Duet Partners
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Weekly Briefing Note for Founders

21st January 2021

This week on the startup to scaleup journey:
  • 2021 UK outlook for Venture Capital
  • London continues to dominate the European investment scene
  • What is a ‘venture-backable company’?
  • Do early-stage VCs care about financial models?

1. Insights of the week

2021 UK outlook for Venture Capital

Pitchbook’s latest private capital outlook report predicts that Brexit will not stifle VC deal value in the UK; it will remain the most active country in Europe in 2021 with over €10 billion invested. Since the referendum in June 2016, Brexit uncertainty has not dampened VC deal value. Consecutive annual records have occurred in the last three years, and 2020 has beaten them all despite COVID-19. UK Venture Capital investments in 2020 were €13.4B exceeding the €12.0B recorded for 2019. But deal volumes dropped almost 25% from 2,447 to 1,848, creating huge anxiety for founders especially at early stage.
At the European level, Pitchbook expects follow-on rounds to grow well beyond 90% of overall capital invested, keeping further downward pressure on the number of first-time rounds. Late-stage businesses in particular will drive follow-on investment upwards, ramping up deal sizes and valuations. Startups that are beginning to see early growth potential will be sought after, especially from smaller to mid-sized funds searching for quality whilst the bigger funds compete for the mega-deals. Across the board, round sizes are growing, with investors more willing to push further capital into proven propositions rather than spread the jam more thinly.
VC deal value with non-traditional investor participation will likely reach a new record in 2021. Corporate Venture Capital (CVC), sovereign wealth funds, PE firms, family offices and other private investment vehicles all want a bigger slice of the startup pie, especially in those sectors that have shown pandemic resilience. CVCs have continued to target specialist startups to outsource R&D efforts, as it has proven more cost-effective than setting up new internal research business units. This is particularly helping deep tech startups struggling to lure in VC during the early stages of high technology risk.

London continues to dominate the European investment scene

A new report from Dealroom this week confirms the pre-eminence of London as the driving force behind Europe’s tech ecosystem. The capital’s tech companies raised a total of $10.5B in VC funding in 2020 – close to the record levels ($10.7B) seen in 2019. London is the only European city in the global top 10 for VC investment since 2016. And the future looks even more promising. A third of new European funds raised in the past 2 years have been raised in London. VCs there have records amount of dry powder to deploy, with almost $8B added to coffers in 2020, despite the pandemic.

London startups have a more internationally diverse mix of investors compared to other European tech ecosystems, with a remarkable 57% of capital coming from outside Europe with two thirds of this coming from the US. This share varies considerably with stage: 39% of funding at Seed and Series A is non-UK/European, 43% at Series B, 63% at Series C, and up to 82% for the biggest megarounds. London is by far the unicorn capital of Europe with 43, Berlin is next at 11. Not surprisingly, Fintech ranks as the number one sector for unicorns followed by Enterprise Software. In 2020, London raised almost half of all Europe’s fintech capital.
According to Beauhurst, 426 UK startups announced equity fundraising for the first time in 2020, down 23% from the 550 recorded in 2019. Of these 276 were Technology/IP-based businesses, of which a large portion, 141, are located in London. This was flat compared to 2019, suggesting that tech companies headquartered in London - especially those at early stage - have weathered the pandemic better than those in other parts of the country. But for London-based VCs looking to deploy record amounts of dry powder, identifying the top talent in emerging UK tech hubs outside of London is now becoming increasingly important as competition for the very best deals increases.

What is a ‘venture-backable company’?

Not all companies will be an exciting prospect for VC investors. It’s vital for founders to grasp what attracts this class of investor versus say a corporate or strategic investor, a family office, a crowd funder, an asset manager, or an angel network. The essence of a VC-backable business is that it can scale as a function of capital. This means that growth can be driven and then accelerated by applying external rather than just organic investment. This doesn’t mean revenue growth per se, but valuation growth. The two are usually linked but not always so. Valuation growth can sometimes be a function of the prospect of future revenue growth.
Take the example of a $200M VC Seed fund. Limited Partners (LPs) investing in such a fund would typically expect gross returns (before expenses) of perhaps 4x, i.e., $800M. Such a fund would typically make around 30 investments and look to hold around 15% of the equity at exit. (Given the potential dilution during the course of several rounds, Seed funds will look to secure up to 30% of the equity when they first invest). This $200M fund therefore needs to see $5.3B in exits ($800m/15%) to meet investor return expectations. Given that 75% of VC-backed startups fail, a handful of companies in the portfolio will end up having to deliver the big returns.

Given the unpredictable nature of picking these future winners, VCs need to believe that each one of their investments could return the fund on exit. If we apply this to Atomico’s new $820M Venture fund focused at Series A and beyond, where they are potentially targeting a 10% holding at exit (as they are participating later, with a lower risk profile than Seed), the numbers are huge. This is an enormous fund (most are a lot smaller) so they must believe that each one of their investments has the potential to exit at $8.2B. But with this magnitude of investment firepower, big funds have the means to aggressively drive growth. The question is, will the business (at some point) be able to scale as a function of capital applied? If a VC has real doubt when initially assessing the company, they will likely 'pass'.

Do early-stage VCs care about financial models?

A financial model is the numeric version of your business plan. It reflects your key economic assumptions about the future of the business and incorporates these in a linked P&L, Cash Flow and Balance sheet, usually looking out over a 3 to 5-year period. It is a planning tool that enables the senior management team to evaluate business scenarios and make informed decisions about future performance and funding needs. As a CEO you should be intimately aware of all the key inputs (the assumptions) and outputs (the implications). If you are raising any appreciable amount of money (£1M+) VCs will expect this spreadsheet to be part of your management tool kit.

But why do investors care? As Pauline Brunel at Impression Ventures says in her excellent post on the subject: “Going through a financial model and analyzing the form as well as the substance will help us gain a better understanding of the opportunity, your knowledge of the market as well as the solution you’re selling, growth expectations, and some of your personality traits…The way your model is built will tell us a lot about your personality and can be extrapolated to help us understand the way you manage and lead the business.” CEO’s should care because the model allows them to retell the story and rationally demonstrate there is (i) a big opportunity, (ii) a path to realise it, and (iii) a good likelihood of successful execution.
Some founders make the mistake of thinking that a financial model is a tool for the accountants or that you don't need one until you are already generating appreciable revenues. In our highly competitive funding environment, especially in the Seed to Series A transition, a financial model could be your differentiator. The ability to model scenarios is now a critical competency for startup teams. When you’ve pitched your story and the interested investor asks for a copy of your financial model, having one ready will impress. It will demonstrate professionalism, give confidence that you will be a good shepherd of the investor’s cash and, above all, keep the process moving at speed.

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

‘It’s going to kill your business’: Startups turn on €2B EU fund
As reported by Politico, a number of high-tech European startups awarded cash and investments by a special European Commission innovation fund say the process has actually left some of them on the verge of bankruptcy.

Global VC Report 2020: Funding And Exits Blow Past 2019 Despite Pandemic
Global venture funding was up 4 percent year over year to $300 billion in 2020, as reported by Crunchbase, but it was a mixed picture depending on stage. At $3.3 billion, Seed funding in the fourth quarter was down 27 percent year over year. Early-stage funding (Series A & B) totaled $22.7 billion in the fourth quarter, down 11 percent year over year. Late-stage venture capital, which includes Series C and later rounds, grew 8 percent year over year.

Rich Europeans need to invest 10% of their money into tech and stop buying stupid stuff like hotels
An appeal by Frank Thelen, the investor and TV celebrity famous for his appearances on Die Höhle der Löwen, Germany’s version of Shark Tank, who is on a mission to create a strong European technology sector.

6 Important Things (SaaS) Founders Get Wrong In Their Core Metrics
A valuable blog post by Jason Lemkin: "SaaS metrics can be more confusing than one might think.  What if some of the revenue doesn’t recur?  What if the client never deploys?  What if a customer churns, but is on an annual contract?  Is that just a blip in our NPS?"

Pricing Insights from 2,200 SaaS Companies
An excellent study on pricing trends in SaaS by OpenView Ventures: "A few years back, we launched a tool for SaaS companies to assess their pricing maturity and get advice on how to take their pricing to the next level. Now we’ve had more than 2,200 SaaS companies participate. This dataset offers a unique vantage point into how SaaS companies approach their pricing and packaging including who is responsible for it, how frequently they revisit pricing, and how much they charge."

Happy reading!

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