Duet Partners
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Weekly Briefing Note for Founders

16th September 2021

This week on the startup to scaleup journey:
  • Setting investor expectations pre Product/Market fit
  • Test the proposition before the MVP
  • Will your business strategy deliver long term value growth?
  • Founders must have the ability to 'rethink'

1. Insights of the week

Setting investor expectations pre Product/Market fit

As the early stage market continues to overheat, competition for the best deals is increasing. This sounds like good news for founders who are snagging much larger rounds than planned. But the bigger the investment the bigger the expectation. This is a particular issue with Series A VCs jumping into Seed stage deals to buy 'optionality'. Being on the cap table early gives them more leverage to deploy greater amounts later on where competition from other Series A investors is intensifying. For VCs whose sectoral focus aligns strongly with the strategic focus of the startup, the motivation to invest ahead of the fund's normal investment stage can be too much for some funds to resist. This is where mismatched expectations can lead to serious fallouts. Series A investors are by nature early growth investors: Product/Market fit (PMF) has been achieved so both the development risk and market risk are minimal. The real challenge is now execution risk and this is where most big VCs like to play. In simple terms, the focus becomes revenue growth.

For Seed stage companies still striving for Product/Market fit, nothing must distract from this mission. Yet on too many occasions, investors - often sitting on early stage boards -  are pressing founders for revenue growth before PMF has been nailed down. This can be a recipe for disaster. The problem is that Series A investors are often very out of tune with what it takes to find true PMF, as investor John Danner explains in his recent article. Their investing experience doesn't help them and more often than not they haven't been founders themselves. Where such investors sit alongside NEDs that don't have recent early stage experience, board meetings can often just be a torture chamber for founders. The journey to PMF can be hugely indeterminate, partial or full pivots may be required, and this all must be done as economically as possible by the initial core team. Money is really not the issue here - it's the ingenuity of founders to define and execute the experiments that deliver the problem/solution breakthrough moment.

Serial founders have the advantage here over first-time founders. They understand the importance of running a lean ship until PMF is found. They aren't about making promises on commercial traction that they can't possibly keep. They aren't splashing the cash building up the team before they are totally convinced they can see real scalability. And the bigger the team, the more managing is required. This is precisely what pre-PMF founders should not be spending their time on. As PMF emerges, revenues will naturally start to flow - in fact they are a key validation point for PMF. But the sequence of events here is vital. Founders must ensure that these expectations are clearly set for any new investor. If there is alignment in expectations then fine, take the money. But if that deep understanding isn't there, you may be in for some unpleasant board meetings.

Test the proposition before the MVP

There are many misconceptions about where the Minimum Viable Product (MVP) sits in the evolution of the startup. The most common is that an MVP must first be built before customer engagement can begin. This is based on the (incorrect) notion that customers will first need to evaluate some form of 'prototype' before useful feedback can be obtained: "Let's build a product we think people will want and go and try it out". But the journey to product/market fit is far more incremental than this. The risk of jumping straight to an MVP to test the market is just too big. Instead, experienced founders start small - they focus on the core proposition they are creating and test this first. The starting point is the insight. Every founder has an insight that is the germ of their big idea. The insight will reveal a pressing problem that needs to be fixed or a big opportunity that is not being addressed.

The next step is to define the promise you will be making to your customers. This is the core value proposition at the heart of what you will ultimately deliver. Think Uber: a taxi will arrive on demand within 5 minutes, or Stripe: one line of code to replace days of implementing complex payment processing. If you get this core part wrong, you simply won't have a proposition, a product, or a business. Experienced founders find ways of testing these core propositions very early on, BEFORE they develop a fully fledged MVP. These initial tests probe the key aspects on the proposition, the central assumptions that you must be right about. These assumptions should be thought of as key risks until you have confirmed that you can conquer them. Serial founder Gagan Biyani describes how he found innovative ways to test out the core assumptions for each of his 3 businesses in this excellent article. Gagan's approach is to test assumptions one at a time, starting with the riskiest. He calls this the 'atomic unit' test - seeking validation that you can deliver the central element of your value proposition and that this is indeed something that people want.

The atomic unit test for Google was a search query. For Amazon it was ordering a book online. As Biyani says, when devising a test, do not build out everything. In the case of Amazon, you don’t need to build a web ordering system, a warehouse and a delivery system to evaluate whether people want eCommerce. Instead, identify your risky assumption: is it whether people actually want to buy books online? Then test just that by building a web page for book buyers. Your solution will help you learn whether your instincts are right. If you build a massive list of books, and the customers hate it — then you know that isn’t the right solution. If instead you build a search form where they can search for a book and customers don’t know what to put in, you know this is a discovery-based business rather than a search-based business. The journey to the first MVP is as much art as science and there is no one-size-fits-all approach. Online consumer-facing businesses will always be able find much more cost efficient testing methods that DeepTech startups, for example. But the starting point is always the same: What is the promise that you will make?

Will your business strategy deliver long term value growth?

The path to success on the startup to scaleup journey relies heavily on making the right strategic choices. In particular, founders must select a business strategy that fits the time - one that leads to strong and sustained value creation. Making the right choice will accelerate growth and positive outcomes. The wrong choice will lead to years of frustration and even outright failure. This choice is not made at the outset; founders must first create something that people want. But as thoughts turn to how the business can be scaled, the choice of business strategy becomes a pressing matter. Everything else a startup does is there to support the execution of this business strategy; the choice of business model, the go to market strategy, the selection of the right team, and so on. If the overarching business strategy is flawed, no amount of execution excellence will make up for this weakness. Instead, a pivot will almost certainly be required. To deliver strong and sustained value creation, founders must become adept at evaluating strategy options so that informed decisions can be made.

In his seminal work, 7 Powers: The Foundations of Business Strategy, Hamilton Helmer provides a unique framework for assessing strategy options. First, he defines the 'Power' of a business as the set of conditions creating the potential for persistent differential returns. The strategy of the business is then the route to continuing 'Power' in significant markets. This linkage is profoundly important in the startup world. Any business can have a strategy, but if this does not have the potential to deliver consistent enterprise value growth, venture investors will simply not be interested. This requires that a startup not only has a strongly differentiated value proposition but that this differentiation is durable. i.e. the proposition is being built to withstand competitive onslaught as the market grows. It is one thing to demonstrate that you have created something that people want, but institutional investors (i.e. VCs) will need to be convinced that this desire will survive for years to come.

Founders who can skilfully articulate their business strategy will draw investors in. For those startups in the early stages, especially in the transition to initial scaling, a compelling rendition of the business strategy can itself be seen as leading indicator of success. Providing evidence of progress, such as the growing number of customers or revenues, is of course also powerful, but these are lagging indicators and are not necessarily indicative of long term success. History is littered with companies that clung to such indicators whilst cracks appeared in the underlying business strategy, leading to uncertainty, dramatic late-stage pivots, and even failure. Big companies such as Intel (in their former memory business), Kodak (in their photographic film business), and Nokia, were not immune. For startups that are more fleet of foot, finding the route to continuing 'Power' in significant markets is the essence of strategy development. Founders that identify and develop those rare conditions that produce persistent value creation will then reap huge rewards.

Founders must have the ability to 'rethink'

One of the foundation stones of modern startup theory is the experiment. Taken from the scientific method, the business strategy starts out as a theory. Prior insight and customer discussions enable the development and early testing of hypotheses. Finally, a fully fledged MVP enables experiments to validate the core solution with early adopters. Results are measured to determine if the hypotheses are supported or refuted. Small changes are then made to zone in on the beachhead market that will provide the strongest cohort of initial customers. But when the evidence indicates that the foundational hypothesis is flawed, a pivot may be required. Research shows that entrepreneurs that have been taught to think like scientists pivot twice as often. They are more at ease rethinking their business models to find high growth opportunities.

Yet, many founders step back when faced with the prospect of a radical change to their business model. In Adam Grant's Think Again, he cites some remarkable research that shows how entrepreneurs who are not cognisant of lean startup theory, will typically stay wedded to their original strategies and products. They are more likely to preach the virtues of their past decisions and prosecute the vices of alternative options. Some of this may be due to founders believing that to waver shows weakness. Grant says; "We typically celebrate great entrepreneurs and leaders for being strong-minded and clear-sighted. They’re supposed to be paragons of conviction: decisive and certain. Yet evidence reveals that .. the best strategists are actually slow and unsure. Like careful scientists, they take their time so they have the flexibility to change their minds."

But this is not an open-ended experiment. Research by Startup Genome reveals that there is a limit to how much fundamental rethinking is good. Startups that pivot once or twice raise 2.5x more money, have 3.6x better user growth, and are 52% less likely to scale prematurely than startups that pivot more than 2 times or not at all. Founders should ideally prosecute any pivot(s) before investing in scaling activities. Pivoting at Seed stage is almost taken for granted by investors, whereas later stage pivots are often much more expensive and disruptive. For this reason, Series A investors will want reassurance that the company is through pivot territory and onto a clear growth path where strong and sustained value creation is underway.

2. Other pieces really worth reading this week: 

Usage-Based Pricing: Customer Success Is A Mindset, Not Just a Job
45% of expansion stage SaaS companies now say they have a usage-based or consumption-based pricing model, according to data from OpenView’s forthcoming 2021 Financial and Operating Benchmarks Report. One quarter of these companies started to implement usage-based pricing within the last 12 months. A big sea change is underway and founders need to be aware.

Negotiating tactics against your VC
VC Sammy Abdullah provides a great synopsis of a book called Never Split the Difference by Chris Voss. Chris was one of the premiere FBI Hostage Negotiators in the world, and his tactics could be useful for negotiating with customers, vendors, and of course your VC. 

Is it so bad to take money from Chinese venture funds?
China is becoming a superpower in the tech industry. According to Straits Times, China is the only place in the world where it takes less than six years for a startup to become a unicorn — it takes seven years in the U.S., eight years in the U.K. and 11 years in Germany. Despite geopolitical tensions and recent amendments in CFIUS and the UK's National Security and Investment Bill, it is hard to ignore China. VC Denis Kalinin shares his first-hand perspective in this recent article.

Happy reading!

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