Duet Partners
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Weekly Briefing Note for Founders

29th April 2021

This week on the startup to scaleup journey:
  • The outlook for 2021 in VC
  • Big valuations limit future options
  • Not all Corporate Venture Capital is equal
  • Did you pick the wrong VP Sales?

1. Insights of the week

The outlook for 2021 in VC

2020 was a record year in VC. KPMG's European VC report describes a venture capital scene at its peak. In 4Q 2020, $14.3B was invested across Europe in 1,192 deals. But this deal count was the lowest on record since the high of 2,200 deals in 1Q 2019. Analysis by TechCrunch shows that Growth stage deals have taken an increasing share of the pie: The median size of a Series B rose from $10 million in 2016 to $20 million in 2020. Series C rounds were similar, rising from $20.6 million in 2016 to $43.6 million in 2020, on a median basis. Looking at Silicon Valley Bank's (SVB) most recent markets' report, its obvious why deal sizes are ballooning and that's because fund sizes are surging. In 2019, $103B was raised globally by VC. In 2020, when many expected this number to fall, it actually rose to $127B.

The major economic drivers of low interest rates combined with the several big tech trends, such as the acceleration of corporate digital transformation, indicates continued growth in VC. Indeed SVB expects VC fundraising to reach new records in 2021. And it anticipates that late-stage valuations will grow further this year as well. Early stage businesses, those undertaking Seed and Series A rounds, will need to deftly construct their funding plans to stand out from the crowd. As fund sizes surge, so do their expectations. And with first time financings in continuous decline since 2014, those startups in the transition from private to institutional finance will need stellar propositions to compete.  As KPMG observes "In recent months, a number of startups pulled back on funding rounds given concerns over valuations and access to potential funds — instead looking to shorter-term interim funding to keep them afloat and push their need for larger raises down the road."

This KPMG analysis closely echos our own observations. We heard of so many cases in 2020 where early stage campaigns just petered out. Those startups with a strong roster of Angel investors on the cap table were able to partially rebuild balance sheets to go again when the investment proposition becomes more advanced. But for many others it has sadly been the end of the line. The irony is that Investors are keenly aware that the best companies are often formed in downturns. The rise in both the number and size of new funds raised during a turbulent 2020, confirms that Limited Partners feel the same. 136 new funds were established across Europe in 2020 (130 in 2019) with $17.7B raised ($15.5B in 2019). Whilst some Seed/Series A funds have been heavily oversubscribed, forcing them to seek more mature propositions, a number have intentionally capped their fund sizes so they can remain true to their original early stage remit. We really respect that and hope it continues.

Big valuations limit future options

As the venture market breaks records in capital deployed, the competition for the best deals is becoming more intense. VCs are in the hunt for the big outliers - the ones that will break the $1B valuation exit threshold and be able to return the entire fund. 26 new unicorns have been minted globally this month alone, according to Pitchbook. In the frenzy, valuations continue to rise to support the ever larger cheques that are being written. But this comes at a cost, as expectations of future returns climb ever higher to support the ROI multiples required. This places an ever greater burden on founders to drive rapid and sometimes unrealistic growth.

In a recent post on valuation trends, Finn Murphy of Frontline VC comments: "..raising at higher valuations in the current environment closes more doors than it opens — only push for this if you’re happy reducing your optionality to increase your potential rewards. If you’re a first-time founder, raising smaller amounts of capital at lower valuations gives you a margin for error to make mistakes as you learn along the way." There is a lot of sense in this, especially prior to Series A when the business model is not yet proven. Running a really tight ship on costs is vital, as unforeseen expenses often occur when navigating the twisty road to product/market fit. Once scaling begins you can then let the brakes off.

Until investors are chasing you to participate in the next round - when you are more in the driving seat on valuation - you need to maintain optionality. i.e be as attractive to as many funds as possible. Understanding how VCs make money is vital as you set expectations with current stakeholders for each round. This means taking a milestone-based approach to funding, raising what you need (plus contingency) to get there, and ensuring you can give investors what they need (usually between 15% and 30% of the shares at each major round) to justify their participation. Having too big an expectation on valuation in the early stages will limit your options to a smaller cohort of bigger funds, which could easily work against you if one doesn't step forward quickly.

Not all Corporate Venture Capital is equal

European VC deals with Corporate VC (CVC) participation shot up to €19.4B in value in 2020, from the previous record of €15.6B the year before. This trend is expected to continue through 2021, according to Pitchbook. Corporates will look to leverage synergies with startups and stay ahead of competitors to ensure future revenues remain healthy. CVCs have also targeted specialist startups to 'outsource' R&D efforts, as it has proven more cost-effective than setting up new internal research business units. Such collaboration can pay huge dividends to all parties. However, founders engaging with corporate investors must navigate the process with great care as looks can be deceiving. Many established CVC teams who are experienced in the art of VC dealmaking will operate much like their VC counterparts, even though their underlying motivations may be different. But corporate investors that don't operate within a 'VC-like' operating structure have the potential to severely disrupt the funding process.

In many corporations, minority investments still come under the purview of the M&A department, rather than a dedicated CVC team. In Scott Lenet's article into the CVC investment environment, he comments; "As a result, it’s natural to view investing and acquisitions as part of a continuum that ranges from partial control to full control. I believe there’s some validity to this thinking." But, as Lenet says, VC investing is very different from M&A. The sourcing and diligence activities vary, transaction terms are deceptively different, and the post-deal management of an investment is very different from what happens following an acquisition. These minority investment campaigns run by M&A departments can appear clumsy, even aggressive. M&A execs often operate with the mindset of an acquirer, forcing unnecessarily rigorous due diligence and investment terms that look to assert too much control. The classic one being right of first refusal, otherwise known as the 'kiss of death' for a startup.

To protect against such risks, founders must first establish what 'category' of corporate investor they are dealing with. When compiling the investor target list, any that do not fit the established CVC model should be clearly identified as they will need special attention. They will require greater attentiveness through the due diligence process, which will be much more technically weighted. Second, the power of syndicating can really pay dividends here: If the lead investor is an experienced VC that knows how to rally the other co-investors behind a 'sensible' term sheet, much of the commercial job will be done for you. Often the VC's lawyers will be much more founder-friendly and au fait with the Venture investment process, which can be another big plus. In return, the corporate's evaluation of the product can often (and even unwittingly) act as a proxy for the normal technical due diligence step, which may no longer be needed.

Did you pick the wrong VP Sales? 

Bringing in the right VP Sales provides a rocket booster for revenues. But bringing in the wrong candidate can send everything backwards, severely damaging the prospects for growth. This is one of the most critical hires in any startup. Founders that don't have a commercial background may struggle to properly define and time the role, and that's where the problem can sometimes start. In the very early stages when the product is evolving, 'selling' is done by the founders or a Business Development (BD) person. When the product is ready for broader adoption and the business is starting to scale, then it's time for a VP Sales. In short, BD sells what you don't have, Sales sells what you have - in volume. Two very different skill sets.

The clear signs of a VP Sales mis-hire are well documented: They won't commit to a number or take real ownership / Can't meet deadlines or forecasts / Don't understand (or agree with) their mission / Can't open customer doors at the top level / Become too defensive about their poor performers. But perhaps the biggest sign that something isn't right is they can't hire anyone great in the first 2-3 months. Top sales leaders build a following, and their followers want to work for them. You can sense this happening right from day one. The new sales leader sets the expectations on hiring a great sales team with the founder(s) even before they join. 'Scaling everything' is in their DNA. They're lining up the names for each new box on the sales org chart well in advance. They quickly develop and optimise the sales process for growth, and know how to adapt this when international expansion starts.

The other key litmus test for success is the working relationship with Marketing and Engineering. If these channels are starting to break down quickly then you have real problems ahead. Successful sales leaders know how to get the organisation to 'bend' to give them what they need to drive revenues - and feel good doing so. They are great persuaders and know how to quickly build credibility, not just with customers but internally as well. Bullies may get some of their way early on, but it doesn't last. Things break. Everyone then has their name on a bullet and then it's just a question of time. But time is a killer in a startup and founders don't need a big HR distraction when they have so many other worries. If the wrong hiring decision has been made then founders shouldn't lose a moment correcting it. The long term impact of inaction will be 10x worse than the short term hit.

2. Other pieces really worth reading this week: 

How hedge funds are leading the race to stake startups
Pitchbook reports on the frothy state of the US VC market where traditional VC firms are being significantly outbid by hedge funds and other crossover investors looking to play in the red-hot venture capital market. "These investors' strategy for getting into promising startups is to knock out all competition by offering terms most traditional VC firms cannot match. "It is not like there are bidding wars. They are changing dynamics of the rounds altogether."

Why Chief of Staff will be a critical scaleup role
From the pen of Paul Smith, previously Co-founder & CEO at Ricochet AI, Entrepreneur-in-Residence @ Techstars & Ignite. "In late seed and Series A teams, everything is on fire...What’s needed is an experienced generalist who can support the CEO and leadership team, complement and deputise for them, roll up their sleeves and lead on short-term projects across the business as and when required."

How Logz.io Took Self-Service from 0 to 50% of New Customers
From the OpenView blog, some great pointers on product led growth: "At the end of 2019, Logz.io launched their first self-service offering with only two engineers and a completely manual back-end process. They’ve since scaled up their product-led motion and now a whopping 50% of their new customers come in via the self-service channel. On top of that, about 10% of their self-service signups become enterprise opportunities."

Superfounders: What Data Reveals About Billion-Dollar Startups  Ali Tamaseb has spent thousands of hours manually amassing what may be the largest dataset ever collected on startups, comparing billion-dollar startups with those that failed to become one—30,000 data points on nearly every factor: number of competitors, market size, the founder’s age, his or her university’s ranking, quality of investors, fundraising time, and many, many more. His new book Superfounders is out soon and will be an eye-opener for investors.

Happy reading!

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