1. Insights of the week

Founder liquidity at early stage creates winners all round

With the huge upswing in private market investment over recent years, companies are staying private longer. From a median time of 4 years to IPO in 2000 this has stretched to almost 12 years for tech companies today. Now founders can drive their startups through all the growth stages without ever having to be concerned about an IPO as a capital-raising event. This is one of the reasons that public listings have generally been in decline over the past two decades. The result is that whilst private assets made up less than 7% of global assets 20 years ago, that share is now 22%. With increasing volatility in public markets, founders have a much more stable and predictable route to growth. And with VC-backed businesses privately raising almost as much as they would at IPO, there are some very sound reasons not to float. But this is not all good news. Without a liquidity event, there is no crystallisation of financial returns. For the startup team, the moment to cash in all that blood, sweat and tears gets pushed further into the future.

But more and more investors are waking up to this, recognising that this 'trapped capital' leads, understandably, to deep founder frustration and often misalignment of exit timing — and value. This is detrimental to the business as a whole, impacting the ultimate return for institutional investors such as VCs. As a result, there is a growing number of private 'secondary' transactions. Today, about $30 billion in private company shares changes hands every year - a 300% increase over the last decade. But this is still just 2% of the $1.5 trillion in value represented by all late-stage, venture-backed companies. Whilst secondaries have been more a feature of later stage rounds in the past, they are now creeping into early stage - at Series A and even at Seed stage on the hottest deals, as we reported in January. Investors have seen first-hand how founders, freed up from immediate personal worries, transform and feel empowered to take even bolder decisions - fundamental to building category leaders.

This increasing private market liquidity is starting to reshape the way that companies, investors, and markets operate. Forward-thinking funds are seeing ways to take larger stakes in outperforming companies without overcapitalising them. In some cases fund managers are setting aside up to half the fund to invest in founders who are building massive, market-defining businesses and looking for liquidity. In turn this is enabling alumni from the most successful startups to recycle some of their new-found wealth into the next generation of startups, creating a virtuous circle. Beyond founders, some early stage investors - Angels and seed stage VCs - are also seeking the opportunity to cash out ahead of time. This enables cap tables to be refreshed, bringing on new, strategic investors who may be a better fit for the long haul ahead - without the dilution of a primary round. We are entering a new era where secondaries look like they are finally coming of age.

Keep DeepTech investment propositions simple

DeepTech founders know that the early stage funding process is going to be fraught with uncertainty. That's because most investors have a hard time coming to terms with technical risk (Will it work?). They are much happier when all they need to assess is market risk (Will there be demand?). This is the essence of mainstream VC. The majority of software startups carry little technical risk - they might be developing a new application but they are unlikely to be pioneering the core tech. For SaaS business models, which have driven a huge proportion of investment dollars over the past decade, the key metrics of success are well known at every funding stage. Similarly, the methodology of valuing such businesses is well understood. In the early stages, growth is almost entirely a function of applying capital: Equity raises essentially fund CAC. At Series A and beyond, the current year's performance is also highly predictive of next year's. All these parameters relate to market risk. The better they are understood, the lower the risk.

But in DeepTech, things are not quite so simple. In the early stages, sometimes for many years, technical risk prevails. Think semiconductor development, advanced materials development, new drug development and the like. Here we are truly pushing the boundaries of science. The danger is that technical risk then compounds with market risk making the overall risk profile unpalatable. In the words of investor Elad Gil, each major category of risk requires a 'miracle' to overcome: “If your startup needs zero miracles to work, it probably isn’t a defensible startup. If your startup needs multiple miracles, it probably isn’t going to work — with every miracle, you are multiplying in another low probability event to get an even smaller expected outcome.”  Multi-miracle startups do of course succeed, but the road to commercialisation can be long and painful. Such startups can be almost impossible to fund via VC. Success here is generally the exception not the rule. Think SpaceX for example, once a little startup that closed a $12M Series A back in 2002.

However, for businesses whose pioneering endeavours have created a genuine scientific breakthrough, there should be little real market risk. True DeepTech investors will immediately see this, provided we can cross some minimum evidence threshold. If we discover a vaccine that cures a major disease, design a chip that revolutionises how we communicate, develop a material that has unmatched strength and conductivity, few would argue that it will be hard to find a huge global market. Execution risk will of course always be an underlying doubt in any new business. But aside from this, founders can unwittingly raise investor anxiety by complicating the early stage funding proposition. For example, by expounding the need for other 'miracles', such as new business models or new go to market strategies - all at the same time. If the technical breakthrough truly is an industry game-changer, then there is no shame in leveraging proven customer engagement strategies and economic models to drive early growth. Revenue flows will always take longer to switch on compared to SaaS, but they will quickly overtake when the market suddenly sees the potential.

Customers must not hijack your product

Revenues are evidence of commercial traction, the key care-about for early-stage investors. But not all revenue is equal. For any startup, engagements with early adopters that are not strongly representative of the particular problem focus can become a huge distraction. Worse case, they could pose an existential threat to the business before it even begins to scale. It won't take prospective investors long to figure this out in due diligence. Experienced founders know that by focusing on solving one problem really well, momentum can be developed by finding more customers with the same problem. We now accept that such 'cohort analysis' is critical in developing SaaS businesses, but it's just as important in other business models. 

Refining the exact qualification criteria for the initial target cohort can be a lengthy, iterative process. And every month, dwindling cash balances put founders under ever greater pressure to pursue potential revenue opportunities where the cohort fit may seem dubious. In business models that require deep engagement with each new customer, for example where technology or product integration is required, it may take months to confirm viability. Here the immediate qualification criteria must be willingness to pay, right from the outset: pay for the initial feasibility study, pay for the proof of concept, pay for any joint development, and so on. Customers that are not sympathetic to the enormous opportunity cost for a startup should not be allowed to hijack your product to solve their own unique problem.

Some founders, often those with a limited or no sales background, can be nervous about seeking early cash commitments. Worse, by initially trying to paint their startup as a more 'established' business - for example, by adopting the behaviour patterns learnt from earlier experience in the corporate world - they are inclined to link payment solely to hard deliverables. In fact startups are uniquely positioned to leverage their often tenuous cash position to negotiate for up-front payments for the privilege of securing an early adopter slot. It's also an entirely reasonable request, considering the huge opportunity cost for the startup. Where deep engagement is essential, willingness to pay is also a sign of intent and a confirmation of a painful unmet need. Even so, accessing cash from customer operating budgets can take time, so the sooner you make your case the better.

2. Other pieces really worth reading this week: 

The Playbook This Startup Used to Get Their Founders on 100+ Podcasts in 6 Months
It’s no secret that the podcast industry has been exploding over the last decade, with plenty of us tuning into podcasts for news, advice and entertainment. Brands are following consumers into the space, figuring out how best to leverage this relatively new platform. A “podcast tour” is when a brand secures podcast interviews for its founders on shows that its target audience is likely listening to. For a startup, the main value of a podcast tour is education and awareness. The impact can be transformational for lead generation. From the First Round Review, here's the playbook on how to make it happen.

If we’re all so busy, why isn’t anything getting done?
With endless meetings, incessant emails, and casts of thousands, companies have mastered the art of unnecessary interactions. Winning in the next normal requires much more focus on true collaboration. Following a recent survey by McKinsey, this article provides a thought-provoking analysis of where companies need to make changes.

Frameworks for Startups
Curated by Louis Pereira, this working document on business model frameworks, authored by VC Chris Paik, is a gold mine of insights for founders. This is an open, living document and the real-time comments from founders are as interesting as the content itself. 

Happy reading!