1. Insights of the week

Make something people want

One of the traits of successful founders is the ability to question convention. They know that startups can be so weird that even trusting your own instincts can get you into trouble. In Paul Graham's landmark essay, Before the Startup, he says "Startups are counterintuitive...starting a startup is a task where you can't always trust your instincts." He compares it to skiing: "When you first try skiing and you want to slow down, your instinct is to lean back. But if you lean back on skis you fly down the hill out of control. So part of learning to ski is learning to suppress that impulse."  In the startup to scaleup journey, there are many impulses that must be fought off. This takes conscious effort, so the starting point is awareness. Awareness that what has previously been accepted as 'the way this is done' will not only cause pain and delay, but potential failure. These failure mechanisms will sometimes deceive, as in the corporate world of established businesses they can sometimes be accelerants.

Instincts can drive behaviour so strongly that it is often hard to advise founders in the art until their skis have shot out from underneath them a few times. A bad run of investor meetings often seems to be the tipping point, but by then it may be too late to recover. Graham reminds us that the most basic question an investor will ask is "Are you making something that people want".  Some founders will walk straight into this trap by talking about the product. This is what corporates do. They have the resources, market insights and financial resilience to drive a 'product first' strategy - often the primary accelerant of growth. But venture investors don't care about the product - at least not to start with. And the idea of a 'product launch' will almost certainly frighten them away. They care about the customer and the problem you are solving for that customer. They care that there are potentially huge numbers of such customers willing to spend money to solve their problem and fuel early scaling. They know the journey there is an iterative process, not an event.

One of the other fallacies of the startup funding journey is that revenues demonstrate progress. They may, but in the very early stages, rarely on their own. Again, this seems counterintuitive. But it is understanding why customers buy your product that investors see as true progress. For many, this question trumps all others. This is particularly vital for startups selling through third party channels, where end customer relationships and insights are much harder to develop. The acceleration of the direct to consumer (DTC) business model through Covid has boosted customer insight in both B2C and B2B settings. The data gleaned is enabling customer cohort analysis at unprecedented levels. This is providing the evidence needed to demonstrate sustainable growth - and thus fundability. Founders skiing on instinct, relying on the headline story of revenues alone for early funding rounds, may suddenly find their investment propositions come crashing down.

Market type heavily influences investor perception

Understanding the market type your startup is addressing is crucial. It can have major implications, from your cost structure to your 'market fit' as a founder. It also sends an immediate signal to investors about the scale and complexity of the journey your business faces. Broadly speaking there are 3 different types of market: Existing, Re-segmented, or New. Most startups either find themselves disrupting existing markets (creating segmentation through some form of reinvention in how things are currently done), or creating new ones. The challenges associated with simply entering an existing market often make such moves unattractive to high growth startups. Not least, the cost associated with displacing incumbents. In Steve Blank's book, The Startup Owner's Manual, he shows that the cost to displace a dominant player is 3x their combined sales and marketing budget. Even to displace an 'also ran' takes 1.7x.

Re-segmenting is thus a popular strategy, and generally falls into either re-segmenting through new features or low cost. Finding a niche where some product feature disrupts the market, creating clear competitive advantage, is often the aim. As Pete Flint of NfX describes in his latest essay, one of the biggest ways in which we continue to see existing markets reinvented is through digitising and organising existing offline behaviour. The Covid era has accelerated digitisation in every industry. This is most obvious in e-commerce, but it’s visible across the board — every part of life from going to the dentist (which now requires online booking) to eating at a restaurant (online reservations) has increasingly moved online. Opentable has built a business worth billions of dollars simply by digitising offline behaviour. One of the telltale signs that a market is ripe for reinvention is traditional advertising. If you see a lot of advertising in a market category, that’s a good signpost that there’s significant product atrophy: Existing players are competing for big revenues based on ad spend.

Whilst reinventing existing markets is the most popular way for a startup to start out, creating a new market is often where the real value ultimately lies. But this seems like a much greater hill to climb. Flint offers a useful framework for new market creation to spur thought. In Tech, one of the most leveraged strategies is 'feature abstraction'. Shopify, Twilio, Stripe, and Snowflake are all examples of B2B businesses built around products that were initially just features. Flint observes that when he meets a team with a lot of industry experience, they tend to excel at creating businesses that focus on reinventing existing markets because they have built up the ability to execute well over their careers - it makes more sense for them to take on execution risk. On the other hand, the archetype for Founders creating new industries is that they’re often creative, technical, and quite naive (in a good way). But they are often people who are able to think from first principles, are outsiders with limited business experience, but have deep domain knowledge from a technical standpoint. Which one are you?

Convince yourself before trying to convince a VC

We often hear the phrase 'investor conviction' - the need to find conviction before investing. As founders we are conditioned to think that the vehicle for generating this conviction is the investor pitch. But this is wrong. It is the founder themselves that is the vehicle. This may sound obtuse, but no matter how great your deck is, if you don't radiate conviction that you believe the business will be a success, you won't convince investors. That's because investors will assess you first, and they will assess the viability of your story on the basis of whether they think you're a winner or a loser. That decision gets made in the first few minutes of meeting the investor. This might sound callous, but first impressions count - a lot. Does this mean the founder that is better at pitching will get the money? Generally speaking, no.

Investors will typically characterise a 'winner' as a founder that has a bold vision, a resolute belief in the opportunity, and the determination to see it though. These are all cues for something deeper. You may not be the world's smoothest presenter but if you can convey a genuine belief in a bold vision and that one way or another you will get whatever you need to deliver it, you'll inspire confidence. You might have the best slides in the world but if you can't convince an investor you will walk through fire, everyone will pass. Your belief - in other words your own personal conviction - is the foundation. The best pitch is a story that helps you articulate this conviction. This demands that you deeply understand the opportunity space you are describing and have a game plan for grabbing it. You will have also gathered some clear evidence that supports these initial claims. The essential skill is then being able to translate your big idea into a big market opportunity. Investors think in terms of markets.

Some founders believe that the reason to raise capital is that their startup is running out of cash. This is not why investors invest. They invest because they buy into you and the opportunity you present. If you can't first convince yourself that your business deserves investment, then you will almost certainly not be able convince an investor. This is not about trying to offer any form of certainty. The nature of the startup journey and the early stage investment that fuels it, is that no-one can ever truly predict how things will turn out. But experienced investors are very good at pattern recognition - they have seen it all before, many times. If they see in you a founder with a winning mentality, a big enough market opportunity, and some early evidence that makes this all sound plausible, you'll get a ticket to the next stage.

A due diligence trap to avoid

When a VC shows interest following your pitch, they are going to start asking more questions. A dialogue will begin as they drill into your story and get comfortable with the proposition. But if there's no or low competitive pressure from other investors wanting to move on the deal, there will likely be little incentive for the VC to hurry things along. And if the Partner didn't get the go ahead at their Monday morning meeting to immediately invest resources in the initial due diligence, you are likely headed for the slow lane. You will not be on their priority list and the time between conversations, or even just email exchanges, will start to increase. This is when other more exciting or time critical opportunities will come along and grab the VC's attention. You therefore need to spot these signs early and start ramping up the FOMO.

One method VCs use to keep potential deals ticking over, with almost zero effort on their part, is to ask you to speak to a portfolio company in the same space. This will give them another point of view. This not only signals the slow lane, but is potentially dangerous. The situation is invidious for both you and the portfolio company. It's likely going to be a big lose/lose. As a Founder, you won’t want to share your plans with a company so close to your space. Plus, the portfolio company is likely to prefer that the VC not invest in another company in their space, so will almost certainly recommend against. The VC may have genuine intent but there is always the risk that you will just be briefing a potential competitor with free information. This is obviously a scenario to avoid.

The right course of action is to immediately let the VC know that you are uncomfortable with the idea, but at the same time offer an alternative. Suggest that you could meet with an independent industry expert instead, and be ready to offer up some names. If you already know these people then this could really work in your favour. If the portfolio company reference is not competitive, then there is another tack you can take. Use the call to reference check the VC. As it's highly unlikely that any portfolio company is going to speak ill of their investor, you will need to be well prepared. If you can carefully frame the right kind of questions, you will potentially learn a great deal. Anything other than hugely positive replies should ring alarm bells.

2. Other pieces really worth reading this week: 

What’s So Special About Founders?
Some great insights in HBR this week on what sets founders apart. "..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. Those notions can have major consequences."

Determining Market Size When Evaluating Innovation
VC Mattias Ljungman provides useful guidance for market sizing in the Moonfire blog this week. "As a venture capitalist you cannot be too early or too late. In order to gain a competitive advantage, the goal should be to get there early enough so that no one else can understand the underlying market dynamics. You don’t want to be so early, however, that there is a mismatch between market availability and market demand, which leads to burning cash to create a market that people do not want to purchase in."

M&A in VC: A Path to Successful Exits
Hector Shibata is Director of Investments & Portfolio at ACV, a global Corporate Venture Capital (CVC) fund. Here he provides a useful summary of the key M&A motivations that drive deals. "Independent VC funds, unlike corporate or Family Offices, have an exit period to realize their financial return. Therefore, they will look for an option that suits their interests. Mergers and acquisitions are one of the most efficient ways to carry out an investment exit."

Leadership: An Unusual Morality
Impressive analysis of Stripe's leadership team and mission by Mario Gabriele in The Generalist makes this a 'must read' for founders "..the Collisons seem to have forged an alternative for elite leadership that does not seek to excuse a noisome, polluting process with a favorable outcome. Just as Patrick notes that the “no jerks policy” companies sometimes apply to restrain themselves from hiring brilliant assholes is “too low a bar,” Stripe’s leadership seems to understand that success alone is not enough. You have to win with grace."

Happy reading!