Duet Partners
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Weekly Briefing Note for Founders

10th February 2022

This week on the startup to scaleup journey:
  • CVC investments providing more options for founders
  • M&A market booming driven by new trends
  • Family Offices are a burgeoning source of investment capital

1. Insights of the week

CVC investments providing more options for founders

Corporate Venture Capital (CVC) is on the increase. In a bid to stay on the innovation curve, companies are launching new CVC arms and existing CVC programs are urgently being resupplied with capital. Research has revealed that out of the 1,952 CVCs that made an investment during the first 15 months of the pandemic, ending June 30th 2021, more than 900 were making their first foray into CVC investing. That is a nearly 50/50 split between “veterans” and “rookies” participating in COVID-era corporate venturing. For many, targeting startups to monitor emerging technology areas or 'outsource' certain R&D efforts has proven more cost-effective than setting up new internal teams. Startups benefit too. Typically, CVCs don't like to take board seats due to potential conflict of interests in the future. In this sense they can be less burdensome that VCs. But not all are after the same thing. Founders engaging with corporate investors must navigate the process with great care to ensure a clear alignment of interests. Looks can sometimes be deceiving.

In our recent article, Corporate investment in startups is booming, we explained the difference between those corporates that invest directly off their balance sheet and those that have a dedicated fund. The balance sheet investors are likely to be less practiced in the art. They will not have a dedicated investment team and the process will likely be driven by a business unit (BU) exec who will 'sponsor' the deal. Usually it's the CFO that ultimately needs convincing. The process can often be slow and there is the risk that the sponsor will suddenly find their priorities have been changed. As a result, such deals can suddenly fall away. For an increasing number that have a dedicated CVC fund, the process is usually much slicker. The motivation to invest is usually driven by one of two factors. For the 'strategic first' investors, the BUs will be involved but the deal won't necessarily need their approval. There is more autonomy to take risks. Then there are the 'financial first' CVCs where the investment rationale is entirely about financial return. In these cases, there is usually a Chinese wall between the fund and the BUs. A good example would be GV (Google Ventures).

The other variable is the stage at which the CVC will invest. GS Futures is the CVC arm of Korean firm GS Global and based in the US. They operate a big multi-stage VC fund (Seed to Growth). Recent insights into how they evaluate investments at different stages is illuminating. These fall into 3 categories: 'Core', 'Adjacent', and 'Beyond'. Core deals are undertaken with partners whose product or technology can be utilised immediately in the core business of GS. For example, to increase business efficiency. As there is a high sensitivity to risk, only late stage companies are considered. Adjacent deals are done in new sectors and business models where there is a desire to participate in the technology or industry space within the next few years, and this needs accelerating. Often these are done at Series A or B. Finally, there are the Beyond deals, where the technology is perhaps 5 to 10+ years away from having strategic relevance, but has real promise or is just too hot to ignore. Here, Seed stage deals are common, enabling a watching brief on how the tech and use cases will develop.

M&A market booming driven by new trends

All the headlines about big tech exits in 2021 seemed to be taken up by high profile public market transactions - IPOs, SPACS and direct listings. But M&A has also been a remarkable story over the past 12 months. According to Pitchbook's latest M&A report, deal activity rebounded from the COVID-induced slowdown in 2020 with a record number of deals in 2021. In 2020, almost 26k transactions generated $3.2T in global deal value. In 2021 this jumped to over 38k transactions generating almost $5T in value. As earnings and profits rose alongside valuations in public markets through 2021, companies felt more at ease taking on higher levels of risk. This translated into greater confidence in pursuing M&A deals. This was key as public companies are considerably more acquisitive than private companies.

But Corporate M&A is just one half of the story. A important trend for boards to be aware of is the increasing viability of Private Equity as an exit strategy. PE hit an all time high in 2021 taking an increasing proportion of the overall number of M&A deals, with Corporate M&A taking up the rest. PE deals hit almost 38% of total transaction share in 2021, up from 35% in 2020. Historically associated with final engineering-focused leveraged buyouts (LBOs) PE companies are becoming much more sophisticated operators, both as growth equity players (within the VC domain) as well as buyout, in all its various forms. Another key trend is ESG (Environmental, Social & Governance). In 2021, ESG-related acquisitions more than doubled as CEOs looked to reshape their businesses around a low-carbon future. European companies are leading the way, developing the strongest ESG credentials. Foreign companies looking to acquire European businesses will be forced to meet an ever growing list of ESG disclosure requirements.

Europe M&A also hit records highs in 2021, both in deals completed (over 16k) and deal value (almost $1.8T), both up over 50% on 2020. For corporate acquirers, the desire to drive further business scale beyond organic growth seems to still be evident. PE funds, just like VC, are also awash with capital and remain on the hunt for high growth opportunities. A concern in the UK is the tightening regulatory environment. The National Security and Investment Act came into force in January. This allows the UK government to intervene in takeovers of UK companies in 17 sensitive sectors. In the US too, there is increasing regulatory scrutiny, especially around potential 'monopoly plays' in Tech. These combined UK and US regulatory forces have continued to stall the $40 billion Nvidia- ARM merger. But across the broader market, M&A momentum continues. As interest rates and other macroeconomic factors apply further downward pressure on valuations, buyers will remain keen to take advantage of these cooling prices.

Family Offices are a burgeoning source of investment capital

Family Offices are an increasingly important part of the financial marketplace with an estimated $6 to $7 trillion in assets under management. By comparison, global hedge funds have around $3.4 trillion in AUM. PE and VC asset classes combined have around $4.7 trillion, according to Preqin. The super-rich — those with over $250 million — form family offices in order to bring their wealth management, tax planning, family services, and sometimes charity activities under one private roof. Campden Research, estimated that there were around 7,300 family offices in 2019, a 38 percent increase over the previous two years. This number is thought to have grown considerably since then. As of March 2021, there were 2,755 billionaires globally, with a combined net worth of $13.1 trillion. Billionaire wealth surged by $4 trillion over the first year of the pandemic. Plus, many more millionaires were minted in the heady markets of 2020/21 as founders cashed out of enterprises after sales or IPOs, and now have large pools of cash that need managing.

Three-quarters of family offices are based in North America and Europe. Most are in the U.S., which houses over 3,100 offices, or 42 percent of the global total. An estimated 1,000 family offices are based in London, managing over $1 trillion in private wealth. Families with over $150 million will usually form a 'single-family office' to serve their unique needs while families with as little as $25 million might engage services through a 'multi-family office' that serves dozens of families. Over recent years, an increasing proportion of AUM has moved beyond public market securities into venture capital, impact investments, and other more speculative investments. Those seeking venture capital, especially General Partners of major VCs, now regularly pursue family office investment as they build new funds. Analysis by the FT showed that 59% of family office investments are deployed in traditional asset classes (e.g. public equities, fixed income etc.) and 35% in alternative asset classes including PE (16%). This is split between direct investments (9%) and allocation to funds (7%), including VC.

For founders seeking new or alternative sources of capital, family offices can be a very attractive option for direct investment in certain circumstances. Free of much of the structure of institutional investors like VCs, the investment decision-making process can be very brisk. The initial challenge before making an approach is figuring out if there may be a fit, especially in terms of stage and sector. Being typically very private in how they operate (many won't even have a website beyond a simple home page) working this out can be tricky. Most are strongly thematic with their investment preferences, so doing the research can pay huge dividends. Then it's about finding a way in, which often requires some detective work. But if there is a potential match, things can move very quickly. Having helped several founders solicit direct investments from family offices, our experience has generally been very positive. This has included syndicating Series A deals alongside both VCs and CVCs, as well as some highly unusual turnaround and recapitalisation projects. Founders building funding strategies for 2022 investment should factor family offices into their thinking.

2. Other pieces really worth reading this week: 

Josh Wolfe - This is Who You Are Up Against
Josh Wolfe is a founding and managing partner at Lux Capital, one of the leading DeepTech investors in the US. In this interview, he reveals insights into the development of new investment theses, why the minority opinion tends to lead to the best investment outcomes, and how he evaluates the competitive advantage of a business. And in a follow-up interview, he discusses the checklist he uses to evaluate leaders, the closing gap between sci-fi and sci-fact, and the current theses that Lux is chasing. This is pure gold for DeepTech founders everywhere.

The problem with engineering-led growth for early stage startups
Some great insight into the different stages of growth in this article by David Peterson of Angular Ventures. "In reality, different growth teams, with different skill sets and profiles, are needed during each stage of a startup’s development. Engineering-led growth teams have their place, but if you’re thinking of hiring a growth PM to solve your growth problems and you only have a few hundred users…stop. And keep reading this post instead.".

The Cadence: How to Operate a SaaS Startup
David Sacks is a VC and co-founder of PayPal. In this In this article he describes how to synchronize the major functions of a SaaS startup so that the team works together in lockstep. "The Cadence is an operating philosophy that I first learned as COO of PayPal (during the so-called “PayPal Mafia” founding era) and then adapted for SaaS as founder/CEO of Yammer, which Microsoft acquired in 2012 for $1.2 billion. To this day, Yammer is still the fastest unicorn exit among SaaS startups, and a lot of that success is due to the Cadence."

Happy reading!

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