Duet Partners
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Weekly Briefing Note for Founders

24th November 2022

This week on the startup to scaleup journey:
  • Superior tech doesn't always win out
  • Is your corporate investor ready for 2023?
  • Behaviours that signal your startup's culture

Superior tech doesn't always win out

Last week we said a great product that doesn’t have an effective way to reach customers is not a viable product. This is the reason why growth investors (and for that read anything from Series A onwards in the current market) see the Go to Market (GTM) strategy as more important than the product itself. Founders must therefore spend as much time and thought designing their GTM strategy as they do developing the product. In the lean startup model this process doesn't happen sequentially but through a series of experimentation loops: The MVP is first used to attract early adopters and find initial product/market fit (PMF), then to gradually discover the strongest customer cohort for early scaling (in the beachhead). This MVP-driven approach works best in software businesses, especially those targeting consumer markets. If the early adopters don't turn out to be representative of the beachhead customers then this is no big loss - to either party. In a sense, these early users are expendable. They were key to the initial PMF experiment but not necessarily key to early growth. There are plenty of others to go after.

But for DeepTech businesses things are very different. In B2B settings, the process is far less iterative as the MVP is rarely a standalone, incomplete product. More likely it is several pieces of technology that may even require a services 'wrapper' to prove initial efficacy in a specific application. The early adopters, with whom there will almost certainly need to be a highly collaborative relationship, are hardly ever 'expendable'. As development cycles are much longer than the quick-spin software MVP, these relationships are likely to become ever more crucial over time. They will be pivotal to the startup gaining deep insight into the application space. The collaboration will be through a formal engagement to bring the product to fruition in a specific use case. This should also present a revenue generating opportunity, well before any final product is ready. The choice of these early partners is of paramount importance as they must play their full part - above all they must have willingness to pay. Bad choices can become an existential threat to the resource limited startup. The right choices, where the customer truly shares the same vision and spends big on the back of it, can even propel the startup across the 'chasm' into the mainstream market - with even greater impact than a consumer software business might.

In the DeepTech startup the maxim that the GTM strategy is more important than the product itself therefore holds especially true. The goal is to find the right early adopter customers and engage in a collaborative effort as early as possible. This will be the first real moment of market validation and so can be a vital sign for investors during capital raising. Such engagements can be structured in a variety of ways from a basic 'proof of concept' all the way to a joint development agreement (JDA). The two key principles are, 1. not to fall into the trap of bespoke development, and 2. retain all the IP necessary to exploit the product in the general market. This is incredibly difficult to pull off when you attaching a substantial price tag (perhaps several £100k's or even £1M+) to the project, but this level of commitment will be essential evidence when it comes to convincing investors. The GTM strategy therefore requires a high degree of commercial nous and experience to execute. For technical founders that don't feel equipped to secure these early deals, they should be making their first senior Business Development (BD) hire at the earliest possible moment. The brutal reality of DeepTech is that superior tech doesn't always win out. Developing the GTM strategy alongside the product will give it the best chance.

Is your corporate investor ready for 2023?

As the Tech market slowdown took hold in early 2022, investors quickly went into triage mode. Which portfolio companies would they support and which ones would they let float away to fend for themselves? The established fund managers expected that capital raising would become much harder for both themselves as well as their portfolio companies. VCs began offering advice to startups on how to prepare for the worst, with the famous Balderton letter capturing the mood. But behind the scenes another form of triage had begun. Experienced founders, especially those that had lived through prior market meltdowns, began assessing the viability of their investors. Which ones could they depend on going forward? Which ones might struggle and not be able to follow their money? If new investors were going to be needed, where would they come from? Now, looking back over the past 2 quarters, we can start to see the fallout. The bigger VCs (contrary to their earlier concerns) have continued to raise even more money, whilst smaller and newer VCs are having a hard time as we reported last week. But how are other investor types faring? Will the so-called 'nontraditional' investors be able to plug the gaps?

Pitchbook defines nontraditional investors as corporates, corporate VC arms (CVCs) and financial institutions including investment banks, certain private equity (PE) firms, sovereign wealth funds, hedge funds, pension funds, asset managers, family offices and other special purpose vehicles. So far this year they are keeping pace with the market. VC deal value with nontraditional investor participation hit €58.9 billion through Q3 2022 across Europe, on track with 2021’s record figure. Just like VCs, nontraditional investors have been enticed by high-growth companies emerging in nascent sectors. In particular, VC investments have enabled corporates to keep abreast of technological development and leverage expertise from growing businesses via strategic partnerships. At the same time, financial institutions have been able to diversify portfolios away from core investment areas and generate stronger return profiles for shareholders or limited partners (LPs). But as we look ahead to 2023, it's clear that the worsening macro-environment is going to bring much greater pressure to bear on corporates. Will they continue to be a reliable source of capital for 2023 funding campaigns?

They key to this question is to appreciate the 2 different types of corporate investor as they will have contrasting outlooks. The most active corporate VCs (CVCs) will have a fund structure similar to that of a normal VC, operated on an arm's length basis from the parent company. If that fund was raised in 2021, they are likely sitting on a pile of capital they can continue to thoughtfully invest. But others may get capital that is gradually fed by the bank balance of the corporate, or provided on a case by case basis. "Expect those structured this way to suddenly have to jump through way more hoops" says Suranga Chandratillake at Balderton. This experienced VC is encouraging founders to engage with their corporate investors and get a real sense of their appetite for further investment in 2023. He suggests that the big CVCs are going to be fine but some of the smaller, newer entrants to the market will have a crisis of confidence as investment values get marked down and CFOs get tighter. "If one of those is an investor in your business, it’s time to ask some difficult questions."

Behaviours that signal your startup's culture

On the journey to product/market fit, just about every aspect of the business model is under scrutiny. New information is being discovered almost daily as the 'experiment' progresses. Tweaks are being made constantly. Sometimes the discoveries are so profound that a pivot is eventually required. But one aspect of the company isn't tweakable or pivotable - and that's the culture. This is the DNA of the startup. It's created by the values, behavioural characteristics, and leadership style of the founders. Any outsider that interacts with the company will quickly experience it. But it's not necessarily what they may see or hear, it's how these interactions make them feel. It's all about the instinctive, emotional reaction. Investors, in particular, are highly attuned to picking it up. It may never appear formally on a VC's due diligence scorecard, but it is always 'assessed'. A startup radiates signals right from the outset that act as a proxy for culture. Any one could be the make or break of an investment decision.

The first big signal is the personalisation of the initial approach. VCs claim that less than 10% of all deals that are sent to them are truly personalised by the founder. This is the first easy filter that an investor will use to discard a deal. If a founder can't immediately tell an investor why they might be a great fit for their business, they have reduced their approach to little more than a mailshot. Their email will hit the bin fast having received a zero rating for lack of common courtesy (not to mention poor sales skills). The second signal is the actual design of the deck. Investors will rarely admit it, but a pitch deck that looks beautiful and alluring will open doors. Julie Penner, venture partner at Frazier Group, says; "Investing is more of an emotional decision than VCs own up to... if you send an ugly deck, I will assume you will build an ugly website and an ugly product and no one will buy it...and, if anything about the deck is incongruent, I will struggle to make sense of the deal (and I might not be conscious of why I can’t get comfortable with the deal)."

The third big signal is response time. Even though this is where VCs themselves get ranked low by founders, not replying promptly (not necessarily immediately but within 24 hrs) suggests you are not on top of your game, whatever the reality. And by keeping email responses concise, you are again showing respect for their time, as well as just being professional. Another hint at being disorganised is a poorly constructed/populated data room. This is likely the first opportunity to convey operational excellence, but too many founders flunk this test. Teams that are disorganised often have paperwork that’s missing, and that represents a risk for investors. A complete data room also facilitates quick response times - on both sides. As Penner adds: If you come to the table already organized, that investor will assume that it’s less likely that you have missed something big that could be a company killer or that could be a costly mistake down the road."

Happy reading!

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