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


Weekly Briefing Note for Founders

22nd April 2021

This week on the startup to scaleup journey:
  • Revealing the true intent of an investor
  • Is remote funding here to stay?
  • Founders feel duped with investor value-add
  • Startup experience alone is not enough

1. Insights of the week

Revealing the true intent of an investor

Most institutional investors, especially the major VCs, provide clear signalling on their investment thesis. Many will prefer certain stages (Pre Seed, Seed, Series A, Series B, etc.), or certain market sectors, or even specific business models (B2B, B2C, B2B2C...). What is often less clear is their investment horizon: In what timeframe will they be seeking a return? For a typical 10-year VC fund, where the initial investment period is usually the first 3 years of the fund, the return period will often be stated as '5 to 7 years'. But this is not information investors feely offer, so founders must ask. This is a crucial piece of information when selecting an investor, as having investors with non-aligned goals on the cap table often leads to trouble. It also explains why investors that are coming to the end of their initial investment period seek more mature businesses than they did when the fund was initially minted.

When developing target investor lists, founders must therefore pay particular attention to the age of the fund. But there is another tell tale sign in how a fund is likely to evaluate a potential investment opportunity, and that is who the Limited Partners (LPs) are. The LPs are the investors in the fund and these can typically include pension funds, sovereign wealth funds, insurance companies, family offices, university endowments, and high net worth individuals. Certain LPs are institutional investors themselves and set out their own investment criteria for the investors that they are accountable to. Other LPs such as Family Offices are accountable only to themselves. Research into Europe’s 1,200 venture capital and private equity funds has shown that the types of LP significantly influence fund behaviour. "Beware of venture funds that present themselves as 'founder friendly', but whose limited partner list is a roster of investors who seek short-term rent."

It is well known that different LP types will have different aspirations depending on their investment horizons. But it is also apparent that they also differ in financial sensitivity or the magnitude of how their funding cash flows are affected by changes in underlying financial or economic factors. For example, many institutions are restricted by a set of predetermined rules, such as being able to invest only in funds with a clear exit plan or being forced to reduce their contributions, or drawdowns, below certain public equity valuation multiple thresholds. As a result, 'patient capital' is more likely to come from VC funds that have a strong element of strategic (e.g. Corporate or Government) or Family Office backing. When developing a relationship with lesser-known VC fund for example, it is therefore important to do some research into their LP base as part of your own due diligence. If you can't find the answers easily, ask the VC partner you are dealing with. If they are not immediately forthcoming, this should raise a flag.

Is remote funding here to stay?

One year in and the process of doing remote deals has become normalised. Nearly all major funds have completed at least one remote deal and some of the big VCs have done dozens. Many seem to have shifted their entire process to a remote model with very little change in approach, other than meetings are no longer face to face. We have certainly noticed more meetings during the process as investors seek to understand the proposition and build relationships virtually. To support this, we have seen a clear uptick in the number of reference calls being made on the founders as well as the business more generally, often going beyond the normal circle of customer calls.

Research by Omers Ventures surveyed over 100 VCs across Europe and North America in June 2020 and again in January 2021, to find out how their habits had evolved. VCs have changed how they are spend their time, with less emphasis now on current portfolios and more time on sourcing. Deal flow coming into their pipelines has now fully recovered and in fact increased. Interestingly, a large majority of VCs report being happier in their careers as a result of traveling less! This correlates with 73% saying they will conduct the majority of their founder meetings virtually going forward and 6% saying they will now do all meetings virtually. 21% of VCs that prefer to 'lead' will look to meet in a socially distanced way, but those 'following' will likely do so fully remotely.

One particular observation is the number of reference calls being undertaken, not just with customers but also with existing investors. It was usually the case that a new institutional investor would take informal soundings with the principal incumbent investor before making an offer. Now, all of the incumbents are likely be polled and these will be more than casual conversations. As average deals sizes continue to also jump at all stages, founders should expect the vetting and diligence process to be more thorough than ever before. Having friendly VCs already on the board or as investors in the company is seen by a growing number of prospective investors as very important in their diligence process. Founders should be warming up the big names on their cap tables well in advance.

Founders feel duped with investor value-add

Successful VCs possess several core competencies. They are highly effective capital raisers; they are astute at picking winning investments; and they are skilled at negotiating deals. But in an increasingly competitive environment where the growth in the amount of capital being deployed is outstripping the growth in deal numbers, VCs must find new ways to compete. Reputation, as ever, is key. Having a big name VC on your cap table provides powerful signalling for a company's credibility and subsequent raises. But to win that slot, VCs are now going further by claiming their special 'value-add' will have great impact post investment. As most founders say they are looking for more than money when they bring an experienced investor on board, this would indicate strong alignment. But the reality is that the claims made by VCs before the deal is done don't always materialise.

Extensive research by VC Forward Partners recently gathered insights from over 500 founders. This revealed that 3 in 5 founders felt duped when it came to value-add. 92% of VCs specifically claim to be value-add investors, but 59% of founders reported a negative experience compared to what they were promised. 47% of founders said that their investors turned out to have little knowledge of the sectors they are investing in. 49% said that the 'value-add' provided had no impact on their business. 33% felt that overall, value-add was both over promised and under delivered. Founders said that great VCs help by providing strong strategic oversight, make the effort to understand the nuances of the business, and provide real empathy. They truly understand the challenge startup founders face and provide effective and empathetic guidance. The difficulty is that few VCs seem to be living up to this requirement.

Founders shouldn't be so surprised. VCs believe they must appear 'founder friendly' to pull in new deal flow. But a small number of VCs are being more honest, saying they don't want to paint themselves as the 'support person'.They will assist if asked, but never want to create a dependency. “Is your in-house recruitment company going to be as good as a Heidrick & Struggles or a Korn Ferry? If not, it doesn’t matter that they are cheaper or free, they are noise to Founders because you need to be optimizing for best in class.” says Hussein Kanji of Hoxton Ventures. Scott Maxwell, Senior Managing Director, Openview Venture Partners, goes further; "I would admit that we have tried to offer value add services that we have ended up shuttering because the standard we were able to reach was not comparable to what was available out there on the open market. I think that the industry is littered with crap. I call it value minus. You have people that act like they are doing something but in fact they are not.” It takes some courage to actually play down the value-add like this, but at least founders know where they stand.

Startup experience alone is not enough 

Founders with a previous exit seem to have an advantage over first-timers when it comes to winning investment. Investors often see serial founders that have had prior startup experience as more 'bankable'. Some of this thinking makes sense: Crunchbase data shows that experienced entrepreneurs raise more funding rounds with each venture, which would seem to correlate with success. In addition, surveys show that previously exited founders have a much higher chance of having another exit. Later successes are also usually larger than previous successes. Other research has revealed that “the number of prior firms going public increases the next firm’s revenues by an average of 115% each”.

Prior experience in general is rated highly by investors and this includes industry skills as well as startup know-how. It's certainly true that experience the team brings is important. But we know that experience alone is not a guarantee of future success, and in fact can sometimes create a false sense of security. A recent study, reported in HBR, found that "experience alone was not enough to make a team thrive. While experience broadens the team's resource pool, helps people identify opportunities, and is positively related to team effectiveness, a team also needs soft skills to truly thrive. Specifically, our study shows that shared entrepreneurial passion and shared strategic vision are required to get to superior team performance as rated by the external venture capital investors."

Astute investors will therefore assess both hard and soft skills. In particular, how the team works together, how open and honest they are, and how they communicate. Drilling into this is much harder for investors over Zoom calls. That's why we are seeing more meetings taking place in the virtual environment, with investors keen to mix up attendees from the leadership team to discuss different topics. This starts with the co-founders. For those setting out on their first venture, demonstrating strong alignment of vision and entrepreneurial passion could easily give the edge over a much more experienced team that may be at loggerheads.

2. Other pieces really worth reading this week: 

How much do you pay a CTO?
"How much do chief technology officers get paid? Has average pay changed over time? And… do men get paid more than women?" With the help of hiring startup Cord and its (mostly UK-based) data, Sifted has found out how much CTOs actually get paid and what factors play a role in that.

The CEO’s Guide to Hiring Executives
From the blog of OpenView Partners this week: "Over a thousand CEOs were interviewed about the #1 threat to their business and 80% said: a scarcity of skills in the job market. While hiring all talent is tough, hiring executives can be particularly excruciating. Competition for top talent is fierce. Employers’ demand far outpaces the talent pool. And the specter of making the wrong decision looms large—one wrong hire is all it takes to poison a culture."

Legendary Startup Product Expert
On the Mike Maples, jr, podcast this week: David Sacks, known as one of the best startup product strategists and operators of the last 20 years, discusses key lessons learned from his tenure in the PayPal Mafia, where he was head of product, along with key takeaways as founding CEO of Yammer and what he learned from working directly with industry greats like Peter Thiel and Elon Musk. Compelling listening.

A Path to the Minimum Viable Product
Steve Blank, 'The Father of Modern Entrepreneurship', publishes a compelling essay this week on the concept of the MVP Tree. "During the crucial mission-to-MVP planning phase, the objective of a startup is to solve one job for one customer group such that customers consistently use your minimally viable product for an important part of their work or personal lives. In other words, you prove retention. It’s really all that matters at the earliest stage. The tool for doing this efficiently and effectively? We call it an MVP tree."

Happy reading!

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