Duet Partners
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Newsletter

Weekly Briefing Note for Founders

2nd September 2021

This week on the startup to scaleup journey:
  • Global VC funds overflowing with capital
  • European valuations break all records
  • Warming up investors for the next round
  • 'Inside rounds' are suddenly acceptable

1. Insights of the week

Global VC funds overflowing with capital

This week, Pitchbook reports that global venture funds raised a staggering $88.6B in 1H 2021. Analysts believe we are on course to exceed the $136.6B record set in 2018. But just as deal count is plateauing in terms of investments made by VCs into startups, so too the number of funds being raised by VCs is dropping off. To compensate, the average fund size has rocketed up to $219.8M, up 38.9% over 2020. Whilst established managers have been announcing new funds almost daily, first-time fundraising is at its lowest ebb since 2014, with only $5.7B raised across 84 inaugural funds in 1H 2021. It seems like new VCs are having just as hard a time raising their first-time rounds as founders! Limited Partners are pursuing trusted brands more than ever and are fighting to get allocation. The big VCs can almost pick and choose who they take money from. As a result, dry powder in VC coffers is currently at an all-time high of over $278B, with the vast majority of this 'overhang' from 2018/19/20 vintage funds. At the same time, as a result of the steady stream of remarkable exits over the past 18 months, a record $133B of returns were made to LPs in 2020, further fuelling their appetite to invest again.

As global markets heat up, cross-border investing is on the increase. This is not just the big multistage VC funds looking for value outside their home turf, but by new players muscling in on the VC landscape. Most notable is New York hedge fund, Tiger Global Management. According to Business Insider, Tiger Global is amongst the growing crop of "crossover" firms — investing both privately and publicly — in Tech startups. Tiger's activity in Europe has noticeably accelerated through 2021 and there are signs its jaws are widening. In the second quarter, the firm was the most active dealmaker in all venture capital globally. According to Insider's calculations, Tiger was involved in a tenth of all European startup deals by value, backing deals totalling $6 billion. This is a 17-fold increase on the $350 million total worth of deals it backed in 2020, according to figures from Dealroom. The investment giant averaged around 1.3 deals a day globally, according to figures from CB Insights. A deal a week would be considered hyperactive by most venture capitalists.

In parallel with the growth in VC funds, Corporate investment in startups is booming. Whilst corporates typically invest straight off their balance sheets and not through managed funds, they are often important co-investor partners for VCs. The health of this investor type is of great importance to key parts of the Tech ecosystem. According to CB Insights, Corporate VC-backed deals reached $78.7B in 1H 2021, a 133% year on year increase and more than the $74B raised in all of 2020 (and $59B in 2019). This was spread over a record 2,099 global deals. IPOs of CVC-backed companies maintained momentum from 2H 2020, with 120 IPOs in 1H 2021 – a nearly 3x increase from 1H 2020. Corporates have been rushing to invest in the same hot deals as the big VCs, driving up deal sizes. In 1H 2021, average deal size for a VC only deal stood at just over $30M. When CVCs were involved, the average was a remarkable $46.9M. An increasing number of these larger deals are syndicated with investors from all over the world. The major VCs, as well as CVCs, operate way beyond the geographic boundaries imposed on smaller funds. This places additional pressure on founders in cultivating overseas investor relationships, not just those close to home.

European valuations break all records

VC valuations in Europe reached record highs in 1H 2021 according to the latest research. At every financing stage, 2021 figures have exceeded those from the previous high in 2020. Despite the pandemic and the uncertain macroeconomic climate, Venture investing is on the rise as many startups show real resilience. Certain sectors such as e-commerce, cybersecurity, remote work, food delivery, online retail, business productivity and many others have boomed, driving an investing frenzy for the top deals. Early-stage startups (typically Series A and B) now possess the size and characteristics that equivalent late-stage startups did five to six years ago. For example, investment criteria previously associated with a Series B round now apply at Series A. The average valuation at Early-stage hit a record €23.8M in 1H 2021 and the average deal size was €7.8M. Interestingly, despite the deluge of capital entering the market, the median time between rounds has remained steady over recent years. For Early-stage this is still tracking at around 16 months and for Late-stage around 22 months.

As we have reported before, nontraditional investors such as PE firms, hedge funds, pension funds, sovereign wealth funds, investment banks, and corporate VC (CVC) arms, have increased their investment levels and round participation in European VC. A combination of reduced interest rates, low return profiles in other investment strategies, and public equity volatility have pushed a new wave of investors to inject capital into the VC category. VC deals with nontraditional participation hit a record €38.6 billion in 1H 2021, surpassing the record €33.6 billion from 2020. In addition to new streams of capital, startups have benefitted from fresh advice and insight from this new type of backer. As we mention above, expanding CVC activity is launching more strategic partnerships and commercial collaborations alongside investment. The presence of larger amounts of patient capital is providing R&D intensive businesses with greater scope for longer innovation cycles.

Exit valuations in 1H 2021 dramatically exceeded 2020 figures. Post-money exit valuations at the upper quartile hit €257.3 million, representing the largest increase across quartiles from 2020 figures at 152.2%. Overall exit value generated in Europe topped €46.8 billion in 1H 2021, beating the previous high of €43.1 billion in 2018, with six months of 2021 remaining! The huge reduction in exit events during the pandemic produced pent-up demand. As certain companies benefitted from these unusual market conditions, they pushed ahead with exits amid reduced competition. IPOs rather than M&A have driven the astonishing rise in exit valuations, despite some volatility in public equity markets. The big Tech companies have fared very well during this period, pulling behind them numerous Tech-based VC-backed companies to exit with record valuations. Strong returns are now fuelling new cycles of investment as LPs reinvest capital for further growth.

Warming up investors for the next round

One of the first things successful founders do after closing a round is to create a target list of investors for the next. Why is this important? The best time to start developing investor relationships is when you don't need to. You're not asking them to make an investment decision at this stage, just to start monitoring the company. This is how the journey often begins. It's low pressure and can pay real dividends - even if they never invest. The biggest benefit is that they help you understand the criteria that investors will likely use to judge your business later. Without an imminent deal they will typically be far more candid about what they really care about. Setting out your key milestones is a great way of soliciting feedback and many will be happy to tell you if you are headed in the right direction - or not. This also creates trust. If you are open about your goals and show a willingness to listen and perhaps adapt, this fosters goodwill. Then you have the platform to keep an investor updated on your progress towards these goals. This gives you the perfect excuse to keep in regular contact over the coming months.

The reality for many founders is that this level of effort so early in the cycle can seem like an unnecessary burden. It certainly is if you are attempting to do this with the entire target list. The trick is to whittle this down from say 100+ on the long list, to a select few that are the best fit. If you are maintaining a dialogue with 5-10 that could possible lead the next round, this should be manageable. If you use a monthly newsletter with a summary of progress this can really help take the strain. A regular flow of news helps with mindshare and is a demonstration of confidence in your ability to make progress. It provides talking points for personal meetings and calls. The objective is to navigate your way to the official start of the campaign with a cadre of top investors that are nicely warmed up. They will all know the fundraise is approaching and it will feel much more like a natural milestone rather than a surprise. On the day, your investor pitch will be more understandable and you will have an informed audience.

The secret objective is of course to never launch an official campaign as such. We are in an era of pre-emptive rounds, where the big funds are stalking emerging scaleups with promising futures. In this scenario, the round never actually reaches the 'market', with lead investors moving early and often syndicating with trusted funding partners. They already know the company, have themselves become part of the narrative, and have made the emotional buying decision at a much earlier stage. As the market heats up even further, astute founders are front loading the effort like this, before running short and efficient campaigns 'off market'. This reduces the formal part of the exercise to weeks rather than months, a phenomena we have already been witnessing in the US market for the past year.

'Inside rounds' are suddenly acceptable

Until quite recently, every new funding round required a new lead investor. Incumbent investors, as well as the wider market, would see this as a sign of validation. Not only would a fresh pair of eyes bring real objectivity in assessing the proposition, but would legitimise the valuation. Existing investors could then confidently mark their books up on the back of this true market price. A new fund at the table would also spread the risk, as well as being another source of follow-on capital as the company grew. The market would see such an externally led round as a sign of strength, versus an internally led that would be seen a sign of weakness. But the market is changing. As fund sizes break all records and multistage VC firms become ever more common, the rule book is being rewritten. The big VCs now have the means to double down on portfolio companies that are taking off. As VC Hunter Walk says, these are "offensive rounds not defensive ones".  As outlier returns look more and more certain there is simply less willingness for the big incumbent VC to share the pot. In turn, founders benefit as a formal funding campaign is not required. Inside rounds are so much simpler.

Multistage funds have a particular advantage. International VC firms like Accel, Balderton, Index, Octopus and many others, have individual funds targeted at different stages. Some will operate Seed and Early Stage (Series A, B)  funds, others Early Stage and Growth. Some of the big global operators like Sequoia and a16z now operate across all stages. Just this week, leading global VC Andreessen Horowitz ('a16z') announced a new $400M seed fund, adding to its portfolio of specialist and generalist funds. Each fund will usually have a different General Partner and will operate in a quasi autonomous fashion. As portfolio companies progress, they can take Seed investment from one fund, early stage investment from another, and growth investment from yet another - all under the same roof. This 'hand-off' ensures the risk/reward profile of each company fits the mandate of each fund. The new challenge for founders is understanding this progression, which is not always explained well by VC firms. Term Sheets may only state the name of the VC that is investing, but founders must be very clear on which fund the money is coming from on each occasion.

An associated complexity of working with a multistage firm is how they handle competitive portfolio companies. Historically, as single fund operating vehicles, VCs generally adopted a 'no competition' policy. If they invested in your business they wouldn't invest in a competitor. Whilst this has always been a grey area with many caveats, it now inevitably changes. It becomes increasingly likely that a single VC firm may have broadly competitive companies spread across their different funds. As Walk says, "They will make the case (often credibly) that these companies will be indirect, not direct, competitors, and that there will likely be different GPs working on each deal. This approach will allow GPs in different vehicles to not have their performance handicapped by their partnership." Founders must be tuned into this possibility and if they have the leverage to influence a VC's position, they should use it. The most compelling case a founder can make is to ensure the GPs see you as the winning investment in that space. If they buy into this, the less likely they will be to compete with you.

2. Other pieces really worth reading this week: 

Finding Billion Dollar Secrets
"If you aspire to do something truly legendary, in business or any other field, you will discover that the biggest breakthroughs come from obsessively pursuing insights that defy conventional wisdom." Some great insights for founders in this timeless article from VC investor, Mike Maples Jnr. 

Rise of Scout Programs Across Venture Capital
"If you’re at all familiar with the venture capital industry, you know it can be hard for VC’s to maintain hyper-awareness of the early-stage startup scene. By the time a promising startup has come on the radar, chances are that they have already received funding and closed a substantive round. So how does a VC stay at the top of their game? Enter venture scouts." A great primer - from US law firm Maynard Cooper & Gale - on scout programs, an increasingly popular way for VCs to build deal pipeline.

“Get Off the Floor” and Other Career Advice..
An insightful interview with Nick Caldwell, VP Engineering at Twitter, that covers the many aspects of leadership within a startup. "It’s an incredibly wide-reaching set of frameworks and although Caldwell’s bread and butter is engineering leadership, there’s plenty to sink your teeth into for managers all over the org chart."

Happy reading!

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