1. Insights of the week
Successful disruptors know how to unleash 'trapped value'
Many interesting discussions with founders this past week over our recent article 'Crossing the Chasm - from Seed to Series A'. Two major observations: First, the realisation that so many (young) founders are unfamiliar with the works of Geoffrey Moore, celebrated author, business consultant and now Venture Partner at Wildcat Ventures. His book, Crossing the Chasm, has become a canonical work for companies trying to unlock new markets. It is as relevant today as it was when first published back in 1991. His other books, especially Inside the Tornado, have been thumbed eagerly by scale-ups on high growth trajectories now for many years. Second, how Moore's insights into the supremacy of 'category power' enable the most successful disruptors to find and then unleash 'trapped value' in new categories. This potential for huge value release is the ultimate founder insight.
For those looking for a primer on Moore and his work, his interview on this week's Colossus podcast is inspirational. One of the most enlightening topics is the Hierarchy of Powers, where 'category power' trumps all other forms of economic power. The most powerful business is the one that defines and owns the new 'category'. As a category becomes established, competitors gradually move in. But if a company has cemented its category-leading position it will continue to reap the greatest profits (until someone else redefines that particular category). That's why thematically-driven VCs study the potential emergence of new categories as this is where future unicorns are often birthed. Importantly, in the formative stages, new categories spring from quite narrow use cases that then expand over time. Eventually, startups often transition to become 'platform' companies where they are gradually able to support many use cases - sometimes across multiple industries.
As a VC assessing new categories, one of the first questions Moore asks founders is, "Where is the trapped value?". This is the economic value that cannot be released in the current definition of the category. Travis Kalanick (Uber) found the trapped value in the back seat our cars; Brian Chesky (Airbnb) discovered we had trapped value in our spare bedrooms. The second question is, "What is trapping the value?" and the third is "What (disruptive solution) unlocks this value?". VCs pay most attention to where high concentrations of trapped value can easily be found in the very early stages. For example, at launch, Uber concentrated on one city only, San Francisco. But not all trapped value sits in existing 'suboptimal' categories. In DeepTech businesses, where pioneering technology development can take years, the initial use cases that prove trapped value can be released are often not even known. Everything is much more speculative to begin with. For example, early pioneers in quantum computing only had a vision for what might one day be possible - and this remains very much still in the future. But so compelling is this vision (that dozens of industries could be disrupted beyond recognition within the next 10 years or so, creating many new categories) that investors now simply can't ignore it.
Europe vs US: Series A funding gap widens
We are used to seeing a significant gap between the size of funding rounds in the US and Europe. But in 2021, much changed. The rush of US venture capital into the European market helped push up deal sizes and valuations through the growth stages dramatically. So much so that at Series B the gap almost closed. In Europe, the median Series B last year was $29.4 million. In the U.S. it was $33 million, according to Crunchbase. At Series C bigger changes were afoot; European businesses actually raised more than their US counterparts. Median deal sizes were higher in Europe as late stage financing was up 230% YoY. This was heavily driven by big international growth equity investors, including many non-traditional VC players such as hedge funds and PE. Ironically, most of these were US-based, seeking value opportunities outside their home turf.
Whilst European median deal sizes at Seed stage continued to track at around 75% of the US, the Series A gap widened marginally. The median Series A in the U.S. was $13 million in 2021, with Europe at $8.5 million, approximately two-thirds of the US figure. In the hunt for clues as to why this disparity still exists, figuring out who led funding rounds at each stage is revealing. At late stage (Series C onwards), US investors led a remarkable 43% of European deals (Europe investors led 49%), demonstrating huge appetite for non-domestic investment. At early stage (Crunchbase defines this as Series A and B) this drops to 28% (European investors 68%), still quite a remarkable figure but way down compared to late stage. At Seed, it's 14%, with European investors leading 77% of deals at this formative stage, much more in line with what we'd expect. It's impressive that at Seed stage, median deal sizes are closer to those of the US even with far fewer US investors leading. This demonstrates the strength of the Seed investor landscape here. But this momentum is clearly not maintained at Series A.
It's also interesting to look at what's happening in Asian venture markets, especially China, which is by far the biggest. With very limited cross-border investment into Europe over recent years, most of the Chinese VC focus has been domestic. China's tech startups soaked up a record $131B in 2021, but government regulation is tightening as Beijing attempts to consolidate and control its most profitable and powerful industries. 2021 went down as the year that China cracked down on Big Tech, erasing $1 trillion in value from Chinese stocks. This hit consumer startups like Alibaba, Tencent and Didi Chuxing the hardest. These companies have effectively been barred from US markets, blocking the traditional exit road for VCs active in Asia. As a result, local VCs have shifted heavily away from consumer and towards hardware and DeepTech. For example, a record $8.8B was pushed into Chinese semiconductor startups in 2021, significantly more than the $1.3B raised by US peers, according to Prequin.
Societal issues are increasing employee activism
Over recent years, the role of companies as a force for good within society has become a hot topic. ESG (Environmental, Social, and Governance) factors have come to the fore in how investors evaluate risk and growth opportunities. But an equally pressing matter for business leaders is the increasing level of employee activism on these subjects, accelerated further by the pandemic. Employees now have even higher expectations in how their employers should be engaging in social issues. The likes of Google, Coinbase, Shopify, Amazon, Basecamp and many others have been caught up in high profile disputes and in some cases employees, upset at the lack of engagement in societal issues, have just up and left. Once outside the field of vision of startups, such matters can no longer be ignored.
Where founders have actively tried to divorce their businesses from any form of position-taking on societal matters, they have found increasing pushback. In September 2020, Coinbase CEO Brian Armstrong told employees that the company would not engage in societal issues "..unrelated to our core mission, because we believe impact only comes with focus." Coinbase offered severance packages to employees who did not agree, and 60 people walked. The software company Basecamp instituted a ban on political discussions in April, and a third of employees quit. In May, Shopify CEO Toby Lütke emailed managers stating the company's core beliefs. This was in response to a group of employees publicly rebuking the company for the handling of certain racial and social justice issues. Lütke's uncompromising email, published by Business Insider, stated that Shopify "..is not a family...and is also not the government...we can't solve every societal issue."
In assessing ESG factors, investors are increasingly sensitive as to how these tie in with a company's overall culture, mission and values. US funds seem especially keen to probe on these topics, often seeing them as key to attracting and retaining employees. Founders are having to be far more proactive in articulating their views on these matters. Momentum is also building behind B Corp Certification where companies are confirmed (by B Lab) as meeting high standards of social and environmental performance, transparency and accountability. More than 100,000 companies across the globe have applied for B Corp certification since 2006 and only 3,500 companies have managed to pass (600 are in Europe), with many high growth startups now featuring on the list.
2. Other pieces really worth reading this week:
BlitzFail - How Not To Go Off The Rails
Great insights in this article from VC David Sacks on how high-growth startups can crash. "How does a BlitzFail happen? “Gradually and then suddenly,” to use Hemingway’s description of bankruptcy. As in a bankruptcy, the startup gradually accrues too much debt. Tech debt is a well understood concept. But there is also financial, managerial, compliance, cultural, and operational debt. Founders should seek to pay down this debt over time. Otherwise, it may suddenly come due all at once."
Finding the Perfect Match - Startup + VC
For founders eyeing top tier US investors and seeking a deeper understand of what matters to them, here is a great primer. This week on the Kauffman Fellows Podcast, two guests who intimately understand the value of a team: Ann Miura-Ko of Floodgate and Adam Goulburn of Lux Capital.
How do VC funds relate to CVC for Portfolio Growth?
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds. In this article, investors Hector Shibata and Ricardo Latournerie discuss the potential for collaborative power between independent VC funds and CVCs. Both players are important not only to provide capital to the startup but also to drive its development.
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