Weekly Briefing Note for Founders

30th September 2021

This week on the startup to scaleup journey:
  • When founders trip up on the competition question
  • The arms race in seed funding
  • When to hire a growth leader
  • The growing importance of ESG risk factors

1. Insights of the week

When founders trip up on the competition question

It's the email you weren't expecting - and you immediately get that sinking feeling. The pitch and the follow-up session had gone well. The investor had registered strong interest and had already assigned some resources to taking a closer look. Now, after a few days of initial due diligence, an Associate has sent you a question: "Please comment on these three companies that seem to be competitive. They didn't come up in our earlier discussions." You don't recognise any of the names, but on closer inspection it looks like they could be emerging threats. How did you miss them? How are you going to respond? Over the past 10-15 years the world has become a much smaller place. Back then if you had a UK startup and discovered a potential competitor in Chicago, you didn't sweat too much. Where you were based played a big part in where you would find your customers. You could still attract top-tier VCs based on a European business plan. Now, that emerging threat in Chicago is real. A few minutes on their website and a customer can be up and running with their SaaS product, wherever in the world they are.

During investment preparation, a 'peer group' analysis is an essential checklist item. This is aimed at flushing out any potential threats that may have not been picked up earlier. This is often revealing, but not always for the reasons founders may expect. The threat level is not just based on the competitor's value proposition, but on who the backers are. Emerging startups that may seem to be further behind may have just received an outsized investment from a big US VC, and you must be across this. Money isn't everything, but if your prospective investor sees that Sequoia or Andreessen Horowitz has just written a $10M Seed cheque for this company, this will give them pause for thought to say the least. Of course, you can't change these facts, but you can get ahead of them. If you are building a startup that aims to be a category leader, an in-depth understanding of the competitive landscape at a global level is now vital. Critically, in the run up to funding, this means assessing these emerging threats through the lens of an investor. How well funded are they? Who are the investors? How do you position against them if they are accelerating this fast?

The reality is that few value propositions are truly unique. Competitors of one sort or another will be offering alternatives if the market opportunity is that exciting. But the golden rule is not to be caught flat-footed by investors. Showing lack of awareness here could be a deal breaker. A competitive analysis is always a crucial item for the data room. Refreshing this as early as possible during investment preparation will give the founder the maximum amount of time to formulate positioning. It also shows thoroughness, operational rigour, and above all, confidence. "We can see the full competitive landscape and this doesn't change our view about the amazing proposition we are creating." Added to which, an understanding of what criteria competitors are hitting to secure investment at the key stages - Seed, Series A, B - will give you the edge to make sure your investment proposition is well aligned with investor expectations.

The arms race in seed funding

Not often do we comment on specific funds, but this week there is really no choice. Greylock's announcement of a new $500M seed fund has caused a huge stir in the industry. This is the largest pool of venture capital dedicated to backing founders at day one. The sheer scale of this fund, coming not long after a16z's $400M seed fund, Index's $200M seed fund, and Sequoia's $195M seed fund, has sent shockwaves through the global VC community. As Biz Carson commented in his Protocol blog, "The big impetus for Greylock was the new speed with which deals were getting done and the number of interesting opportunities at the seed stage."  This gives Greylock the ability to write a $20M cheque for a seed deal, changing the game at early stage, to which Carson says: "There's a question whether these funds are playing offense or defense. Offense: Snap up larger stakes in the best startups earlier. Defense: Don't let the Tigers of the world eat their lunch in later stages. The answer: Both, as VCs get sandwiched."

The Greylock move signals a structural shift in VC that has been emerging through 2020/21. Gale Wilkinson of Vitalize says the seed industry will bifurcate and that "we're going to naturally have a falling out into two camps. The first: multistage firms raising the giant seed funds. The result for founders will be more money at higher valuations with more resources. The flipside: The potential for signaling risk if one of the firms doesn't double down on the company. Plus there's a fear companies can take on too much funding. The second camp will be specialized seed firms with strong brands that founders want to work with. They admittedly have fewer resources and can't go lead a Series F down the line, but founders are choosing to work with specialists in the early days to get companies off the ground, before turning to multistage funds to pour fuel on the fire." Others agree that for VCs caught in the middle and not able to strongly position at either extreme, there will be problems.

Why should European founders care about this? These big multistage funds are mostly US based, so what impact will this have here? First, these funds are not just investing in the US but across Europe too. For example, Greylock has invested in 26 UK companies alone over the past 9 years, according to Pitchbook. Index is well known as one of the most active VCs in Europe, especially the UK. Indigenous VCs are undoubtedly feeling threatened by these announcements and, where they can, are moving to sharpen their support offerings. Greylock is proactively positioning to counter this by saying, "We are active company-builders at the seed stage. Our specialist teams support portfolio companies with their first hires, first customers, and first press — not with “advice” but with action."  Whatever the reality, this is good news for founders. With greater choice and more competition amongst VCs for the best deals, the balance of power is shifting in the right direction.

When to hire a growth leader

For founders, the journey to product/market fit is all-consuming. With limited budget and a small team, the intensity of the customer development process can be exhausting and stressful. But when the dials start to flick to the right as initial demand accelerates beyond the early adopters, the world changes. You can see the open road ahead. Few founders experience this spine-tingling moment - most startups never find product/market fit. For the brave and lucky few, refuelling with a Series A round to start the real scaling process is often the next step. Investors are lining up to supercharge businesses that are ready for growth. First-time founders will often take this as the signal to boost headcount. Growth teams are all the rage, so there is impatience to bring in an experienced growth leader - an expert that can drive demand creation through the plethora of online channels that now exist. But the heavy hitters won't come yet. They will need more convincing.

Experienced founders know they must be patient in hiring the growth leader - that moment to fully open the throttle is still a few steps away, even with the Series A cash in the bank. The analytics dashboard is starting to splutter into life as data gradually flows in. The team is starting to track an increasing number of KPIs around demand creation effectiveness, user growth, retention and other key metrics. Navigating this period of initial scaling is the first time the go to market strategy has been properly stress tested, and this will almost certainly need adjustment. Gradually, the elements of the business model start to work together and revenues are consistently building every month. The experienced founder is now convinced there is real repeatability and dedicated resources are now required to take things to the next level. To lead this effort, it has become increasingly common to appoint a 'Head of Growth' (what we may have previously called 'demand creation'). The big challenge now is that experienced growth leaders are themselves in great demand, often to be found driving aspiring unicorns to their next destination. But if the founder has shown a strong commitment to planning, achieving and rewarding early growth, top candidates will be easier to persuade.

Casey Winters is the Chief Product Officer at Eventbrite, where he leads the growth marketing team. He has helped scale multiple startups into large technology companies and is heralded by the VC community as one of the highest impact growth marketeers of our time. In a recent interview he describes why, when and how to hire the Head of Growth role. He says that one of the most common mistakes is to make the brief too broad. The growth function is about connecting prospective customers with the value that has already been created by the business, i.e. today's product. In other words, this is about revenue acceleration. This often starts with optimising product driven growth and is accelerated with performance marketing and, in some cases, with network effects. The bedrock capability for all of this is data analytics - capturing, analysing and rapidly acting on an increasingly diverse set of data. This is a critical skill set for the growth team as a whole. As the startup ecosystem matures, growth leaders will become harder to find. To snag the top candidates, founders should begin cultivating these relationships well ahead of hiring.

The growing importance of ESG risk factors

Sustainable investing is becoming a hot topic in private markets. Increasingly, LPs in VC funds will assess each fund's sustainability credentials when allocating capital. As a result, the GPs (General Partners) of these funds are paying more attention to sustainability, particularly as this pertains to their portfolios. Founders must become more sensitive to these emerging requirements, in case they fall foul of criteria that weaken their investment proposition. ESG criteria (Environmental, Social and Governance) - the cornerstone of a company's sustainability profile - are of increasing significance. Importantly, GPs are beginning to agree that the risk factors identified as part of the ESG framework are worthy components of the investment evaluation process. This is not just because of the values that they convey in the domain of responsible corporate citizenship, but because they have been accepted as an important element in overall business risk assessment. Further, for those funds that set themselves up specifically as 'Impact Investors', their investment thesis will extend beyond the basic ESG requirements. Here the bar will be set even higher on investment criteria.

The number of Impact funds has increased steadily over the past 15 years. 120 new funds were launched in 2020 across all investment categories, around 50 of which were VC. European LPs are well ahead in investing their assets into sustainable strategies. The largest impact fund is the (EU) Horizon 2020 Fund, with government backing. Other big impact investment funds come from the corporate world, including Amazon’s $2 billion Climate Pledge Fund and the $1 billion Microsoft Climate Innovation Fund. Interestingly, as revealed in a recent survey by Pitchbook, some GPs would prefer not to be categorised as 'impact investors' - even though they are clearly investing with that objective - because potential LPs may misconstrue the label as an indicator that financial returns are a secondary focus. But as LPs intensify their interest in sustainable investments, this attitude is changing. Some say that the startup is exactly the place to start companies on the path to making better products for the world, better companies with a stakeholder focus, and business activities that have a sustainable focus, rather than trying to retrofit a company after it has already embraced “bad habits.”

VCs are increasingly focussed on the dual objectives of achieving both financial returns and a measurable impact on social or environmental metrics. The Pitchbook survey highlighted that 73% of VCs plan to increase their attention to ESG risk factors in the coming year. Areas that they are most focussed on, in priority order, are; environmental health and safety, social issues, natural resource preservation and management, with corporate governance (incorporating diversity matters) bringing up the rear. While some believe that VCs should focus strictly on scaling and profits, younger companies may be at exactly the right stage to be thinking of diversity initiatives. For example, to ensure that the company grows with a representative board. Founders must stay abreast of these trends as they are only heading in one direction. For further background and insight the ESG and the Private Markets report and Impact Funds by Reason and Region report are excellent resources.

2. Other pieces really worth reading this week: 

Lessons in leadership from Doug Leone of Sequoia
If you listen to no other podcast this year, listen to this. Doug Leone is the Global Managing Partner of Sequoia Capital, one of the world’s most renowned and successful venture firms with a portfolio including the likes of Google, Airbnb, Whatsapp, Stripe, Zoom and many more. Doug, joined Sequoia over 33 years ago and has led investments in Nubank, Meraki, ServiceNow and TradeRepublic to name a few. His insights and values are an inspiration to all in the venture world. Listen, learn, and enjoy.

The Global Startup Ecosystem Report 2021
According to a report from Mountside Ventures and Allocate, 43% of institutions or fund-of-funds sped up their investments into VC as a result of Covid, while just 20% of LPs slowed their investment activities. The report, which surveyed 73 LPs, including big names like the European Investment Fund, the British Business Bank, Isomer and Top Tier, shows other positive signs for the European venture ecosystem — and some warnings. Sifted also took a look at the most interesting findings here

The Changing Venture Landscape
Further great insight into the investing world in an article by former entrepreneur turned VC, Mark Suster of UpFront Ventures. Even though this takes a largely US perspective, seeing how an experienced operator is reading market trends is illuminating. "However, to be a great VC you have to hold two conflicting ideas in your head at the same time. On the one hand, you’re over paying for every investment and valuations aren’t rational. On the other hand, the biggest winners will turn out to be much larger than the prices people paid for them and this will happen faster than at any time in human history."

Happy reading!

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