Duet Partners
Tel: +44 (0) 20 7416 6630 / Email: partners@duetpartners.com


Weekly Briefing Note for Founders

11th February 2021

This week on the startup to scaleup journey:
  • Rethinking is a critical founder skill
  • Tell VCs why they shouldn't invest
  • How will you answer the "Who Cares?" question?
  • Consumption-based pricing drives valuation premiums

1. Insights of the week

Rethinking is a critical founder skill
There is a belief that VCs back entrepreneurs that have real conviction in their ideas. Those that take pride in their domain knowledge and expertise and use this to pursue their breakthrough idea against all challenges. But this is a fallacy. Herein lies the risk of what psychologists call cognitive entrenchment, staying stubbornly true to a belief or opinion, despite changing circumstances. Instead, VCs want to see founders rethinking the assumptions that they and everybody else have made about an area, technology, or market. This unlocks breakthrough thinking in order to make the seemingly impossible, possible.
Adam Grant is an acclaimed organizational psychologist and best-selling author, whose work is followed by some of the world’s leading VCs. In his most recent book, Think Again, he says, “Our convictions can lock us in prisons of our own making. The solution is not to decelerate our thinking – it’s to accelerate our rethinking.” Recently interviewed by US VC NfX, he says founders must operate with the ‘scientist mindset’. “When you have an idea, you’re not sure if it’s going to change the world so you’re interested in finding out. Okay, I have this hypothesis. Is it true or not? And what data do I need? What observations do I need to make in order to figure out whether it’s true or false?”
The concept of building a hypothesis, testing it, adjusting it and potentially rethinking it completely (pivoting) is the essence of the customer discovery and customer validation steps that early stage companies traverse. This sometimes feels like we are creating an unenviable history of wrong turns, misjudgements and wasted effort. But rather than hide this zigzag journey from prospective investors, confident founders share it – it is an essential element of the process that leads to new insights and scaleup success. The most successful founders realise that confidence and humility go hand in hand, they are not opposites. Demonstrating that you have the confidence to learn, the ability to let go of old ideas, and a deep awareness of the dangers of cognitive entrenchment, will only add to your credibility as a leader.

Tell VCs why they shouldn't invest

In preparing for investor engagement, founders will carefully assemble all the reasons why someone should invest. In fact the essence of the investor pitch is just that - a structured rationale for investment. But experienced founders know this is not enough. They also brainstorm the reasons why investors shouldn't invest. No business is perfect and there are always risks and uncertainties. Capturing these is an important step in preparing for investor Q&A. Developing and rehearsing answers is just the smart thing to do. We want to be prepared, on the front foot, and not taken by surprise when the questions start flying. That could happen in the pitch or in early due diligence.

Some founders go further. They convert the Q&A into an appendix to the investor deck for the live pitch. When a VC Partner asks one of those awkward questions, they refer to that slide in the appendix. Documenting and sharing the Q&A like this sends a strong message; we know where our weak spots are and we are across them. This demonstrates confidence and openness. It also engenders trust, an essential element in the relationship building process. But there two other powerful reasons for doing this: First, having the executive team brainstorm these points in advance puts the whole team on the same page prior to external scrutiny. Everyone will be singing from the same hymn sheet. Second, you are going to increase your chances of funding success by enabling the Partner to better sell your proposition internally

Once a Partner takes an interest in your startup they will need to bring additional resources into the picture as the due diligence process starts. These resources will increase as they head towards making an offer. But the other Partners in the firm will also need to be convinced that this is all worthwhile - they will be competing for the same resources. Part of their job is to challenge the Partner sponsoring the potential investment (your champion) and ask lots of difficult questions. You won't be there to answer, so by arming your champion with a Q&A, you will be more assured that solid answers will be provided. This makes your sponsor's job a lot easier and will reduce their fear of looking stupid (FOLS), one of the 2 great investor anxieties.

How will you answer the "Who Cares?" question?

In assessing the market opportunity, VCs will often use the "Who cares?" question to prompt discussion about future potential. To paraphrase VC Alfred Lin from Sequoia, "If this new solution were widely known and available, who (how many people/customers, what segments, with what buying power) will care (how much will it improve their lives or businesses)?"  Predicting TAM figures 5 or 10 years hence for what might be a nascent market today is often no more than complete guesswork, so being able to articulate your own qualitative analysis, no matter how rudimentary, will really help support any quantitative outlook. This is where a founder's understanding of the macro market trends (starting with Why Now?) is so vital.

VCs are often accused of being overly risk averse: "What can go wrong with this startup?". But some (like Lin) will bring a more positive mindset: "If everything goes right, what does this company become?". In answering this question, experienced founders will articulate their vision in the context of 'who cares'. Whilst it is often easier to talk in terms of markets they will also tell a story about people: the users and the use cases. This type of narrative brings the story to life, anchors the role of the business more firmly in the investor's mind (how it impacts people's lives) whilst also supporting the qualitative analysis.

In preparing for the "Who cares?" question experienced founders also consider who the losers might be. If this is a competitive environment, how will incumbents react? Who will fight against you? These players will also 'care', so your predictions on how the market will respond and potentially segment will be carefully scrutinised by investors. If this insight can be underpinned by progress you are making in your beachhead market, your credibility will be bolstered. Providing evidence of early market tailwinds will always act in your favour.

Consumption-based pricing drives valuation premiums

SaaS has revolutionised the software buying model, enabling product-led growth strategies to seed almost effortless adoption across the enterprise. Execs and IT managers are having less say in which software is used as employees drive early adoption. This quietly blooms under the radar until an unstoppable beachhead is formed. Subscription pricing based on the number of users has led the way here, but now ultra-confident SaaS businesses are lowering the barriers to adoption even further with usage-based pricing. As TechCrunch recently reported, the likes of Datadog, Twilio, AWS, Snowflake and Stripe are finding huge success with this approach.

Naysayers claim that investors will hate usage-based pricing because customers aren’t locked into a subscription. They also say that customers will find it hard to budget and may prefer a fixed pricing model. But when the price paid is tied directly to the usage of the software, the value proposition hits its absolute peak. There’s no shelf-ware. This is ‘land and expand’ at its very best. According to TechCrunch, looking at IPOs over the last three years, “Usage-based companies are trading at a 50% revenue multiple premium over their peers....seven of the nine that had the best net dollar retention all have a usage-based model. Snowflake in particular is off the charts with a 158% net dollar retention".
The move to usage-based pricing takes both nerve and impeccable planning. Key considerations will include speed of initial sale (land), user experience and customer care investment (expand), sales compensation, and revenue predictability. Above all companies will need to pick the right usage metric to determine pricing. Attentive, a personalized text messaging platform, uses the number of SMS messages. Data platform Snowflake uses compute resources and volume of data. But transitioning to this model doesn't have to be an all or nothing move. Many companies will offer a mix of usage-based and subscription pricing to start. But the direction of travel for premium valuations has now been set. Founders will need to decide if they are on this road.

2. Other pieces really worth reading this week: 

January 2021: VC Funding, Just Shy Of $40B, Hits All-Time High
Global Venture funding in January 2021 hit at an all-time monthly high of $39.9 billion, an analysis of Crunchbase data shows. Late-stage venture capital — around 69 percent of the total — dominated.  A staggering 102 rounds over $100M were recorded. 38 new unicorns were created in the month. Month over month, M&A counts were up, reaching 193 in January 2021 — an all time high. 2021 is already shaping up to be a blockbuster year for the venture-backed world.

Debunking a lot of the conventional thinking in startups
Investor Romeen Sheth interviewed Jonathan Hsu, Co-Founder of early stage US VC Tribe Capital this week and his insights on assessing investments were profound. The full thread is here and our favorite piece is: "6/ Model every interaction with customers to understand the business. In legacy businesses, we go deep on costs (revenue is only one line on the P&L). In modern businesses, we can go deep on revenue attributors - engagement, activity, time spent. This is where the value lies."

7 Guidelines on Selling Some of Your Stock in a VC Round
From Jason Lemkin's biog on SaaStr: "These days, if you raise money at a >=$80m-100m valuation, and are oversubscribed, most bigger Silicon Valley VC firms will offer to provide some founder liquidity. It’s not out of the goodness of their hearts. It’s so they can buy more. Bigger funds want to own as much as they can, and if they can get another 2%-3% more than otherwise, secondary liquidity is a way to get it. Some advice here though..."

A Few Lessons from Vinod Khosla
Vinod Khosla is the founder of Khosla Ventures, a Silicon Valley VC firm. He co-founded computer hardware firm Sun Microsystems in 1982 before spending 18 years at VC firm Kleiner Perkins Caufield & Byers (now Kleiner Perkins) prior to launching his own fund. His teachings are legion and this article from colleague Kristina Simmons provides real insight.

The Great Unbundling
Every year Benedict Evans, Venture Partner at VC Mosaic Ventures, produces an in-depth report digging into macro and strategic trends in the global tech industry. This is unmissable, thought-provoking analysis. Here is the latest: The Great Unbundling

Happy reading!

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