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


Weekly Briefing Note for Founders

16th December 2021

This week on the startup to scaleup journey:
  • Fly on the wall: How VCs raise capital
  • Making early-stage board meetings high value-add
  • US investors accelerating European investment

1. Insights of the week

Fly on the wall: How VCs raise capital

Just as founders raise capital from VC funds, so too must VCs raise capital from their investors - the Limited Partners or LPs. Understanding the dynamics of the VC/LP relationship provides insight into the mind of the VC. In particular, how they market their overall offering to LPs and how they compete for capital allocation. Whilst a great deal is written about the founder/VC relationship, little (of any real value) is written about the VC/LP relationship. But for founders that wish to 'get inside the mind of the buyer' and find out what makes them tick, some study of this topic will reap dividends. Understanding how LPs assess the VC investment proposition has some remarkable similarities with the VC/startup due diligence process. This should not be a surprise. VC's can only raise capital if they provide their investors with a clear and compelling investment proposition. The essence of this proposition is then reflected in the criteria they (must) use to assess startups.

In a recent analyst note, Pitchbook provided advice for emerging private fund managers preparing to fundraise. This excellent analysis, written from the perspective of an ex-LP, covers the entire private funds market, where more than $1 trillion is committed globally each year. Private Equity (PE) allocation accounts for around half of this with Venture Capital (VC) accounting for approximately 20%. Whilst PE and VC have different target markets, the principles of fundraising by General Partners (GPs) are essentially the same. The first big insight is around capital concentration. Fund managers complain that it is becoming increasingly difficult to raise a fund! This stems from the fact that a small number of large funds from established managers garner an outsized share of capital commitments each year. From 2006 to September of 2021, 8.5% of the private market funds raised globally were over $1 billion in size, but they represented 61.3% of the capital committed. On the other hand, 48.6% of the funds raised were smaller than $100 million, but they only represented 4.0% of the capital committed.

The advice to fund managers seeking a higher degree of funding success falls into three broad categories: know yourself, know your customer, and be prepared. This is almost a perfect reflection of how founders must think about their own capital raising prospects. A framework known as the 'Six Ps' provides a powerful guide in how fund managers should prepare: This covers People, Philosophy, Process, Portfolio, Performance, and Pricing. Whilst the topics founders themselves must use are clearly different (and form the basis of our own Investment Analysis model), the notion of an 'evaluation framework' maps exactly. And whilst there is no single correct response to any of these areas of enquiry, the answer must make sense in the context of what the GP (or founder) is offering, with the responses forming a holistically coherent picture. Founders that form a greater understanding of how fund managers prepare for the capital raising process, will be better positioned to 'understand the mind of the buyer' and, ultimately, secure investment.

Making early-stage board meetings high value-add

It's not often we come across a CEO/founder of an early stage business that truly looks forward to board meetings. When we dig deeper we often find that this is because they don't provide the value-add that founders want or expect. The meeting just feels like an examination of the CEO's performance by the investor directors. The traffic is mostly one-way. This is perhaps not surprising, as we explained in our recent insight, 'How to avoid being fired as CEO'. Investors are primarily there to monitor their investment. But board meetings should also be an opportunity to surface new insights and ideas that the CEO and the management team can then explore. Ideas must come from everyone. If boards aren't collectively doing this, then something is wrong. This is usually down to one of 3 factors: the wrong people, the wrong expectations, or the wrong agenda. The first of these is really 'make or break'. The wrong people can wreck everything, and it's the CEO's job to make sure this doesn't happen.

At Seed stage, boards often comprise just the founder(s) and the lead investor. If other investors have meaningful shareholdings they may also have board seats. Founders quickly discover if they have chosen their source of capital wisely. If the investor director is experienced in supporting founders at this stage and there is great chemistry, then they are off to a flying start. If not, deflation can quickly set in. It is also a particular feature of UK startups for the early institutional investors to require a non-executive chair to be appointed at Seed stage. This can work well and is particularly valuable where there is a relatively inexperienced CEO/founder. The idea is then to find a chair with early stage operating experience - most likely a former CEO themselves - that can support and coach the CEO, in addition to running board meetings. Irrespective of the rationale, the selection by the founder of any board-level appointment, including the non-exec chair, is an absolutely critical decision. It just takes one bad selection to undermine the effectiveness of the board, and in turn the CEO. A founder must make these decisions as if their life depended on it.

To get the most out of the investor directors, experienced founders are often quick to set the tone. This usually revolves around developing a pattern for board meetings so the directors know what to expect from the CEO as well as knowing what the CEO expects of them: the benefit of their experience, their industry insights, their contacts, their strategic input. The way to encourage this is by careful management of the agenda and giving the non-execs time to prepare beforehand. The trick is not just to get papers out well in advance (1 week is often ideal), but to include an overview of the 1 or 2 major topics for debate. In the meeting, the Company update (the major headlines, cash position/runway, financial projections, key metrics dashboard, recruitment..) should be limited to no more than 30% of the time. 70% of the time can then be devoted to these major topics - strategic matters, key initiatives, and debating the big operational challenges du jour - where the investor directors are expected to contribute to a truly collaborative discussion. That is really what founders want. [Further great insights on this topic from VCs Pete Flint and Mark Suster.]

US investors accelerating European investment

The overall investor base in Europe continues to expand across the different stages of investment. According to the latest research, the number of unique institutions active in Europe in 2021 increased by more than 25% from 2020. The most significant changes were evident in the growth stages, where the number of unique institutions participating in rounds of $100M and up more than doubled in the last year, and increased by more than 6x since 2017. 2021 represented a step change in sentiment towards European tech among US investors, with the number of individual investors increasing by almost 50% – a significant leap compared to prior years. Hardly a month goes by without another major US VC setting up shop here. US investors are now participants in over one quarter of all investment rounds in Europe, up from just 16% in 2017. Their presence in the market is helping fuel the growth of European tech, build bridges across continents, and level up the strength of the investor base by bringing different experiences, networks and support.

But how are the big US funds able to muscle in on the European market so easily? The answer lies in pure scale. The number of large funds (>€250M) raised each year in Europe remains small. In 2020, just 14 funds of greater than €250M were closed during the year. During the first half of 2021, the number of such funds closed has totalled just five. In comparison to the frequency and scale of megafunds raised in the US, Europe remains on a different footing. In terms of total capital raised, funds in the €100M to €250M range take the lion's share of capital across Europe, but this is a very concentrated group by number. Smaller funds (<€25M) continue to account for the largest volume of new funds closed each year, with 2021 on track to break another record in terms of the total number of VC funds raised in any category. As a result, startups that anticipate multiple rounds of funding - especially those with capital-intensive strategies such as DeepTech - inevitably begin to look to US funds as they undertake major developments and start to scale.
It seems remarkable that while the US accounts for just 4% of the world’s population, it generated 24% of global GDP, and accounted for 50% of all venture capital investment in 2021. Europe, by comparison, represents around 10% of the global population, generates 22% of global GDP (very similar to the US) but still represents only 18% of the global VC market. Dan Lupu, Partner at Earlybird Capital Venture, stated recently that "While the relative scarcity of capital continues to be an issue in Europe, due to the paucity of large private institutional investors, the recent successes attract foreign and non-traditional investors - this is ominous."  In other words, overseas investors are playing an increasingly important role in the European ecosystem. This means that a growing percentage of the spoils from successful exits are flowing back into US LPs and are not necessarily being recycled back into the European market. In the short term, founders that attract US investment won't be complaining, but this may not bode well for the long-term health of the European venture scene.

2. Other pieces really worth reading this week: 

Interview with Sonali de Rycker of Accel
In Sifted this week, an interview one of the leading figures in European VC, Sonali de Rycker. Some remarkable insights into how the VC mind operates: "To make sure Accel doesn’t miss any future superstars, it has catalogued the top talent of 200 leading European startups, across sales, engineering and product, says de Rycker. The belief is that as soon as those individuals emerge with their own startups, Accel can recognise and back them instantly."

5 things the most secretive people in tech — those who invest in venture funds — wish VCs knew about them
Further deep insights into the world of LPs in this Business Insider article. "There are still way more venture funds raising money than money to go around, so most of the time LPs, with their deep pockets, are in the business of rejection, turning down hundreds of venture firms a year who seek them out as investors."

Leader or follower? Types of VC Investors
A great primer on the VC landscape by international Corporate Venture Capital (CVC) fund, ACV. "There are multiple types of investors that participate in the industry, which can be classified according to geography, industry, stage of investment and, finally, in followers or leaders. Usually funds are not promoted by their position as a leader or follower in an investment round, however, entrepreneurs need to be able to identify them and make the best decisions."

Next week, our final edition of the year with a special look ahead to 2022.

Happy reading!

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