Duet Partners
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Weekly Briefing Note for Founders

22nd July 2021

This week on the startup to scaleup journey:
  • What will your org chart look like in 12 months?
  • Having a vision can blind you to the problem
  • Good business models are harder to build than good products
  • US early stage investment market overheats

1. Insights of the week

What will your org chart look like in 12 months?

During funding campaigns, investors pose many testing questions. One of the trickiest is: "What will your org chart look like in 12 months?" It can sound quite innocuous, but a founder's answer will reveal much about their ambition as well as their ability. This question has particular significance at Series A and B, which are major inflection points for early growth. The 'A' round usually marks the transition from building a product to building a company. The ambition is to shift gears, from experimentation (finding product/market fit) to early scaling in the £M's. This requires a very different organisational capability and the founder must show they grasp exactly what is needed. The ability to then execute this plan must be clearly evident.

Series A and B rounds are major milestones in the graduation from a startup team to that of a more established business. But founders that try and leap too quickly by creating a very 'corporate' looking organisation will likely cause investor anxiety. Acquiring the next phase of customers - the 'early majority' - often requires a blend: still retaining responsiveness and customer intimacy, whilst at same time driving greater efficiencies from more dedicated functions. A founder must now also be able to work effectively between two timelines - the tactical issues of the here and now, as well as those on the 12-18 month horizon. As new products, territories, and even markets are planned in, so too the roles that will own these objectives.

Where will this talent come from? Who will move up and who will you hire? The temptation is to only bring in big hitters from outside, but this can cause disquiet. Moving some people up into key functional roles, provided they are ready, sends a strong signal to the team that they can grow with the company. Investors will ask about the development of these candidates and your plan for building out the wider team. This will require the implementation of sound management practices, hiring at scale, and the many other aspects of human resource management. Those founders that have already demonstrated the ability to hire and deploy top flight people, especially those that are hungry and still on their way up, will have the least to prove. Finally, when investors are confident with these plans, they will check the financial model to ensure they are all fully costed. After all, this is what their money will be primarily used for.

Having a vision can blind you to the problem

Entrepreneurs are often cast as visionaries. They can see a different future for the world, a country, a market. Some are able to harness their personal charisma and energy to build amazing teams and products that reshape or create entire industries. Steve Jobs was one such visionary. But in the formative stages of company building, investors are wary of founders that claim to be driven by a particular vision. Having a vision is no guarantee of being able to build a business to deliver it. In fact, vision obsession at too early a stage can lead startups to crash, pursuing a dream that is just not viable in that particular time and space. Instead, investors seek startups that are obsessed about solving a particular problem. A problem that is big, addressable, and ideally flying below everyone else's radar.

VCs, in particular, know that the bedrock of a successful startup is a clear problem/solution thesis. Those that are then able to prove the thesis and generate real traction are on the way to product/market fit. Then, with the first product starting to scale, they expand the product or add in others. It seems to be at this point when, for most, a vision truly starts to emerge. Armed with early evidence of demand and customer feedback, the bigger picture, the vision, starts to come into focus. In fact, as the products roll, it can become an imperative, helping to guide thinking to enable important trade-off decisions. The vision in this sense becomes 'retrofitted' onto the business, as if it were there from the beginning. This is a less romantic version of how a vision becomes a reality, but it's one which is more fundable.

The vision-obsessed startup can miss the real problem to solve. The starting thesis is no more than a solution thesis: 'Build it and they will come'. All eyes become focussed on the product rather than the customer. The product is 'released' but there are few, if any, takers. USPs that appeared relevant at the beginning of the development are ignored by the market. Competitive differentiation is weakened as others arrive, and is not sustainable over the long haul. To be clear, having a strategic vision from the outset is not in itself a weakness. It is more the inability to develop early milestones that require customer validation before further steps are taken. Then, as the insights eventually coalesce to form a truer vision, the courage to alter course. This creates a more credible narrative for investors to buy into.

Good business models are harder to build than good products

After a 30-year journey building the robot industry, Colin Angle's discoveries make powerful reading for any entrepreneur. iRobot's 14 failed business models is a classic founder's tale - of the extreme variety. But the lessons and insights could apply to any technology platform company today. "For a long time the robot industry was unfundable. Why? Because no robot company had a business model worth funding. It turns out that a business model is as important as the tech, but much more rarely found in a robot company."  Angle describes how his company changed the world by eliminating the need for people to vacuum the house themselves. But this is a long way from where they started. Each successive business model 'experiment' delivered fresh insights until eventually they landed on the business model that would unlock a huge market.

But funding the almost endless experimentation required a particular approach to partnerships. "The kind of partnership we looked for were ones in which there was a big company–one that had a lot of money, a channel to the marketplace, and knowledge of that marketplace, but for whatever reason lacked belief that they themselves were innovative. We were a small company with no money, but believed ourselves to have cool technology, and be highly capable of innovation."  The corporate partnership model needs very careful navigation as it creates risk in some areas as well as reducing it in others. The reduction element is about managing your own financial risk by having a partner underwrite the big costs. The risk creation element is who owns the results? But the most valuable results for iRobot were in fact the disasters. The things that failed. They provided the true insights that could be carried forward.

The accumulation of lessons learned from trying different monetisation strategies (royalties, licensing..) different markets and different manufacturing approaches, finally provided the ingredients for the bold vision. In Angle's view, iRobot has now succeeded in changing the world is by making robots a daily reality for it. The company, listed on NASDAQ, has made the robotic vacuum a mainstream consumer product. To date they have sold over 30 million consumer robots. The corporate partnership approach remains a powerful experimentation model today when there is a longer road to travel. Provided the partner pays - usually via some form of non recurring engineering (NRE) fee  - and the IP rights are carefully managed, a low cost journey to product/market fit can eventually be found.

US early stage investment market overheats

A recent analysis of the North American Venture Capital funding market helps explain why so many US VCs are becoming active in Europe. The competition for deals is pushing valuations to record highs. Supply (of capital) exceeds demand. Late stage rounds (Series C onwards) have so far been responsible for record busting round sizes and valuations. 2021 will easily surpass 2020 as a new record year for investment into the most mature startups. Now, a similar story is unfolding at Early Stage (Series A, B). According to Pitchbook, while the last three years (2018–2020) have each surpassed $40 billion in annual deal value, "2021 will likely shatter that high-water mark since, at the current pace, it would exceed $60 billion."

Early-stage VC is undergoing an identity crisis as deal size distribution weighs more and more heavily toward outsized financing rounds, largely due to recycled liquidity from an overactive exit environment and nontraditional investors descending to the early stages of the venture life cycle. The explosion of 'crossover investors', namely, buy-side public equity asset managers that also invest in privately backed companies—has dramatically increased capital availability within VC. These funds are now dipping down into early stage as they look to expand their opportunities by participating (and sometimes even leading) Series A and B rounds. With fund sizes swelling, the early stage of venture is likely to be fundamentally altered for the foreseeable future in the US. 

The attraction of huge returns in VC is driving this feeding frenzy. Last year, total VC exit value in the US scored a new high of some $287 billion. Already in 1H21, this number has been blown away, at $372 billion. IPOs rather than M&A are driving the biggest returns. This is all in stark contrast to the scene just a few years ago, when the IPO market was mired in a dry spell even as billion-dollar companies were being minted at a growing rate. These are the companies now coming to market. 123 public listings have closed so far this year, putting 2021 squarely within the sights of a new decade high for public listing count. Special Purpose Acquisition Companies (SPACS) have helped fuel this surge and account for 34 of the public listings in the first half of 2021 - already exceeding the 33 announced for the whole of 2020.

2. Other pieces really worth reading this week: 

Digitalisation in Europe 2020-2021
This in-depth report from the European Investment Bank presents a country by country analysis shedding light on the state of digitalisation. "The adoption of digital technologies by firms in the European Union is improving, but it has not yet closed the gap with the United States. While some EU countries are at the global forefront of digital transformation, others risk being left behind."

Startup Cities in the Entrepreneurial Age
A new report from Dealroom & Sifted as part of the European Startups project. "...some €49B was raised by European startups in the first 6 months of 2021. That’s 2.9x as much as was raised by the region’s technology upstarts in the first half of 2020 and easily crests previous full-year records set in 2020 and 2019."

£375 million 'Future Fund: Breakthrough' opens for applications
"A new £375m scheme to drive investment in the UK’s most high growth, innovative and R&D intensive firms opens today (Tuesday 20 July) – in a move designed to supercharge the UK’s post-pandemic economy. To be eligible, firms must be looking to raise at least £30 million of investment and have commitments of 70% of an investment round from private investors with a track record of financing innovative companies - such as VCs."

What’s So Special About Founders?
In HBR this week  "..myths about founders are powerful. They act as a filter for who gets the capital to start companies and a model for those trying to replicate phenomenal success. But although many investors have honed the art of the judgment call, it turns out that popular notions of what a promising entrepreneur looks and acts like are often wrong."

Happy reading!

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