Duet Partners
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Weekly Briefing Note for Founders

1st July 2021

This week on the startup to scaleup journey:
  • It's not a pitch meeting - it's a strategy session
  • How much should you raise?
  • Should startups ignore competition?
  • Signs you hired the wrong scaleup exec

1. Insights of the week

It's not a pitch meeting - it's a strategy session

We know the odds of a VC meeting leading to investment are low - somewhere between 1% and 10%. This is the truly the numbers game. This means first, you have to plan on meeting a lot of investors during your campaign. The more highly qualified they are the higher the chances of a fit, so doing your homework on who is on the target list can save a lot of wasted time. Second, when you do meet them, learn as much as you possibly can - this may be all they are able to give you. Otherwise you are wasting 90%+ of your meetings and your very precious time. As a founder, your number one goal in building your startup is to learn fast. If you are sitting in front of a well-qualified investor, this is an opportunity not to be missed.

In our article, The golden rules of the investor pitch meeting, one of the key actions we highlight is to ask questions. Don't let the conversation become one-sided. If you’re unsure why a question is being asked, probe for understanding. If things are veering off track, consider using a rhetorical question to pull it back. If you want to know more about the fund – and you should – then ask. Show interest. You will be judged on the questions you raise as well as the answers you give. If you get to the end of the meeting and you haven’t asked any good questions, they’re going to think you’re desperate. Present with your cofounder or another senior executive so you come across as a team. Be sure to take notes when not speaking so you can review all points that were raised in your debrief together afterwards.

Seasoned investors may not be experienced operators, but there will be little that they have not seen before - particularly if they are investing regularly in a specific sector. They should have a real sense of the gaps in the market, the potential failure mechanisms that others have run into, and the metrics that signal hope rather than fear. You must tease these out. This is invaluable information and could be gold dust for future use. Best case - it could help you avoid failure. Worst case - it could help you finesse your deck before the next meeting. Some founders will lose interest in an investor when they sense an early 'no' in the meeting, but that is often when the investor wants to help you the most. You may not be getting the money but you could be getting something just as valuable.

How much should you raise?

In any VC-led round, the amount that you set out to raise and what you plan to do with it needs careful thought. Any investor is going to expect that you have modelled this and can easily provide the rationale (and the spreadsheet) when asked. If it looks like you are winging it you will get a 'pass'. Aside from good governance, the investor is going to undertake some simple tests to ensure your plans are reasonable. The basic assumption will be that you are raising enough cash to provide 18-24 months of runway, and that will enable you to hit some key milestones. These will be enough to justify a subsequent round - at a much bigger valuation. Given that you should be planning for at least 6 months to close each round, that means you will have 12-18 months to make tangible progress. The last thing any investor wants is for the founders to be in a  constant state of capital raising.

As investors start digging into your plans, the quantum of the raise and the associated milestones will really come under scrutiny. That's partly because the investor, who is about to lead your current round, is thinking one step ahead. As most investors only lead one round, they will assume that some other new investor will be leading the next. This concept of stage-based 'external validation' is important to VCs. That's because in an illiquid market, 'honest' valuations can only be set by new investors who have no skin in the game. Incumbent VCs will be keen on pricing their books 'up' at each round as this is what their LPs are expecting to see. As a result, they will be very keen to make sure your objectives are both ambitious (will attract later investors) but realistic (you will deliver on them). Then they will want to be confident you have sufficient funds to resource these objectives, with some modest amount of contingency.

In the current market, some founders are being tempted to take advantage of surging valuations and push up round sizes. This is risky, particularly if there is a struggle to raise immediate interest. It's always easier, as well as better optics, to move the 'ask' up based on investor demand. Filling up the coffers just to provide an extended runway (well over 24 months) or perhaps to have the capacity to make some small acquisitions may be tempting, but it's unlikely to get support. Any M&A activity, which is generally a feature of growth stage/later stage businesses, is best tackled very specifically as the need arises and justified on its merits at the time. With 2021 valuations blowing away 2020 records, founders must also be mindful that they don't price themselves out of the market on future rounds. As funds generally look for a certain % ownership when they invest, the bigger the valuation, the bigger the VC fund needed to carry the round. And when outsize funds enter the fray they will expect outsize milestones to be set. Be sure you are ready and willing to take these on.

Should startups ignore competition?

Early stage investors will often tell founders not to get too distracted by competition. Instead, they will want you to focus on developing the product, engaging with customers, and building out the vision. The words that one major startup accelerator - YC - uses are unequivocal: “Ignore your competitors, you will more likely die of suicide than murder.”  Whilst the sentiment is understood, in our view it should only apply if you have done your competitive research first. If we can't convince ourselves that we are building a business that can become a leader in its space, we have no right to try and convince others. You have to assume that there are going to be other companies trying to do the same thing as you, either at the same time, or once they see that it’s successful. Competitive leadership will therefore require 2 things: First, a clear USP that will open up the market to drive early growth, and second, the creation of a long-term defensible position - a 'moat'.

The USP and the moat will almost certainly be different. The USP can be a key product capability or feature that gives you a calling card to make the early sale. In tech businesses this is often some form of IP that may even be patented. Sooner or later though, if the market is big enough, someone else will find another way of doing it. Over the long haul, it's becoming harder to gain leverage from what was a 'unique' capability at the start. A moat provides this long-term protection, but its creation is far more nuanced and often a combination of factors. Examples are brand, embedding, and network effects. Brand creation is considered by some to wield less power in the online world and can also take considerable time and money. Embedding works when you integrate your product into a customer’s operations so they can’t easily rip you out and replace you with a competitor (think Stripe for payments processing). A network effect is when another user makes the product or service more valuable for every other user, as we discussed in our earlier article.

So when Investors say you should not get distracted by competition, keep this in perspective. I can't think of an investor pitch where competition wasn't a discussion point. With each stage of investment, the competitive positioning becomes increasingly important. It's usually a hot topic by Series A, as the market is often starting to wake up by then. The irony is that investors will see competition as a form of market validation, as long as they are confident that you have a strong USP and are developing the moat. Putting competitive risk to bed quickly and confidently in the investor's mind is key. You can then focus on operational execution, where the ultimate risk of failure is much higher. This is where the ingredients - the team, the product, the chosen point of market entry, etc. - are much more under your control. And as you execute these plans, gradually and intentionally build the moat, squeezing out any longer-term threats.

Signs you hired the wrong scaleup exec

With venture capital flowing into startups at historic rates, there is a frenzy of hiring activity to build out growth teams. Execs that know how to scale once product/market fit has been reached are in ever greater demand. The competition for the best people has put founders and hiring managers under pressure to move very quickly on candidates - and mistakes are inevitably being made. Founders must be on the lookout for early signs of poor role fit as new hires become operational. Whilst the journey to product/market fit was highly experimental and iterative, early scaling typically requires the rapid planning and execution of a land grab strategy. New execs, at this critical juncture, will spare no time in setting and then delivering on aggressive goals, managing the transition from the 'wild west' to a professional operating business.

The first signs of failure are execs that shy away from either setting such goals or find excuses for not attaining them. This is easy to spot, but there are other slower burn issues that can have even greater impact on future growth prospects. The first warning sign is that as the CEO, you are still heavily involved in the role you actually hired for. As veteran VC Elad Gil says in his excellent blog on the subject, "The whole point of hiring executives is to have people who are stronger than you take over a function, or so that you can delegate major items and expect them to be done well. If you are constantly being pulled in to help a function or to cover for an executive, it means they are in over their head." The right hires bring their playbook and adapt it quickly to the business. For example,  your new  VP Sales will relieve you from pipeline development, building and pitching the proposition, and negotiating terms. If you are still doing this, ask why.

But the biggest point of anxiety can be felt in their own ability to back-fill with top flight people as the business starts to grow. If they are unable to hire strong lieutenants to their team it usually means they are promoted beyond where their own experience or current abilities merit. The lack of ability to either map out the next stage of their team or attract top calibre candidates is evidence that the executive can not scale and should be replaced. As Gil says, "Usually you can tell you have hired an experienced executive if one of the first things they discuss with you is their functions future org chart. They come in prepared and know that people who work for them matter most for company scaling."  The challenge of hiring the right execs is a particular risk for first-time founders, especially at Series A. The first move could be hiring a top flight talent acquisition specialist to help recruit and build. If you have such growth ambitions, the sooner you bring this person in the better.

2. Other pieces really worth reading this week: 

A Tactical Guide to Managing Up: 30 Tips from the Smartest People We Know
A comprehensive guide to the art of managing up from the excellent team at the First Round Review. A great coaching and awareness tool for founders and senior leaders.

Corporate innovation in the entrepreneurial age
A new report from Dealroom on corporate investment. "Even though VC investment by corporates is on track to reach an all-time high this year, the corporate's share of total VC investment is the lowest it's been in nearly a decade."

The Role of Product Marketing—And Why Startups Need to Define It
A great article in the OpenView Venture Partners Blog this week on Product Marketing. "Unlike functions such as sales, engineering, or finance—where the roles, responsibilities, and outcomes are clearly understood (and measurable)—product management and product marketing can’t always make those claims, particularly in early-stage companies."

From the pen of our favourite writer, David Perell, a short form essay on the subject of narrative-market-fit. "To identify a solution to market problems, founders tinker with their products until [they find] product-market fit. Media narratives are governed by an analogous idea. The closer an article’s topic reflects the zeitgeist, the better narrative-market fit it has. Just as companies with product-market fit are more likely to be funded, stories with narrative-market fit are more likely to be written."

Happy reading!

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