Duet Partners
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Weekly Briefing Note for Founders

15th April 2021

This week on the startup to scaleup journey:
  • 1Q 2021 VC investments break records
  • Network Effects are the biggest competitive advantage
  • 'Willingness to learn' will draw investors
  • PR is a power tool for founders

1. Insights of the week

1Q 2021 VC investments break records

As reported by Crunchbase, European venture investments reached $21.4B in the first quarter of 2021, more than doubling year over year and almost double over 4Q 2020. This represented an all-time high and funding value at every stage was up. In keeping with the recent trend, late-stage funding dominated the first quarter at $14.3B, growing 202% year over year and 126% quarter over quarter. As a result, late-stage companies scooped up almost 67% of all equity invested in venture-backed startups.
At Seed stage the value of all investments grew 10% quarter over quarter to $1.3B, which represented a solid 26% year over year increase. But deal count continued the downward trend we have seen right through 2020. In Q1 2020, a total of 1,405 Seed transactions were reported across Europe and in Q1 2021 this fell by 35% to 919. There is always a reporting lag on these numbers so they will go up in the coming months, but the downward trend seems clear. This is a continuing source of anxiety for startups trying to enter the venture ecosystem. At Early stage (Series A, B), deal volume was flat year on year but value invested shot up 49% quarter on quarter and 62% year on year to $35.5B, a new record. As a result, average deal sizes at both Seed and Venture stages are continuing to surge upwards.
On the exit side, acquisitions trended up dramatically too, rising 28% quarter on quarter to 147 events in 1Q 2021. Acquisition values more than doubled quarter on quarter to $9.7B. On the public markets, only 2 venture backed companies made their debuts above the $10B threshold. These were London-based Arrival, an electric-vehicle company valued at $13 billion in its debut via a SPAC, and Deliveroo at $10.4B. Provided public markets continue to gain ground it seems likely that VC investment momentum will continue strongly, making 2021 a blockbuster year.

Network Effects are the biggest competitive advantage

Long term competitive advantage, or 'defensibility', has always been a hot investor topic. It’s often linked with either Scale (e.g., economies of scale that others can’t match, such as Amazon); Brand (e.g., familiarity or default choice, such as Google); or Embedding (e.g. high cost of change, such as Oracle). But the most powerful defensive capability of all is now considered to be the Network Effect. This is where every new user of a product makes the product (OR service/experience) more valuable to every other user. These mechanisms are unusual as they aren’t the preserve of big established businesses with deep balance sheets, monopolistic market positions, or extensive patent portfolios. According to US VC firm NfX, network effects account for the majority of value created in the technology industry in the past few decades, since many winner-take-all companies in tech were powered by network effects.
The unique feature of a network effect - unlike other defensibilities - is that it's native to the digital environment. These days a highly capital efficient software startup with a handful of employees can leverage network effects to dramatically scale its business. But network effects are not just cheaper to create and easier to harness than other defensibilities, they also improve retention. As new users join, they add more value to other users, increasing the overall rate of return to everyone else. They often build gradually but then hit a tipping point that drives highly efficient growth. This must not be confused with virality, where existing users enable new users to be acquired for free. Network effects are primarily about defensibility and are linked directly to user value creation. Examples include social networks (e.g. Facebook), marketplaces (e.g. eBay), matchmaking (e.g. Craigslist), restaurant bookings (e.g. Opentable), and there are many more across all business models.
Building in long term advantage in the face of increasing competition is now seen as a critical factor in corporate value creation. That’s why investors love talking about Network Effects. Some will say that the priority should be on delighting customers - making them fall in love with the product. That’s all fine, but you can bet that before any institutional investor - like a VC - issues a Term Sheet, they will carefully assess your competitive positioning to see how durable it may be. Factors like speed of execution, personal relationships, talent, and even patents will all be important in establishing this position, but network effects will keep you there. Founders must therefore look at ways in which network effects can be designed into their product offering and exploited. No investor pitch now seems complete without a probing discussion on the topic.

'Willingness to learn' will draw investors

Just about every analysis of the key traits investors look for in founders highlights 'willingness to learn'. Why? Almost every aspect of the startup journey requires an ability to learn at pace: To be open-minded, to experiment, to discover, to adapt. There is no real preparation for the startup to scaleup journey, except the experience of having done it before. If you are coming from the corporate world, there is an added twist; having the ability to unlearn is also seen as critical. For example, you must unlearn the process of creating, building and launching a product. Established companies intuitively understand their market and fashion a solution to fit. Startups understand their solution and fashion their market to fit. The road to product/market fit is more about user cohort analysis to find the growth sweet spot than ‘fixing’ the product to immediately appeal to as many users as possible.
Former VC Lakshmi Balachandra spent 10 years capturing what happens in pitch meetings and quantifying the results. Her research drew several key conclusions: 1. Passion is overrated (investors prefer a calm demeanour - studies confirm people equate calmness with leadership strength); 2. Trust beats competence (competency can be taught but character is less malleable), and 3. Coachability matters. This last point lies at the heart of 'willingness to learn'. Many investors believe that their value-add as mentors, especially to first-time founders, is important and can have real value (even if this belief is sometimes misplaced!). Where the investor has particular knowledge about an industry, this is especially true. Investors can be put off investing in entrepreneurs that appear arrogant or fixated on their own views.
The pitch meeting is possibly the first serious interaction an investor has with a founder.
Experienced founders approach the pitch less as a formal presentation and more as a conversation in which attitude and mindset matter more than business fundamentals. They listen hard to the questions being asked and are thoughtful in their responses. If they don’t know something, they offer to find out—or ask the investor what he or she thinks. Above all they don’t react defensively to critical questions. So, instead of obsessing over the specifics of your pitch deck, Balachandra advises, “think about being calm, cool, and open to feedback.”

PR is a power tool for founders

PR is often one of the most underestimated tools that a founder has at their disposal. But taking the initiative to develop a public profile for the business can see like an expensive distraction when focussed on building the product and growing customer traction. Unlike other forms of marketing, the benefits of PR are also hard to quantify, so when there are other pressing priorities, PR gets bounced. But experienced founders know that outside the company, image equals reality. For those that aren’t working within the immediate orbit of the business every day, their awareness will almost entirely be driven by what they can read in the press or online. Controlling this image is the responsibility of the CEO, right from day 1.
Building a profile of a company that looks like it’s really going places is critical to so many aspects of the startup to scaleup journey. You’ll be hiring key people right from the outset and the first thing they’ll do is check out you and your business online. The same applies for prospective customers, partners, suppliers, investors, and later on, prospective acquirors. This all sounds so obvious, yet too many founders only pay lip service to the cause. A nice website and LinkedIn profile is just going to put you on a par with the crowd. How will you stand out? When were you last interviewed or wrote an opinion piece? These days people want to hear your story, your vision for changing the world, your successes. Founders that aren’t in some way thought leaders in their space will struggle to gain investor mindshare.
And there is another key audience that matters; your employees. Positive press reinforces their excitement about working for you. They may not admit it, but it gives them a buzz when they read about the company or hear the founders interviewed on a podcast. Building the image takes time, so the most crucial thing is just to start. A contract award or user story can be worth its weight in gold and will often be a trigger for investor calls. All of this provides a paper trail of good news that builds up over time, its value repeating over and over again, with no incremental effort. Founders that actively manage their external image create a silent power tool that helps build sustainable growth.

2. Other pieces really worth reading this week: 

What big funds look for in a CEO
Sammy Abdullah is the Managing Director and Cofounder of Blossom Street Ventures. He posted this insightful article on Medium this week. "Recently, we got a hold of an investor letter from one of New York’s finest late stage venture funds. The letter shared insights into what the fund looks for in a management team, which resonated with us. Below we share these points, verbatim."

How people get rich now
From the blog of Paul Graham, a fascinating essay on modern wealth creation. "Of the 40 new fortunes in 1982, at least 24 were due primarily to oil or real estate. Now only a small number are: of the 73 new fortunes in 2020, 4 were due to real estate and only 2 to oil. By 2020 the biggest source of new wealth was what are sometimes called "tech" companies. Of the 73 new fortunes, about 30 derive from such companies. These are particularly common among the richest of the rich: 8 of the top 10 fortunes in 2020 were new fortunes of this type."

Joining a startup for the first time
From the First Round Review, 30 actionable tips for employees when joining a startup. "Even in the best of times, startups are hard. They’re designed specifically for growth — and this comes with a set of unique challenges, risks and demands that you need to be ready for. Being motivated by the mission, customer delight and driving impact — those things will keep you going. Being motivated by structure and following traditional career growth paths will not keep you in the game.”  

The Midas List
The 2021 Midas List of top performing Venture Capital investors has just been published by Forbes. This definitive ranking of the top 100 tech investors gives an interesting perspective on the biggest movers and shakers on the global VC stage. 

Happy reading!

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