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Weekly Briefing Note for Founders

2nd December 2021

This week on the startup to scaleup journey:
  • How to avoid being fired as CEO
  • How long can this VC investment boom last?
  • VCs are adding 'green' clauses to Term Sheets

1. Insights of the week

How to avoid being fired as CEO

As early scaling begins, a founder's focus shifts from running experiments to building a company. Investors begin to plough in larger amounts of money to drive growth. There is more at stake. Scrutiny increases, led by the Board. Often, founder/CEOs that have been used to the collegiate atmosphere of the startup board, mistakenly think that the board's role is to continue to support them as founders. VCs in particular will push the line that they are on your board to provide such guidance - part of the value-add they bring as experienced investors. This may be the case in the very early stages, but changes as the company develops. In VC Jerry Neumann's forthright blog on the subject he says: "The VCs are not on your board so they can help you, they can help you without being on the board. They are on your board for one reason: to monitor their investment so they can do something if things aren’t going how they want." In the limit this means changing the CEO. In this context, founders navigating this transition to growth have to retune their senses on what expectations the Board and, more specifically, its investor directors now have. These all centre on increasing the value of their investment. As the CEO you must deliver this. That was the implicit deal you made when you took their money.

It is not unusual for a founder to transition out of the CEO role as the business grows. Not all founders see themselves as a corporate chieftains: Very different skills are required to that of the startup entrepreneur and the burdensome responsibilities are not for everyone. Founders that get ahead of the game and manage this process can create orderly transitions under their own terms. But often the process is not so smooth. Boards may have to do some pushing. If this doesn't work, a CEO may ultimately be forced out. Founder/CEOs that envision an unending tenure must steer the ship accordingly and learn fast. There is much advice out there on this topic and one of the best reads is Startup Boards by Brad Feld and Mahendra Ramsinghani. Neuman adds to this by offering several pieces of advice that strongly resonate with our own experience. The first of these is to be the 'hub of the board'. This means being involved in any and all discussions between the directors on company problems and performance. The most reliable way of ensuring this is to have regular 1:1 discussions with each of them. Be open to feedback and criticism. Take it and deal with it, then provide feedback to that director. By being proactive in a more private setting you avoid others piling in and escalating the drama.

The other golden rule is 'no surprises'. As Neuman says: "The board meeting is not the place to convey important information for the first time. First off, they need to hear important information quickly and board meetings are, at most, once a month. Second, responses to bad news can be all over the place. You don’t want board members over-reacting to bad news (or good news) in front of other board members."  If you have news, tell your board members soon afterwards, once you have gathered your thoughts. Tell them individually, put forward your recommendations, and then listen to what they have to say. If they want to blow up then this will be more of a controlled explosion than it might be in the boardroom. At the Board you can then communicate exactly the same news but now with a considered plan that the directors have already been party to. Don't forget 'no surprises' works both ways. If you have done your homework beforehand you will know how each board member is going to react to each issue in advance. In this way you will stay in charge of the 'agenda' - and dramatically reduce the chances of becoming the agenda.

How long can this VC investment boom last?

Through 2021 we've been witnessing record amounts of venture capital being deployed. This is being driven by record investment returns for the VC asset class on the back of record valuations. The question every founder is now asking is how long can this last? How long can VCs keep pumping ever larger amounts of capital into startups? Well, the answer doesn't seem to be anytime soon. VC fundraising activity - the money that they raise from their LPs - is tanking along. As reported this week by Pitchbook, global VC fundraising reached a remarkable $158.8 billion across 860 venture funds through Q3 2021. At the current pace, capital raised within VC funds in 2021 is on course to surpass the record set in 2019. At the European level, the overall pattern is similar. Although much smaller in scale, European VC funds are expected to raise around €20B by year end, matching 2019.

But whilst fund sizes have been soaring upwards, the number of funds has not been keeping up. As a result, through Q3 2021, the median VC fund size set a new global high of $71.6 million, 25.0% larger than 2020’s record. Established managers with strong track records have taken the lion's share of the commitments, with first-time funds fighting hard to establish momentum. Across Europe, even though capital raised is jumping, only 128 venture funds had closed through the end of Q3. If the current pace continues, we could see the lowest annual European fund count since 2013. Echoes here of the challenge founders face in closing first-time institutional rounds, down at their lowest level since 2014. This points to a picture of increasing capital concentration, both within funds and startups alike. Just as funds are competing to invest in the hottest startups, so too LPs are competing to push money into the hottest fund managers. If the deal in either category isn't considered really 'hot' - in other words, lots of FOMO - then little interest is likely to be shown.

As more enormous funds closed in Q3, there is a record amount of dry powder in VC coffers. Globally, this currently stands at $443B. A vast proportion of this 'overhang' sits in 2019/20/21 vintage funds, still within their most active investing periods. VC assets under management (AUM) also hit a record $2.1T in Q3. The appetite of LPs to commit to VC funds seems insatiable and there is no sign of any let up. Provided the returns being generated in VC stay ahead of other asset classes, the window of record-setting investment levels remains open. Founders must now pay increasing attention to fund size when identifying prospective investors. Some funds are now so big that to hit their return targets they will only invest in prospective unicorns. If these investors can't see a clear pathway to a multi-$B valuation at exit, they are going to turn away, no matter how innovative or disruptive the proposition is. To attract the top funds, a founder must be able to paint a picture of a market that is going to be measured in the $10B's in the future.

VCs are adding 'green' clauses to Term Sheets

Entrepreneurs seeking deals with European venture capitalists are increasingly being asked to implement a 'climate policy' as a condition of investing. As reported recently by Business Insider, early Spotify and Klarna backer Northzone, Depop investors HV Capital, and Global Founders Capital, whose portfolio includes Revolut and Slack, are among those that have introduced a so-called sustainability clause within term sheets and shareholder agreements. Whilst many startups are increasingly climate-conscious, some say this is just VC 'virtue signalling' and are pushing back on the extra admin required. But it looks like this is a movement that is only headed in one direction. Other VCs known to be recently asking for startups to minimise their environmental footprint are 2150 Ventures, Earlybird VC and Draper Esprit (now Molten Ventures). As the list expands, founders are starting to pay much closer attention to this topic.

One of the chief protagonists is Leaders for Climate Action (LCA), a non-profit that promises to turn business leaders into climate leaders. The organisation, which has 1,550 members from the startup ecosystem, aims to make the tech sector climate neutral. The non-profit has developed a sustainability clause that investors can plug into their term sheets to help make their portfolios greener. This requires climate policies to be introduced "as soon as feasible but no later than within 12 months" of the deal being made. It also urges companies to consider energy efficiency, travel, food and drink, waste, and the use of technology. The main aim is for companies to build a sustainable business model. Some investors, such as Early Bird VC and Molten Ventures, have developed their own wording. The Early Bird clause states that carbon reduction should form an "integral part" of the startup's strategy, to be implemented within 6 months of investment, a tighter timescale than that proposed by LCA.

The business case for sustainability is not new. Research from Harvard Business School in 2016, showed firms with good ESG ratings significantly outperform firms with poor ratings. The difference now is where once the focus was only on established companies, it is clearly shifting down into the startup environment. As the momentum grows, VCs that have been on the sidelines are feeling under increasing pressure to incorporate an ESG clause in their terms. If they don't, they worry that their own investors, the LPs, may shift allegiances. Those in the vanguard are constantly raising the bar. For example, Earlybird VC now requires each portfolio company to nominate a 'chief climate officer' to spearhead the company's efforts. They argue that climate policy is part of everything, from finance and risk to company culture and values. Startups may have little environmental impact on day one, but investors increasingly want their portfolio companies to have a positive impact on the world of tomorrow.

2. Other pieces really worth reading this week: 

GenZ will make VC more entrepreneurial
A thought-provoking column in Sifted this week by Nicolas Colin. "Generation Z will help accelerate diversity in the industry as the old rules of society and entrepreneurship are redrawn."

So Your VC Wants To Invest More? 
Some practical tips from VC Amit Garg on the basics of how existing investors can participate in new rounds. "If your VC wants to invest more in you then you have a good problem in your hands. Here are five practical ways to think about it."

Are You Ready to Serve on a Board?
Great insights from this article in HBR: "To better understand what makes a director successful today, we conducted interviews with more than 50 board members representing some of the world’s leading companies. We found that boardroom capital is built on five different types of intelligence: financial, strategic, relational, role and cultural. The categories might not surprise you, but it is important to understand why all are necessary and to think about how to improve in each area."

Happy reading!

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