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


Weekly Briefing Note for Founders

23rd July 2020

This week on the startup to scaleup journey:

  • Sharp decline in equity investment for the UK in 1H20
  • European Funds raising record amounts of capital during Covid
  • When Tailwinds Vanish - what will VCs spend all this cash on?
  • Solving 'harder problems' may lead to the reshaping of VC

1. News & Insights

Sharp decline in equity investment for the UK in 1H20

We've been studying the latest publicly-announced equity deal data for UK companies just published by Beauhurst.  The headlines are:The amount raised in 1H20 totalled £4.77b — a 7% decrease from the previous half and a 30% drop from the comparable period in 1H19.

Deal numbers declined, but not as much as expected. A total of 911 deals were announced during the half, a 3% decrease from the previous half and a 9% decrease from 1H19.

Whilst the number of seed stage deals actually climbed, first-time fundraisings have taken a nosedive, with a 15% fall from 2H19. This shows that early-stage investors have focussed their resources on existing portfolio companies.

1H20 saw the highest proportion of down rounds on record. 15% of announced deals were completed at lower valuation than the recipients prior funding round and this was accelerating as we moved into 2Q20. 

Most sectors experienced a decline or plateau in deal numbers, including investor favourites fintech and artificial intelligence. But the rush to digitisation has advanced some verticals. Digital security companies saw the largest uptick, with a 42% increase from the previous half. 34 deals were secured—a record half for the sector. The Coronavirus outbreak triggered a monumental surge in demand for remote healthcare solutions, and UK startups were well placed to help. eHealth companies enjoyed their first rise in deal numbers since 2H17, ending on 22 announced deals.

The outlook through the rest of the year is very hard to predict. Despite nearly all investors claiming they are now 'open for business', the quarterly trend through Q2 was deeply worrying:

In 2Q20 the equity raised by UK companies dropped by 47% compared to 2Q19. Anecdotal data points suggest that we have not seen the bottom yet. We have had an increasing number of new enquiries from founders seeking advice on funding strategy following dozens of fruitless investor interactions over recent months. This does not bode well for Q3.

European Funds raising record amounts of capital during Covid

Many discussions with founders following last week's article on VC investment across Europe in 1H20, as reported by Dealroom. At the bottom of this link was an unexpected datapoint, New VC funds raised reached an all-time record in 1H20. How do we square this with the fall in capital flows into companies?

A closer look at each quarter is more revealing:

1Q20, record amount raised by funds of €4.8B, following momentum from a record 4Q19 (€4.3B). Biggest new fund was the Atomico V (Series A+) $820M, followed by RTP Global and Felix Capital. Covid had virtually no impact in 1Q20 for deals already in process.

2Q20, €4.4B raised, led by the new Index Ventures Growth fund at $1.2B and then the Index Ventures X early stage fund at $800M. Next biggest was Corten Capital's debut fund (B2B services) at €392M. By Q2 investors such as Index and Corten had already raised the bulk of these funds - such big funds can take a year or more to raise - and the crisis only seemed to help. As Bloomberg reported, Index will now go on to test a long-held piece of VC wisdom: that the most promising startups, and highest returns, are born out of downturns.

"The best funds come out of difficult positions like this", said Mike Volpi, an Index partner since 2009. Volpi cites investments the firm made in past downturns, such as payments company Adyen NV, file storage company Dropbox Inc. and wireless-speaker company Sonos Inc. all of which are now public companies.


When Tailwinds Vanish - what will VCs spend all this cash on?

Even before Covid really started to impact, analysts were debating the disparity between the relentless rise of big new VC funds and the market opportunities ahead. As John Luttig (Principal, Founders Fund) recently wrote is his recent blog on the future of internet businesses:

"The current exponential growth in VC fundraises, startup projections, and valuations for the past two decades all assume these tailwinds will continue in the 2020s.... But if you look at these supposed tailwinds today, a gloomier picture appears: they are not exponential functions, but logistic functions with plateauing growth rates."

One of Luttig's key insights was that for the first time in Internet history, startup growth will require a push from the company and not a pull from the market. Unlike the organic pull that drove many of the dotcom-era successes, today’s Internet startups need to fight for growth by solving harder problems. If this involves a tougher selling process, this will likely mean investing more heavily into sales, marketing, and operations.

He concludes: "The Silicon Valley of tomorrow will not look like that of today – success stories rarely repeat themselves – but new Internet opportunities certainly aren’t going away. Quite the opposite: recognizing where we are in the Internet adoption curve clarifies the opportunities in front of us. Founders may seize this moment to build new tools to better understand operational investmentscreate the financial layer of the Internet, or look beyond the Internet to build new platforms in biotech or energy."

Covid, at least in the short term, has also heavily impacted the market order, accelerating sectors such as grocery, telemedicine and remote working tools. The question is will these new trends last or will serious investors stick to playing the long game on the bigger underlying shifts that were already happening pre-Covid?


Solving 'harder problems' may lead to the reshaping of VC

VCs need certain conditions to be in place for their investments to generate returns. In Nicolas Collins' latest essay 'The Diffraction of Venture Capital', he depicts those conditions as 1. Basic research must be funded by either the state or large companies so that technology becomes robust and abundant, ready for VC to step in, and 2. A liquidity event (acquisition or IPO) must occur to provide strong capital returns.

As companies try to solve 'harder problems' the cost of basic research is increasing. We highlighted this in our recent briefing note - 'The Deep Tech funding challenge.' This is a major issue in Europe. So too the scarcity of exits. As Collins says: "All in all, both trends contribute to degrading the scalability of tech businesses, which in turn contributes to degrading returns in traditional VC."

Will this impact the structure of the mainstream VC investing market? As the focus shifts from growth (at all costs) to profitability, Collins argues that this will lead to a polarisation in VC: at one end "Boutiques of craftspeople [that] remain focused on one narrow segment." and at the other "large, generalist firms integrating different lines of financing". In the US we are starting to see the emergence of more diversified forms of investment, for example revenue-based financing in SaaS.

The reworking of the VC model is being led by Silicon Valley juggernaut Andreessen Horowitz (known as 'a16z'). Back in March, the firm renounced its VC exemptions and registered as a financial advisor, giving it enormous flexibility. For example, the new Growth fund will be able to buy up shares from founders and early investors—or trade public stocks. That’s how the firm plans to keep up in a crowded VC landscape that experts say is bifurcating between specialist seed funds and a handful of giant, all-purpose firms. The full back story is in Forbes.

In parallel, we have seen the birth of the Long Term Stock Exchange in the US (an initiative supported by Marc Andreessen at a16z). Its goal is to reshape the incentives for the next generation of public companies so that they can focus on the long term. In May, regulators approved the LTSE to become the 14th listed exchange in the US, a nine-years-in-the-making accomplishment backed by Silicon Valley heavyweights like Reid Hoffman (Greylock Partners) that is expected to pave the way for it to begin accepting IPO candidates later this year. If the LTSE gets off the ground, it could be a game changer for scaleups. Europe will then need to respond.


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

How start-ups see the future of remote work
A follow up to our articles last week on remote working, this time with some excellent analysis by the World Economic Forum: How start-ups see the future of remote work. "No matter where in the world you log in from—Silicon Valley, London, and beyond—COVID-19 has triggered a mass exodus from traditional office life. Now that the lucky among us have settled into remote work, many are left wondering if this massive, inadvertent work-from-home experiment will change work for good."

Deep Tech insight: Quantum Computing - Frequently Asked Questions
Quantum Computing may seem mysterious and not easy to understand, but it is a critical ingredient in the future Deep Tech landscape. This excellent FAQ document form the WEF answers common questions at a high-level on what makes quantum computing so special and how we expect it to impact the world in the coming years. An excellent primer for all those new to this space and those seeking to invest.

8 vital leadership learnings for startups
Sonali de Rycker, Partner at Accel, has worked with some of the most accomplished entrepreneurs of our time. What has that taught her about good leadership? Sonali, who we have known since here days at Atlas Venture, recently shared some of her best advice on leadership in startups in the new Soaked media launched by Slush. The article is here.

Steve Blank on The Twenty Minute VC 
Steve Blank is one of the leading luminaries of Silicon Valley, credited with being foundational to the creation of The Lean Startup Movement and having spent the last 9 years at Stanford University as a professor and the last 8 as a Senior Fellow at Columbia University. His work has strongly influenced our methods at Duet.

In this podcast Steve talks about The Lean Startup Movement and responds to some questions of our time: What are the 3 core traits that will ensure success for founders in a post COVID world? How should founders change their decision-making process post-COVID? 

Navigating the post-COVID-19 era: A strategic framework for European recovery
An excellent article by McKinsey. Whilst aimed at policy makers, this is a well researched perspective on how different sectors will respond after Covid.

Happy reading!

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