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


Weekly Briefing Note for Founders

25th November 2021

This week on the startup to scaleup journey:
  • VCs will only fund 'category winners'
  • European founders must better understand the US investor mindset
  • Solo GPs are changing the face of VC

1. Insights of the week

  • VCs will only fund 'category winners'

    Startups that create a new category typically capture over 70% of the total category market cap. This is why VCs are relentlessly searching for 'category winners' - or those that look like they will become one in the future. When VCs assess an investment proposition, one of the the first things they examine is the description of what the business does. This provides the first clue about 'category'. The second, but more revealing clue, is the problem the startup is addressing and the solution being created. That's why experienced founders make sure they carefully explain the problem to ensure the investor is 100% clear that the mission is unique. If a VC thinks they already understand the problem (either because it's already well known in the market or they have heard other startups pitch a similar story) they will assume someone else has already defined that particular category - and therefore has an advantage. This is very hard to sell around. It's therefore vital that the founder's insight reveals a problem/solution perspective that is both exclusive and exciting.

    A powerful way of pressing home the founder's unique perspective is through product/market positioning. A quadrant chart is often used here as it can provide a simple and visually compelling rendition of how the category will be perceived by potential customers. This can either be a completely new category (quite rare) or the redefinition of an existing category (quite common). Importantly, the quadrant chart describes how a customer will see a problem and evaluate a potential solution. As VC David Sachs says in his excellent article on category leadership,"Business understands problems by categorizing them, so convincing the world that a new category is valid is tantamount to winning."  He describes how once you’ve defined the category, you can flesh out the category requirements and position them in a quadrant chart. "This is the time to talk about features. You can position yourself and de-position competitors by explaining what functionality is critical for a product of this type."

    But there are several misconceptions around category creation. The most common error is conflating category creation with first mover advantage. The incorrect belief is that category creation is about being first to market with a new product or service. This can sometimes be the case — but often is not. The challenge is broader. Research shows that the emphasis should be on creating the first high functioning 'flywheel', which is the combination of 1) a radical product/service innovation, plus 2) a breakthrough business model innovation, all greased by 3) breakthrough big data insights about future category demand. This is supported by an analysis of the Fortune 100 fastest-growing companies over the last decade. Of the roughly 600 unique companies across the 10 years analysed, companies with the flywheel described above accounted for only 22% of the companies, but drove 52% of the revenue growth and 72% of the market cap growth. Founders must ensure that VCs hear a story that shapes the birth of a new category and the flywheel that will lead them to win.

  • European founders must better understand the US investor mindset

    US investor involvement in European VC deals is at an all-time high: In 2020 US investors participated in €24B worth of deals. In the first 3 quarters of 2021 this had more than doubled to €51B. Founders are quickly having to become more attuned to the tastes and expectations of investors from the other side of the pond. Despite the many similarities across these two established VC ecosystems, there are some startling disparities. Some are obvious (mainly relating to market scale), others less so. Research by McKinsey shows the US produces about 45% of global startups and 50% of the world's unicorns. By comparison, Europe produces 36% of the startups, but only 14% of the unicorns. Overall, European startups have a 30% lower likelihood of success (at reaching a growth round or an exit) relative to those in the US. But most revealing of all, whilst European startups don't fail any more frequently that US startups, they tend not to advance as often.

    This lack of advancement - to the next funding stage - is a key source of anxiety for US investors when turning to Europe. The McKinsey analysis shows that European startups are more likely to stall and not progress to the next big inflection point as their US counterparts would. If things haven't turned out as expected, they are more likely to limp along on the drip of incumbent investor cash rather than be wound up or find a new direction. If things are progressing well, they are more likely to settle for self-sustainability once profitable. US investors are growth-centric in their DNA, so will target those with the greatest ambitions. Profitability is just one factor but will be prioritised behind growth. This often means they will seek out founders with a strong appetite for international expansion once scaling begins. This is seen as key to both revenue growth and valuation growth. For a European startup to address a market that is similar in size to that of the United States, it would need to enter 28 heterogeneous countries (i.e. the EU + UK). This is a huge ask. Instead, early entry into the US market is often seen as critical to the growth strategy.

    One of the biggest challenges for US investors through the pandemic has been the inability to meet European founders and their teams in person. To mitigate this risk, there has been increasing emphasis on co-investing with a UK lead investor - especially in the earlier stages. And during due diligence, there has been a greater focus on both customer references and personal references as a substitute for the in-person judgement. To build high conviction within the compressed timelines of today's hot deals, investors are also doing their homework ahead of time, before the deal clock even starts ticking. Sequoia, for example, built two dozen “landscapes” last year. These are high level market trend assessments in areas they want to focus. This provides a framework in which to quickly position opportunities, enabling faster decisions to be made and new deals to be won.

  • Solo GPs are changing the face of VC

    Solo investing isn't a new phenomenon; super angels are a well established part of the venture ecosystem. Some of these experienced high net worth investors started off by investing their own money, then expanded. By taking in external capital they established their own mini VC funds and became General Partners or GPs. The focus of such funds has usually been to seek out pre-seed and seed stage rounds, often before traditional VC funds would come in. Now that is changing. In a capital market that is booming, solo managers are raising bigger funds than ever, sometimes even larger than the more established VC funds. A $50M solo fund is no longer unusual. Earlier this year, British podcaster-turned-investor Harry Stebbings raised a total of $140m for his 20VC fund, creating the biggest solo General Partner fund in Europe. In the US, some of the biggest solo GP funds are raising up to $300M. These funds have the ability to invest at any stage, from founding moment right through to growth.

    So what makes solo GPs different and why are they of increasing importance to founders? The answer is in the name. As the sole partner in the fund, they make unilateral investment decisions: No other partners, no investment committee, just them. They often equate their personal brand to the brand of the fund. Stebbings is a case in point. It's their brand that gives them access to deal flow, which would otherwise be a limiting factor. Many of these funds are created by former operators, founders that have exited and are looking to reinvest their wealth in the VC ecosystem - and strictly on their own terms. Having an operator background also delivers another advantage - founder empathy. Founders like working with other founders. That shared experience means solo GPs are often willing to accept more founder-friendly terms. The other big advantage is round speed. With no-one else to persuade, solo GPs can make rapid investment decisions. On competitive deals this can endear them to founders looking to build FOMO.

    But is the model working? Are solo GPs performing and keeping their investors - the LPs - happy? A good place to look here is AngelList. As the VC 'stack' has become disaggregated over recent years, many aspects of the investment and fund management process can now be outsourced. For example, AngelList provides investors with all the back office infrastructure they need to operate, so they can focus most of their energy on making the investment decisions. A recent AngelList study, shows the performance of solo GPs is giving traditional VC firms a real run for their money. And as solo firms place less emphasis on management fees (and thus AUM) and greater emphasis on 'carry' (their share of the ultimate valuation gain) they have greater natural alignment with their LPs. The traditional firms with large and expensive teams need big management fees to operate. If the solo GPs can deliver equally exciting returns, a bigger proportion of the LP pie will be diverted here. The writing seems to be on the wall.

2. Other pieces really worth reading this week: 

  • European Tech companies should be minting more millionaires
    "European tech companies are minting fewer millionaires than their Silicon Valley peers. It's a sign Europe's stock option culture needs to change." A timely article in Sifted by Finn Murphy of Frontline Ventures that goes to the heart of employee motivation.

  • How fractional CFOs can fast-track a startup's success
    In TechCrunch this week some great insights by Ranga Bodla, head of industry marketing for Oracle NetSuite: "Fractional CFOs are the answer for a growing number of small companies. By bringing on a part-time CFO, a startup can get the benefits of having a veteran finance leader they likely couldn’t afford or even attract at such an early stage."

  • Finding Language/Market Fit: How to Make Customers Feel Like You’ve Read Their Minds
    In the First Round Review a great article by Matt Lerner, former VC and now growth advisor: "Working backwards, every successful startup creates something that people find truly useful. If you cannot even describe what your customers are trying to do in simple language, how long will it take you to invent a product they will love? With clear validated language, you can improve every aspect of the customer experience."

Happy reading!

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