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


Weekly Briefing Note for Founders

2nd June 2022

This week on the startup to scaleup journey:
  • 'Adapting to Endure' - the new reality for founders
  • Investors apply greater scrutiny to startup growth plans
  • VCs and founders don't see eye to eye on value-add

'Adapting to Endure' - the new reality for founders

The big topic of concern for founders right now is how the funding outlook is changing for startups. Reports from the US market make sobering reading. Sequoia's latest memo, Adapting to Endure, provides one of the the best overviews of market conditions, both at the macro level and within VC. The big takeaway is that the velocity of capital being deployed by VCs is slowing as caution takes hold. Why? The money supply into VC is now becoming heavily constrained. As public markets have repriced down heavily, way beyond the correction in private markets, Limited Partners (LPs) in VC funds are suddenly finding that VC assets represent a much higher percentage share of their portfolio than anticipated. This starts to break their holding allocation rules, so they are being forced to defer further venture investments. In the US, some are even asking VCs not to make capital calls on funds already committed. The same goes for 'crossover funds', such as hedge funds, that have been unusually active in direct investing in startups over the past couple of years. Many now simply don't have the scope to invest any further - at least for now.

It's easy to think that startups that have raised big rounds on cheap money in recent times may have escaped the trauma ahead. Ironically, startups that are still in the early stages and haven't raised over the last 18 months or so may have an unexpected advantage. With less capital to deploy, they will have maintained their sharp operating edge out of necessity. As a result they will be more mentally aligned with tightening market conditions. Cheap money may have lured many of their peers into a false sense of security, perhaps building out teams ahead of sustained demand. As a result, burn rates will have been pushed up and now need to be adjusted. They must quickly figure out how to grow back into their inflated valuations. Easier said than done. Those that have yet to raise won't be facing these pressures. Instead of now focussing on cutting - with all the negative implications that this brings - they can focus on growth. Of course, capital investment hasn't disappeared, it's just going to take longer and be more expensive. We are now firmly in a period where solid, consistent growth and improving margins will be prized above all else. 'Growth at all costs' is dead. 'Default alive' is the new mantra.

Sequoia's memo sets out strategies for uncertain times, with a call to arms that echos Paul Graham's mantra: "We believe that the one who wins is the one most prepared."  To boost founder motivation there is a positive reminder that "people (customers) buy regardless of market conditions" provided that you are either helping them drive growth, saving them money, or reducing risk. Market conditions now provide an opportunity to tighten up the value proposition with a focus on solving real and pressing problems. There are other opportunities emerging. One of these is recruitment, as this is about to get easier. Big Tech and many later stage startups already have hiring freezes. Stock options for those hired in recent years are now almost certainly under water. For those yet to raise, stock options suddenly have much greater recruiting power. Now could be the perfect time to pull in a top notch candidate whose exit hopes may have been dashed elsewhere. As the memo ends: "..we believe the best, most ambitious, most determined of you will use this moment to rise to the occasion and build something truly remarkable."

Investors apply greater scrutiny to startup growth plans

As the venture funding outlook weakens, investment criteria at every stage are getting tougher. Investor discussions are now less about demonstrating progress made and more about the plan for delivering the next phase. As a founder, this doesn't just mean setting out WHAT you will do, but HOW you will do it. This is becoming especially critical at Series A: it's no longer enough to convince an investor you have nailed product/market fit - you must also articulate a compelling growth plan to take the business to the next level. Broad concepts based on simple assumptions aren't enough. Why? The post Series A period is a moment of real discontinuity. The business is shifting from the 'experimentation' phase to the 'company-building' phase and this transition always carries risk. If a Series A investor doesn't buy into your go to market plan - the engine that will enable early scaling  - they won't have confidence that you'll be able to attract a Series B investor 12-18 months down the line. If that becomes a serious concern, they will likely step back.

Delivering a growth plan often relies upon establishing a 'growth team'. This is either a cross-functional alliance or, more often, a dedicated unit. The team takes the go-to-market motion that has started to bear fruit and drives this to a higher level. In consumer internet, often thought of as the pioneer of dedicated growth teams, investors will probe on the key attributes. Is this a 'full stack' team incorporating product managers, data science analysts, designers, developers and channel marketeers? What is the lead metric they will be driving? Whilst customer acquisition is still important, retention is now becoming the hot KPI for product/market fit. This gives rise to further questions, such as: What is the plan to lift retention from x to y? What initiatives will focus on 'marginal users'? So much about early growth is counter-intuitive that founders who appear vague on the key metrics or the analytics they will use to track different user cohorts, will only drive up investor anxiety. For further insights on this topic listen to this recent interview with Assana's former CRO, Oliver Jay.

In the enterprise space, the 'cross-functional growth team' may simply be the entire org. With larger, less frequent transactions, this is usually less about optimising KPIs and more about building customer relationships. Again, this is a critical point of transition: Sales that have been CEO/founder-led should now be moving to campaigns led by the sales team. Similarly, where early commercial traction was product-led (in a self-serve online model) the shift may now be to big corporate transactions. The first 'sales playbook' for each scenario is the responsibility of the founder. This is the operating manual that captures each engagement approach. But while the operating premise for any model might appear straightforward, it's often the nuances that make these transitions fail. Even though many investors have never been operators, they are tuned into identifying such weak-spots, just through simple pattern recognition. Founders must leverage every source of insight and expertise to build these playbooks so they withstand scrutiny. Done well, they bring credibility to the growth plan and give investors confidence that you are truly ready to step up to the next level.

VCs and founders don't see eye to eye on value-add

In research undertaken by European VC firm Creandum, 98 VCs and 121 founders were surveyed on the topic of VC value-add. Respondents covered every financing stage and institutional investors with $30M to $2B in assets under management. As expected, the differences between how founders perceive this relationship was different than for VCs. Founders reported less frequent contacts, less operational support received than VCs reported giving, and — perhaps most revealingly -  quite different priorities. One of the starkest contrasts was the way each group scored how impactful and helpful the VC had been for portfolio companies on a scale of 1 to 10. The average VC scored themselves a 7 while founders perceived them as a 5.3 — a 32% difference. On a positive note, the study showed founders and VCs both reported personal relationship and chemistry with the counterpart as the single most important decision-making factor. This supports the theory that startup financing is a relationship business.

In the same vein, our anecdotal insights suggest that most founders would prefer the VC partner to have operational experience. Someone who has lived the startup journey and has true empathy with the founder's lot. But this requirement is a tough one to meet. In the UK, just 8% of investors have experienced first hand what it’s like to work in a startup, according to the DiversityinVC Report. Instead, venture professionals typically have prior experience in consulting (20%), general finance (18%) or investment banking (12%). This contrasts with top-tier venture capital firms in the US, where 60% of investors have experience working at - or running - a startup. Partners that have a finance rather than operational background will be more likely to fixate first on the numbers, such as revenues and other key metrics. Former operators generally have more sensitivity to 'stage', so their initial focus for support will be the journey to product/market fit, then the go to market plan. When all this is working, the numbers will receive greater attention.

In related research undertaken for the State of European Tech Report 2021, the biggest differences between the VC and founder cohorts related to having an alignment of vision. This was ranked number 1 by founders (55%) but 6th (20%) by VCs. This is surprising given that personal relationship and chemistry was again rated very highly by both cohorts: Building a strong relationship is hard if the importance of a shared vision is not seen to be valued equally. But the most telling insight from this later study refers directly to the importance of value-added services and capabilities in relation to what VCs think it takes to win an investment deal. This was ranked 4th by VCs (23%) but 9th (last place) with founders (4%). The evidence suggests that offering such services may be more of a tactic by VCs to differentiate themselves in a competitive market. But founders simply aren't convinced that such services make a real difference. In associated research by Landscape (a platform for anonymous VC and investor reviews) in the same report, the two stand out pain points for founders were (lack of) professionalism and (slow) response time, providing a call to action for VCs to ensure swift and constructive feedback following the initial approach by a founder.

Happy reading!

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