Weekly Briefing Note for Founders

13th August 2020

This week on the startup to scaleup journey:

  • A deeper dive into VC funds raised in 1H20
  • SaaS business models dominate investor interest
  • The hierarchy of Marketplace business models
  • Writing is a critical skill for founders
  • How Covid-19 has affected VC decisions and investments

1. News and Insights this week

Analysis of new 1H20 VC funds

In our 23rd July briefing we highlighted that in the first half of 2020, European VCs not only continued to raise significant funds, they raised more than ever before. As Dealroom reported, this means there’s more dry powder than ever ready to be deployed into European startups in the rest of 2020 and beyond.

In further analysis this week by Alexandre Dewez of Idinvest, he takes a deeper dive, and looks at:
The opposition between generalists and specialist;
The idea that capital to fund startups is abundant and will not disappear even if the ongoing crisis would last several other quarters;
The rise of pre-seed programs in the past 18 months with initiatives from Atomico, Blossom, Target and Heartcore;
The emergence of funds focused on building on European strengths - either sectors we have an edge on or thematics on which we are at the forefront.

The generalist v specialist analysis should provide great insight for founders who want to understand how different types of VC are perceived by their own investors, the Limited Partners.


SaaS business models dominate investor interest

Why have investors become preoccupied with software businesses in recent months? Simple: the valuations of these businesses is rocketing. In US public markets, whilst the DOW and S&P are down around 5-10% and NASDAQ is up around 10% year to date, the Bessemer Emerging Cloud index (top 100 public SaaS companies) is up an amazing 50% YTD, in the middle of a global pandemic. These are venture level returns - but in public markets!

This isn't necessarily because forecasts jumped (a few did, like Zoom) but it's the multiples that have shot up, especially for SaaS companies. TechCrunch analysis suggests this is a compounding of several factors including low interest rates, strong earnings reports, very good forward visibility (driven by accelerated digital transformation initiatives and exploding TAM), and strong gross margin resilience.

According to Jason Lemkin, founder of SaaStr, "These are crazy times. The economy has contracted at a record rate of -33%. Yet, the Cloud is on fire during Work-and-Do-Everything-Possible-from-Home. Shopify grew 100% at $3 billion in ARR. Zoom is growing at rates we’ve never seen before in SaaS and Cloud. And Morgan Stanley has predicted Cloud penetration will be pulled forward 5+ years or more."

In Nike's 2Q earnings call, direct to consumer (DTC) revenues jumped to 30% of total revenue. This was their 2023 goal, accelerated by 3 years! This DTC shift is having a profound shake up on channels.

Strong DTC growth generally is not just about the increasing importance of the consumer experience, it goes deeper. Investors are now using additional criteria to assess underlying value. One of these is the API strategy - how easy it is to incorporate multiple software solutions together to address new markets. This in turn impacts pricing models which are moving away from user based pricing to transactional pricing in many verticals.

So, whilst against the tide for many traditional business models, this is potentially a great time for SaaS companies to raise capital - before the euphoria ends!


The Hierarchy of Marketplaces

Marketplace business models bring together buyers and sellers through a digital platform. Think ebay, Uber, OpenTable. Many of these turn out be to 'winner takes most' markets, where the time to dominance can be incredibly fast. It took just 3 years for ride-hailing apps (essentially Uber) to overtake yellow cabs in New York. The dynamics of how these markets evolve is critical for founders to grasp as there are many misconceptions about how to plan for and measure success.

We have advised several marketplace businesses over recent years and have seen how measuring the wrong metrics can lead to confusion about sustainable growth. We love Sarah Tavel's latest article on the subject, The Hierarchy of Marketplaces, where she dismisses traditional 'vanity' metrics such as MAU and GMV. She says "buyers and suppliers don't care how big you are. They care how happy you make them versus any substitute."

This is not to say that you shouldn’t grow. In marketplaces, saturation of a market is critical, and the only way to do that is to grow. But if you think of growth as a means to increasing the average level of happiness per transaction (instead of the goal itself), it will focus you on quality growth over vanity growth.

Sarah is General Partner at Benchmark Capital, one of the most active global investors in Marketplace businesses including ebay, OpenTable, Grubhub, Zillow, Nextdoor and many others. She writes extensively on the subject.


Writing is a critical skill for founders

Last week we highlighted a valuable article on the subject of writing skills just published by First Round Capital: A Founder's Guide to Writing Well. We have been investigating further this week.

There is a definite trend back to writing in long form. Founders are leveraging the power of the written word more than ever, both internally as well externally. For newly distributed teams in virtual office settings this can be key in communicating complex briefs.

John Collinson, co-founder of digital payments company Stripesays "the returns to writing well are really high", with 3000 employees now there is a significant amount of asynchronous communication. The company has grown rapidly and is now valued at $36B. Stripe has made a strong commitment to 'extremely clear communications' a core part of its culture as it has scaled. This is paying huge dividends with employees in a remote setting, not just customers.

Even in established companies, Powerpoint has been 'demoted': In senior executive meetings at Amazon, before any conversation or discussion begins, everyone sits for 30 minutes in total silence, carefully reading six-page printed memos. Reading together 'in the meeting' guarantees everyone’s undivided attention to the issues at hand, but the real magic happens before the meeting ever starts. It happens when the author is writing the memo. By having to write it all down — as opposed to dashing off quick bullet points or cobbling together powerpoint slides — authors are forced to think out tough questions and formulate clear, persuasive replies, all while reasoning through the structure and logic.

In helping prepare companies for fundraising this reasoning is a critical backdrop to the story. Whilst founders are often quick to dash out drafts of the investor presentation - bullet points can sometimes come too easily - this all changes when it comes to the Information Memorandum. Often this is the first time that the founders attempt to capture the entire business model in long form and this can be be an enormous test. Institutional investors still put a great deal of store by this document, although the trend is to fewer pages (6-10). But write it properly once and it will sell your shares many times over.


Venture Capitalists in COVID-19 Study

Kauffman Fellows Research Center has helped deploy a survey of over 1,000 institutional and corporate VCs at more than 900 different firms globally. They learned a great deal about how VC decisions and investments have been affected by the COVID-19 pandemic. 

This is an extensive 32-page report that provides rare levels of insight into VC and Corporate VC investing priorities and approaches.

Here are some highlights from the paper’s abstract:
VCs have slowed their investment pace (71% of normal) and expect to invest at 81% of their normal pace over the coming year.
VCs are devoting more time to their existing portfolio companies, managing the VC firm, and meeting LPs since 2015/2016.
VCs report that the majority (52%) of their companies are positively affected or unaffected by the pandemic. 38% are negatively affected, and 10% are severely negatively affected.
VCs expect the pandemic to have a small negative effect on their fund IRRs (-1.6%) and MOICs (-0.07)

A note of caution: This is a survey of VCs where a great deal of the insight is qualitative, so has to be judged carefully. The most reliable UK data for 1H20 is that produced by independent market research companies that focus on quantitative analysis. We refer to these sources in our earlier briefing from 23rd July.

2. Other pieces that are really worth reading/listening to this week: 

Insight into one of the most influential Fund of Funds supporting VC
Jeremy Grantham is the co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo (aka GMO). GMO, which manages more than $60B for clients (60% allocated to VC), publishes some of the most thought-provoking research, most of which comes from Grantham himself.  In this conversation with Patrick O’Shaughnessy, in his 'Invest Like The Bestpodcast, he discusses the current crisis, and provides deep insight into the macro economic factors that drive investment strategy at one of the most influential global 'fund of funds'.

The New Business of AI
In-depth practical advice for aspiring AI founders in 2 high quality essays from leading VC, a16z:

The New Business of AI (and How It’s Different From Traditional Software)
At a technical level, artificial intelligence seems to be the future of software. AI is showing remarkable progress on a range of difficult computer science problems, and the job of software developers – who now work with data as much as source code – is changing fundamentally in the process.
Many AI companies (and investors) are betting that this relationship will extend beyond just technology – that AI businesses will resemble traditional software companies as well. Based on our experience working with AI companies, we’re not so sure...

Taming the Tail: Adventures in Improving AI Economics
AI has enormous potential to disrupt markets that have traditionally been out of reach for software. These markets – which have relied on humans to navigate natural language, images, and physical space – represent a huge opportunity, potentially worth trillions of dollars globally. However, as we discussed in our previous post The New Business of AI, building AI companies that have the same attractive economic properties as traditional software can be a challenge.

Google's $2.1 billion Fitbit deal hits roadblock
Wearables is a sector of great importance to several of our clients so this caught our eye. Google’s bid to take on Apple and Samsung in the wearable technology market by buying Fitbit hit a hurdle on Tuesday as EU antitrust regulators launched an investigation into the $2.1 billion deal. “The proposed transaction would further entrench Google’s market position in the online advertising markets by increasing the already vast amount of data that Google could use for personalisation of the ads it serves and displays,” the Commission said. It will decide by Dec. 9 whether to clear or block the deal.

Why do European companies buy so few startups?
In Sifted this week: European companies are much less likely than US peers to buy startups. It has big implications for the startup ecosystem and tech sovereignty. It’s not that Europe has any fewer large companies than the US. In fact, according to OECD figures, it has about 3 times as many companies employing more than 250 people than the US does. But these companies buy far fewer startups.

The Unraveling of America
In Rolling Stone this week, a forthright assessment by Wade Davis on what has happened to the American dream, laid bare by Covid: For the first time, the international community felt compelled to send disaster relief to Washington. For more than two centuries, reported the Irish Times, “the United States has stirred a very wide range of feelings in the rest of the world: love and hatred, fear and hope, envy and contempt, awe and anger. But there is one emotion that has never been directed towards the U.S. until now: pity.”

The Future Fund - update
As at 9th August, out of 868 applications, 565 companies have been approved for £562m worth of Convertible Loan Agreements since the Future Fund scheme was launched. Latest stats are here

Happy reading!

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