrepreneurs to do well from Italy? Do you think it's fair? Do you think it makes sense to like to have the structure incorporated in Italy? Or do you think that, well, honestly, from your perspective, I get why they feel like this as an LP. But in fact, what matters is where the money is invested. And the fact that the returns are created in a structure that's in Luxembourg, well, it goes back to you and you're not in Luxembourg. Luxembourg doesn't tax it.

37:59So the only thing is really the structuring ecosystem in Luxembourg is, you know, maybe where we're putting a bit of money outside of our ecosystem, but all the rest is coming here. Yeah, I mean, I think personally, it doesn't really make a difference. And I don't think it should. I mean, I'm a big European believer. So I would really love to see a very integrated capital market at the early stage, you know, you know, wherever it's thanks. Thanks to a former Italian prime minister. Yeah, yeah, yeah. Hopefully, you know, we'll see some of that come through. So, you know, I think at the early stages, whatever is cheapest, most efficient, fastest to be to market should be the solution that we all use.

38:40And then, you know, over time, as companies grow, we should, you know, tap the pools of the best types of capital independently of the borders. Reality and culture is a bit different. But I think that's, you know, that's the path we took and still it's been an important point for our local MPs. I think on how we're different, right? I mean, I think a lot of the historical funds have done really well and grew their fund size significantly, right? I mean, I think Andrea mentioned that the last size, the last fund was, I don't recall exactly, but maybe 250 million or very large compared to what we have.

39:15And then I think it's natural that they have to go towards their current strategy, which is, you know, Series A and onwards. But that leaves a very big gap and their expectations are growing. The growth market is hard and everything is pulled upwards from an expectations perspective, which means also the seed and the pre-seed stage is crucial. And I think that's where we really focused our efforts. And we see many other players now operating here too. 360 launched a dedicated seed fund as well. And we have a lot of other peer funds operating too. I would say we've really taken the angle of not having institutional capital, but just private capital with a very strong entrepreneur DNA and being very hands-on.

40:02We don't want to be passive. We don't want to build a huge portfolio of spray and pray. We want to build a concentrated portfolio where we can build a lot of proximity with the portfolio companies and know them well and support them. And that for now puts us apart. But as I said, I think the market is growing and we're very collaborative. So we want to work with as many people as we can and hope to see that the whole pie will grow, not only the number of startups, the ecosystem, but also the managers that can provide an edge to startups. Could you tell me a bit about the fund model that you're executing on?

40:40Meaning what I want to understand here is a bit how you minimize the time and maximize the probability of you creating DPI. Maybe if we start by your track record, you could talk a bit about. So you described multiple investments, 20, I think, in that neighborhood as an angel. Now you've done six from the fund. Tell me a bit about, you know, what's the, if you're up for it, what's the TV buy in total on the full angel portfolio or something like that? I'll let you take it from here and give the benchmarks or give the stats that you're willing to share. Sure. So I think, you know, it's different to be an angel to be a fund, but I'll cover the angel part first.

41:22So I think as an angel, I personally think it's important to take liquidity when it arises. So I've personally benefited to always leverage secondary opportunities to take some money off the table and recycle it. Thankfully, I'm in this industry, so deal flow is not an issue. So recycling those proceeds has been always possible. And so that led me to sort of, you know, bag in some good returns and have a quite positive TVPI. You know, what the exact number is depends. Even DPI. Even DPI, yes. Yeah, I mean, as an angel, I think you can get it earlier, right? So I was lucky that a few of my early investments got acquired over time.

42:04And actually, our secondary options arrived between, on average, my exit times have been around four to seven and a half years. So that's where I sort of, as an angel, try to find liquidity, as I often find that if you stay too long, it's very hard. You sometimes get squeezed by growth investors and liquidation preferences, et cetera. And I think that's where I want to bridge those. These have been important learnings to us as an early stage. Right. I think sometimes your successes, it's really important in venture to convert the successful companies into a strong financial return. And it's not always a given because of the behavior of late stage and what can happen there.

42:46You know, the level of debt. We see it in quite a few ventures that you know, that companies that have done really well end up not being the return expected, even if they're worth a lot of money because liquidation preferences, debt set on the company and all of that. And so to go back to our fund model, we invest, lead or co-lead. We want to be a significant shareholder, ideally 10 % plus of the ownership. We sit on the board. We're very supportive. We keep around 40 % of our fund for follow-ons. So we target a portfolio of around 25 companies. We think we'll invest in around seven or eight with the follow on sort of capital where we can be deploying up to four, potentially five million in total into those companies.

43:31So we want to be a significant and early stage investor, at least for the size of Italy. And then our investors keep on asking us to co-invest, follow on and do more. So we think we will want to continue to deploy maybe with follow on vehicles, et cetera, over time for two reasons. One, to defend the right of the early stage investors. So we think it's important to remain deploying capital into companies to keep that relationship and that position to defend your capital and sit at the table over time. Two, we have two types of entrepreneurs in our fund. We have some maybe younger ones who are very excited to get DPI quickly, and we have really permanent type of capital.

44:18So how do we think we will match those two? and we haven't found a solution yet. But we think ultimately that funding structures to get secondaries even as a fund, maybe even reinvesting them in a continuation vehicle are all very appealing options for us to provide that DPI also to those type of investors who want it really on and to enable the ones that have a very permanent type of capital to remain invested. We think secondaries is important. We work, I think, on liquidity generation we also open a lot and very early the landscape of contacts for portfolio founders. So that means getting to know foreign investors, potential foreign buyers, industry leaders, because you don't know where liquidity will come from.

45:06But we will need for each portfolio company to create it because it's not that we have very liquid capital market that will make it very easy. And we have the chance of coming in a bit later, seeing what happened in France, what happened in Germany. And liquidity, most likely as a European asset class, is the biggest topic we need to solve to deliver concretely in a cash element, the returns everybody writes on their reports and that we promise to our investors. So here, just a note, right? If you were more vertically specialized, vertically focused, this is where one would maybe dig a bit on on will there be sufficient liquidity opportunities within this vertical.

45:51As an example, we all love tech bio, but there's not been that many access from that type of strategy, actually. So for that reason, and that's just because it's a very new space. So that's one place where you might have LPs digging into whether this is a liquid market. I think it's a bit less importance when you're, as you are, not vertically specialized, but rather have a focus on the geo. And then you can always want to then dive into and say, well, have there been created large successes in Italy that you basically go in and take your portfolio model saying, okay, if you're expecting that you're going to create a billion dollar company here, then, well, has that actually been created in this timeframe?

46:39How many of them would you have to invest in for that to be successful? You're nodding a bit. So, you know, I'd love to ask you, I think you've maybe done this exercise. I mean, I've been asked these questions a lot more than done the exercise by some of our LPs and it's early, right? So I think it's also a bit, Unfortunately for us, it's hard to look back at the Italian data to see some of that. I think even listening to the episode with Andrea, even if he's been in the industry for a long time, a lot of the companies are still invested. And I think that it's the case for everybody. So Andrea's strategy is not right on unicorns and the typical venture model.

47:26So to say as much as I haven't seen your portfolio model, but I'm guessing that you're doing a bit more of an alpha strategy, typical VC playbook, which makes it all the more important to ask someone like you, well, is now the time? Do I believe in that? Can you convince me? Yeah. Yeah. Yeah. No, so absolutely. So we're going a bit more for the alpha returns and we come in earlier as well. and sort of larger outcomes where we want also more capital to join into the companies and ambitious foreign capital to join. And we think it's a collaborative approach with some of that vertical expertise or some of those other components that we don't have maybe as a fund we want to find with our co-investors.

48:13The time, at least on the early stage now, with great quality founders, great companies, great talent, building very useful products is coming, right? I think there has been a step change especially in software over the last few years. And we think also that the recent downturn helped focus on economics more. So I think the length or the depth of the cash burns will also reduce, which will widen also the pool of liquidity because more financial savvy type of investors who want EBITDA, who want at least a joystick where the company can control its cash flow destiny, a lot of the European companies are now way more in control of that.

48:57And they've seen that they can operate with much leaner teams, much lower cost bases, etc. And I think we are in a much more healthy environment. So I think the wave of companies that will do well from this sort of measures are going to be way more appealing for those type of investors to be bought. So I think that's widening our opportunity. I think there is still a big liquidity element on IPOs and listing, et cetera, which I think in Europe is extremely difficult. So we don't see that. But I see a good opportunity on preparing our companies to be financially more disciplined, even if they're going for the high growth and unicorn and a bit more the alpha point you mentioned.

49:39And by squeezing the time as well, by having those conversations regularly with the companies and the co-investors, when should we exit? At what time? you also bring down the time span and you push a bit the IRR, right? So for your investors, it's important. And I think that's maybe one component which I find sometimes hard in other strategies is if you think you de-risk and you take more time, the IRR impact is really, really negative because you lower the return and you lengthen the time and all of that, it becomes hard to compete with the liquidity and other elements of traditional, maybe quoted asset classes.

50:19And then people should be, why should I lock in my capital for so long and have so much risk? So we personally think that we need to take a lot of risk. We need to go for large outcomes. And we've mitigated that with our investors by telling them invest less than what you thought. So I think to everybody, we've said, how much do you want to invest? They said X. We said, fine, do half. That's good because they all want to co-invest and deploy capital next to us now. But that also means that they have the right risk exposure for what we want to do here. Yeah, and I think that's both from a fundraising perspective and incredibly bold move.

50:58But I'm also sure that it's one that creates trust with LPs. It's not what they are used to hearing, I'm sure. But I do think you're absolutely right. It's so important that you have LPs that have the right risk profile. So you don't have them breathing in your neck and they're comfortable with what they've done. and all that. And I think that back when I was fundraising from LPs that are not used to invest in the asset class, the last thing you want to do is kind of talk them into to have too much exposure because that's going to blow up in your face. But we're all good salesmen, right? So you can talk people into much.

51:41Now I want to ask you one final thing, And that is, I want to ask you about how do you maintain your discipline? This is the seventh part of the Edge framework here. What are the principles, the parameters, the processes that you run through to make sure that you're focusing only on your niche? And when your ecosystem, back when you were an angel, everyone knew you and you joined in whatever seemed like a good opportunity. But now you have to say, this is my strategy. I'm not doing anything else. So I think first we try to define it very precisely, right? So we defined it, we write it down, we put it on the wall, and then we need to repeat it time and time over again internally to our LPs who we ask for deal flow and to the broader ecosystems, right?

52:27So we need to do even more, I think, to repeat it time and time over again. And I think where we're also lucky is that we work in a very open model, right? So part of our LPs are very engaged and we talk about our deal flow and sometimes they remind us, look, well, okay, this is very exciting, could be a great return, but look, this is too borderline from the thesis we subscribe to. And so we operate, we have a dedicated team. We're all super excited because I think we're doing the job we all would dream for. We meet super interesting entrepreneurs day in, day out. They tell us our dreams. We dream with them.

53:06We support them. We can see some of our impact quickly. So we're all a small, dynamic team, very passionate about what we do. And we have the chance to work in an open way that gives some of the check and balances as well. and we've told the story very clearly to everybody. And we said, please hold us accountable. Like, you know, tell us, be frank. We are very direct. We're very transparent. As I said, we're collaborative and we want to bring people in our journey from co-investors to the right advisors, to the right LPs, to whoever we think can help do what we think is the most important at our phase and at least for the first few years of our companies is do whatever it takes to improve the probabilities of success.

53:48And I think that's something very new, especially in the Italian ecosystem, where there's a lot of optimization, right? I see lawyers being used to have crazy complicated terms and what if an IPO happens and all this. And I'm like, we are pre-seed. Like, you know, if we ever dream of an IPO, there will be, you know, many rounds between these docs and the others. So this close will never be there when the IPO happens. So, you know, we want to behave in that way that is extremely focused on the mission today, the first few years, probabilities, and get this flywheel going to bring success to our entrepreneurs.

54:33What a funny thing to even be talking about terms for the IPO at Prec. Yeah, I think there's a partially you need to understand a bit is the Italian venture ecosystem and maybe many others is born also from many financial players entering the asset class from more mature asset classes sometimes. Or even not the investors, but the lawyers or other supporters, that's what they know. And you start from recycling something. And I think now we see a lot of effort of standardization and a lot of people in the ecosystem doing a lot of great work to mature and adapt to what we really need. But that's some of the things you see and that are positively changing at the moment.

55:16Yeah, no, it's a journey every ecosystem goes through, but it's been a while since I heard about that type of thing. But you're absolutely right. And it's the same thing. It's why you say that angels can be the best people on the cap deal, but they can also be the worst. Because typically as a GP, you'll have raised money, you're part of the venture ecosystem. So typically you know these things, but an angel can end up being the person or being the team that dusts around in the beginning. And then they bring, well, I'm in private equity. I know how to do this. Or who's then a private equity lawyer.

55:55Yeah, some of those profiles, you're absolutely right. I think one other thing we try to do is, you know, we often have angels go investing with us in the companies. And having been an angel and being an angel, I think it's also important to keep these investors in mind because they've taken often the biggest risk. I think it's so important to say that they can be the best and they can be the worst. Yeah, no, no, no, I agree. What I meant is a slightly sub-segment here that's dangerous. No, no, I agree. I think what I meant is more is how do you protect angels through time, right? I think that's one of the most topics I hate the most in venture is when I see angels being squeezed very late in the history of a company because they lost the influence and the power.

56:38And ultimately, they don't get rewarded for the risk they've taken when the result is positive, right? And other investors squeeze them in a certain way. I think that's something as an angel and I think as a community that aggregates angel and that speaks for a lot of them, it's an important element that we never forget that. And founders don't forget their angels who were there at the very beginning when they negotiate later on. Yeah. And unfortunately, you just end up in a situation where it is the founders that need to stick up for you, right? Because as an angel, you can potentially get very squeezed.

57:16Absolutely. Lorenzo, thank you so much for joining me for this conversation. Was it fun? Did it make sense? I really much enjoyed it and very honored to have been the first to go through this new framework. So thank you for that. Did it feel a bit like doing a recorded LP call for the first time? A little bit, but more fun. Was it more friendly? Thank you. I'm happy to hear that. Well, I'm the friendly LP. Lorenzo, thank you so much for joining me. It was really fun. Thank you so much, Andres. Will we be seeing you at 0100 in Milan? Yes, absolutely. We will be there. We're doing a few events around that as well.

58:00Well, so are we. We're doing a masterclass for the community there, but also everyone else. But we're diving in together with Mark Bancala. We're diving into a fully comprehensive portfolio modeling session. So four hours or so of just nerd, nerd, nerd. So that should be good. Very nice. Now we are organizing something with Mark as well around B2B SaaS. So very excited to have all of those experienced brains and people coming to Milan. And we want to make sure the local founders get the most exposure to these as well. It's funny this structure with these conferences, they're always supported by the local governments, right?

58:44So it's this one and everyone else. But it's just so important to bring those 20, 30 VCs to show that what's happening here, allow the founders to meet them, allow the risk capital to also meet them from an LP perspective. That's just so important. I agree 100%. Lorenzo, thank you so much, man. See you. Thank you. Here's a few words from our beloved sponsor. Welcome to the European VC podcast, sponsored by Flow. Combining technology and regulatory rails, Flow is enabling the private markets. For the VC market, Flow is working with integrates every aspect of fund management. From creating investment management agreements to handling custody services and regulatory reporting.

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