Duet Partners
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Weekly Briefing Note for Founders

15th October 2020

This week on the startup to scaleup journey:

  • Global Venture funding 3Q20 - winners and losers
  • Sell the problem not the solution
  • How to avoid 'dead equity'
  • Don't send your fundraising deck as a link

1. Insights of the week

Global Venture funding 3Q20 - winners and losers

As Crunchbase has just reported, when lockdowns were rapidly implemented worldwide in March, the prevailing sentiment was that an economic downturn was coming. Naturally, the thinking went, this would impact venture funding and the IPO markets. That has happened, but not as negatively or in the way many expected. Instead, over the past two quarters, we have witnessed an accelerated shift to cloud-based services that has been both dramatic and likely persistent, as many of these new behaviors seem poised to endure post pandemic. And the IPO market is booming, as we have recently observed.

But, as ever, the real story on funding lies beneath the headlines:

If you're a Late-stage business (Series C, Series D, and beyond) life has probably never been so good as overall funding in this category represented over 70% of total funding in Q3. Funding increased in the third quarter with 452 late-stage rounds raising $48.1 billion, up 24 percent year over year and 26 percent quarter over quarter. But for less mature businesses it has been a completely different story...

At Seed-stage (pre-Seed, Seed, and Angel rounds) funding in the third quarter was $2.6 billion, down 32 percent year over year and down 11 percent quarter over quarter. The number of deals (2,333) was half that recorded in 3Q19 (4,620).

At Early-stage (typically Series A, Series B), funding was $19.3 billion in the third quarter, down 18 percent year over year and down 14 percent quarter over quarter. The number of deals recorded was down 40% on the same period a year ago. As a result of this significant drop in transactions, average deal sizes continue to rise.

As always with these figures there will be reporting lags on smaller deals, but the big picture remains clear. There has been a dramatic shift to Late-stage, not just driven by a flight to safety during the pandemic, but also the rise of mega funds that need to find bigger transactions to offload capital. Whilst Seed and Early-stage have escaped disaster, allocations have been hit hard and, correspondingly, investment criteria have ratcheted up again. We'll be taking a much closer look at the impact for European businesses over the next few weeks, with a special focus on how UK founders can prepare for funding going into 2021.


Sell the problem not the solution

Solution fixation is one of the killer mistakes in any investor pitch. We become so excited about our product that we sometimes forget the whole purpose. Without deep customer insight and a true understanding of the problem we are solving, investors will almost certainly switch off. Painting a picture of how much better the world will be when the business is successful is a critical hook. Without this emotional connection, whatever else we say will count for little. Steve Jobs himself once said: "You have to start with the customer experience and work backwards to the technology." Jobs understood that when you try to reverse-engineer the need statement from the product, it’s too easy to lose touch with reality. The foundation for any great pitch is therefore ensuring investor buy-in to the problem. With this in place we can confidently progress to the problem/solution thesis - how our unique insights have helped us shape our solution and how we will deliver this to customers.

Yet the reality is that for some tech companies, especially university spin outs and others that are pioneering new scientific discoveries, life often starts with 'the solution' - a breakthrough discovery, some unique IP, perhaps a patent and some special know-how. For these businesses, founders have a particular challenge in identifying the most lucrative way in which to commercialise the technology and this quickly becomes the most pressing priority. This is because most investors now see capital efficiency as a key metric. A 5-year development cycle without any customer engagement isn't going to cut it. There is a rare breed of Deep Tech investors that will get turned on by the pure breakthrough potential alone, but this is an ever-decreasing pool of patient capital - particularly in Europe. Founders must therefore become a lot smarter (and quicker) at searching for the business model and presenting this progress in a compelling way.

The twist is of course that not all problems are created equal. Unless you're building a solution to a problem that is worth solving, you will still struggle to excite investors. Capturing the scale of the opportunity is therefore a critical aspect of business model discovery. This mustn't be left to the imagination. How big a market can we reach? How fast might it grow? With emerging markets it's not the scale today that matters but the growth rate. This is a critical aspect to the pitch and needs to be delivered up front.  Review your deck and check that you have nailed all these points.  Above all, sell the problem before you sell the solution. 


How to avoid 'dead equity'

Experienced founders will be well attuned to the scourge of 'dead equity'. This is equity owned by a co-founder that has left the business early on. It sits on the cap table but is not inert - it carries a real burden. As discussed recently in a Techcrunch article,  the opportunity cost of dead equity is talent and capital. Compensating talent and raising capital are the (only) two things you can use your startup’s equity for, and you need to do both in order for your company to grow. If you want to build a big business, the road ahead is still long and windy, and you’re going to need every bit of help you can get. If your competitors don’t have dead equity you’re literally competing with a handicap. For this reason, VCs don’t like to invest in early startups with a lot of dead equity.

Many startups use vesting terms that borrow from the almost universally adopted 4-year vesting period used by established companies. This used to alleviate some concerns over early departures, but the average time from founding to exit has gone from four years in 1999 to eight years in 2020.  A 4-year vesting schedule can therefore severely harm the interests of founders and deter investors. As a result, experienced founders are applying longer vesting schedules that are more resilient to early co-founder departures. More shares are then left in the pool for hiring new talent. In particular, more of the cap table is then available to lure in a new co-founder.

Often this topic is a tricky one for co-founders to broach together when the business is already up and running. If they are already sitting on founder shares or 4-year options it may take the intervention of a trusted non-exec board member to raise the subject and find a pathway forward. But the good news is that with everyone's consent, vesting periods can be elongated at any stage. This is a key matter to assess during the funding preparation process, especially when preparing for the first round of institutional investment. If you've already crossed this bridge then this will send very positive signals to the new investors.


Don't send your fundraising deck as a link

A question that we get asked all the time by founders is whether they should send the pitch deck to investors via a link. This has become increasingly prevalent with the wider adoption of document sending tools that enable you track who read your deck, which pages they read, and how much time they spent on each page. Even the email sending tool can monitor open rates, if it was forwarded to someone, and a host of other insights. The fact is that investors also know all of this and this just makes them wary of clicking on a link - not to mention the risk of triggering a piece of malware.

For those anxious about controlling the circulation of these materials then yes, your pitch is going to get forwarded to others - but this is what you want. Any investor who is excited about your story is going to want to share with colleagues - it's part of the process. Don't make it difficult for them. Your pitch should be your most compelling piece of marketing. In Mark Suster's great article on the subject he says: "Your pitch deck shouldn’t contain your deepest, darkest secrets and plans. That would be something you’d only reveal when you’re well into the VC process and have established mutual trust and they’ve proven engagement with you. Whenever you write your deck and send it out I think you should actually think to yourself, “my competitors are probably going to read this one day and this will be forwarded widely” and if your response isn’t “so what!” or “that would be awesome” then I think you’re doing something wrong anyways."

The simple message here is just send the deck as an attachment and be done with it. Be careful to manage the file size (10MB max) so it doesn't get trapped in email filters. As a marketing campaign it may not look the most flashy but it's more likely to get read and used to further your cause. At the end of the day that's what really matters.


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

Europe’s startup ecosystem: Heating up, but still facing challenges
Europe’s inability to convert many promising startups into dominant global tech businesses is highlighted in a new report this week from McKinsey. Although Europe accounted for 36% of all global startups launched between 2009-19 it had only built 14% of the world’s unicorns in 2019. “Historically, Europe’s ecosystem has been less effective than that of the US at turning startups into late-stage successes,”. The report confirms the high attrition rate from Seed to Growth - only 14% of Seed stage businesses go on to successfully exit or reach Series C.

What Apple and Steve Jobs can teach us
Jean-Charles Samuelian provides a great summary of insights from the book Steve Jobs: the exclusive biography by Walter Isaacson.On Apple's product principles he talks about Impute: this principle emphasised that people form an opinion about a company or product based on the signals that it conveys. “People DO judge a book by its cover,” he wrote. “We may have the best product, the highest quality, the most useful software etc; if we present them in a slipshod manner, they will be perceived as slipshod; if we present them in a creative, professional manner, we will impute the desired qualities.”

40 Favorite Interview Questions
A great piece of research published in First Round ReviewWhen you’re scaling quickly, moving at warp speed, and sitting on several hiring panels, interviewing can seem like a task you just need to get through. But it’s worth pausing to remember that the decision to hire someone is an expensive and far-reaching one. And since you’re forced to make it after spending (at most) a few hours together, maximizing what you can learn about candidates in those precious few minutes becomes all the more crucial.

9 Tricks to Experiment with your Pricing Strategy
For SaaS businesses, an excellent primer on pricing strategy and many other related topics by Julian Lehr, Head of Startup Growth & Partnerships at Stripe. This piece discusses 9 simple pricing and packaging hacks that he has seen work well - especially for early stage founders. Some great insights.

The end of the American internet
From the blog of Benedict Evans, former Andreessen Horowitz Partner and now Venture Partner at Entrepreneur First and Mosaic Ventures: For its first two decades, the consumer internet was American - American companies, products, attitudes and laws set the agenda. That’s not so true anymore - there are more smartphones in China than in the USA and Western Europe combined. Software creation and company creation is diffusing, and attitudes are fragmenting.

Happy reading (and watching)!

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