1. Insights of the week

Why pitching to VCs is the numbers game

A founder's 'insight' is the core ingredient for startup creation. The insight reveals a unique market opportunity that the founder believes they can exploit. The world's most successful VC's know that the biggest returns are often associated with insights or ideas that seem to defy conventional wisdom - what PayPal founder turned investor Peter Thiel calls a “secret” in his book, Zero to One. These are the breakthrough ideas that have the potential to create a "category winner". For a VC, these are the investments that can "return the fund", perhaps several times over. Such secrets clearly must process some special attributes, but what are they? Benchmark Capital co-founder Andy Rachleff has been a long-time exponent of perhaps the best known model. “Investment can be explained with a 2×2 matrix. On one axis you can be 'right' or 'wrong'. And on the other axis you can be 'consensus' or 'non-consensus'. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.”

In other words being right and consensus is not enough. By 'consensus' we mean that the business opportunity is already known in the market - the competitive landscape is warming up and investors have started making their moves. Some VC's will say you simply can't make any kind of return in this 'follow the crowd' scenario as the company will never make a big enough impact. The danger is that this just becomes a race to the bottom on price. VC Mike Maples of Floodgate Ventures has explained the critical importance of non-consensus: "It is extraordinarily difficult for a tiny, undercapitalised, understaffed company with zero customers and no market awareness to identify and exploit a new opportunity fast enough to leave all competitors behind. As soon as a business opportunity becomes apparent to even a small number of people, the odds begin to work against the startup...[but] being non-consensus and right affords the startup the time and runway to survive, adapt, and succeed after trial and error without fatal consequences." Of course, there are cases where a highly successful startup has not held a non-consensus view, but it's rarer than people think.

Marc Andreessen, whose VC firm a16z has invested in some of the biggest startup success stories, has put it even more dramatically: “If something is already consensus then money will have already flooded in and the profit opportunity is gone. And so by definition in venture capital, if you are doing it right, you are continuously investing in things that are non-consensus at the time of investment. And let me translate ‘non-consensus’: in sort of practical terms, it translates to crazy. You are investing in things that look like they are just nuts...It has to be something where, when people look at it, at first they say, ‘I don’t get it, I don’t understand it. I think it’s too weird, I think it’s too unusual." This is why pitching to VCs is often the numbers game. Many will not get it, or they'll think it's just too contrarian. Then, after maybe dozens of approaches - perhaps when you think all is lost - the next VC on the list will lean right into your story. Your secret will have suddenly found a believer.

[This is an abridged version of our latest blog article, which you can read here.]

European VC exit activity soars

Pitchbook data shows that total exit value across Europe shot up to a staggering €142.5 billion in 2021. This was 3x the prior record set in 2018. Tech-based companies took advantage of record valuations across Public Listings, Acquisitions and Buyouts, enabling VCs to make outsize returns to LPs. Not only did exit value blow away prior highs but the number of exit events reached a new peak of 1,241 deals, nearly double that of 2020. Acquisition transactions were in the majority by number, but it was Public Listings (which includes IPOs, direct listings, and reverse mergers with SPACs) that produced over 80% of the value realised at €117 billion, 4x bigger than the 2018 record!

Regionally, VC-backed companies in the most mature ecosystems - DACH and UK & Ireland - led the way by generating over €50 billion each, followed by Israel with €17.1 billion. The question now is what will LPs do with this rush of liquidity? It is likely that much of this will be funnelled back into VC funds rather than into public markets and the indications are already there, as we report below. Exit value began to taper off in Q4, with only €13.4 billion realised. Pitchbook's view is that "2022 may reflect a cooler exit market as highly valued companies seek out further funding from well-capitalised backers....rather than risk a premature exit, founders, board members, and investors may feel companies have more room for growth in 2022."

But founders hoping to see a broader diversity of VC funding vehicles emerge in 2022 might be disappointed. Even though funds raised by VC across Europe were up 10% YoY, almost topping the record of €22.7 billion set in 2017, fund count dropped like a stone. New funds formed in 2021 were down 31.9% on the prior year and hit the lowest level since 2013. In other words it was the bigger and more established VC firms that scooped up most of the new capital into outsize funds. This included Index Ventures, which closed a €1.7 billion growth-stage fund, Cathay Innovation Fund II closing at €649.5 million, Balderton Capital raising €519.6 million, and Accel raising €539.1 million. The result is that the median European VC fund size reached a new peak of €80.1 million in 2021—a remarkable 27.3% YoY rise.

Valuations under pressure as public markets tumble

The party seems to be over. Share prices at some of the most high profile tech companies are being dumped. After warning that its subscriber growth would slow substantially in early 2022, Netflix stock dropped 25% on Friday wiping out $55B of market cap. Zoom has fallen by around two-thirds since its peak in 2020. Twilio has been more than cut in half. As we transition into the post-pandemic era, 100's of other 'stay at home' tech stocks are down between 10% and 20% from 2020/21 highs, some a lot more. With all the tech giants set to report earnings over the next week, beginning with Microsoft on Tuesday, we will see how these companies are performing in this 'transitional' period — and whether their latest numbers can calm the markets. The big question for founders is, how will all this impact private markets as we head into 2022?

SoftBank Vision Fund CEO Rajeev Misra, in an interview this week with analyst Dan Primack, said: "If you look at multiples of [public] SaaS companies in the U.S. today, valuations have gone from 20x forward revenues down to 12X...In the private markets they're still at 20x or higher... I believe that gap is going to tighten over the next six months."  Early stage investor David Peterson of Angular Ventures has commented on how this is already impacting recruitment: "I’ve increasingly heard stories of how exceedingly high valuations are undermining company efforts to recruit senior talent. Execs look at the valuation, and the growth needed to maintain that valuation post-IPO as multiples contract, and they lose interest. Why make a risky bet when so much of the upside has already been pulled forward by the market?"

The only immediate consolation is that companies that raised at sky-high valuations are likely to be sitting on big cash piles. As private market investors, especially VCs, more cautiously assess investment opportunities, cash will have greater 'value'. For those startups with less cushion, bolstering cash runways is going to get harder whilst uncertainty reigns. Regardless of how dramatic this 'valuation reset' period turns out to be, we are headed firmly towards a more grounded assessment of investment fundamentals. Investors are going to be less likely to chase deals at almost any price. Instead they will increase basic diligence to gain stronger conviction, especially at early stage. But founders with solid investment propositions can remain confident. As Peterson says: "Only one thing matters - solving a problem for your customers. That’s it. That’s the entire game. Stay alive long enough to solve a big, meaningful, painful problem for your customers. Minute-by-minute market repricing need not distract you from this goal."

2. Other pieces really worth reading this week: 

Great Startups Deserve Great Brands— Build a Strong Foundation by Avoiding These Mistakes
Arielle Jackson is an experienced technology marketer who worked at Google and Square before focusing on early stage startups. She is currently Marketer In Residence at early stage VC, First Round Capital. In this interview with the First Round Review, Jackson outlines seven of the most common early marketing mistakes that she sees, sharing the very exercises and frameworks that she uses to help founders launch quality brands quickly.

2021 Product-Led Sales Benchmark Report
More companies today are choosing to go Product-Led than ever before, but there’s a dirty little secret most PLG newbies are learning… The best PLG companies we know and love ALL have sales teams. This report from Pocus, in partnership with First Round, is designed specifically for go-to-market (GTM) teams at PLG companies who have added a sales team or are thinking about layering in sales to accelerate revenue growth.

The Emergence of Industry 5.0: The Fifth Revolution Adds Sustainability
Nicolas Sauvage is President of TDK Ventures, a CVC that invests globally in early stage hard-tech entrepreneurs that are helping build a sustainable future. In his latest article he discusses the emergence of Industry 5.0 and how sustainability will be a driving factor. Separately, but on a related topic, The Startup Genome organisation has just published The Global Startup Ecosystem Report: Cleantech Edition that looks at challenges associated with Cleantech funding and the rise of the 'Political Entrepreneur'.

Happy reading!