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Weekly Briefing Note for Founders

7th July 2022

This week on the startup to scaleup journey:
  • Founder anxiety grows over scale-up capital
  • Pivoting is not failure, it's normal
  • Pre-Board 1/1 calls are a power tool for CEOs

Founder anxiety grows over scale-up capital

We might expect that the more established a business becomes the easier it should be to raise capital. But in the UK this is not the case. According to an analysis by The Economist, British startups raised 14% of the money invested globally in Pre-Seed rounds in 2021, and 11% of the total in Seed rounds. (For comparison, the country accounts for around 3% of global GDP). By the time they are after $15m or more, British startups' share of global funding has more than halved. For those founders running a DeepTech startup, the challenge of raising scale-up capital from UK - or even European sources - is particularly acute. According to an analysis by British Patient Capital, a government-owned investor, just 49% of British DeepTech firms reach their second funding round, compared with 63% for American ones. By the sixth funding round, the average American DeepTech firm has raised £113m; the average British one just £25m.

In recent years there has been a sense that this problem had been partially addressed by the increasing internationalisation of venture markets. In 2017, 51% of all VC capital deployed into UK startups was domestic. By 2021 this fell to 27%. During this time US and Asian investors became significantly more active in Europe. According to the State of European Tech Report 2021, in deals <$5M (typically Seed stage) the share of these with at least one US or Asian investor increased from 16% (2017) to 22% (2021). For $100M deals (late stage) this almost doubled from 47% to 90% over the same period. Much of this can be attributed to the rise in so-called 'crossover investors', notably certain US public equity asset managers that also invest in private companies, such as Tiger Global and Coatue Management. The top 12 most active crossover investors alone participated in 32% of European rounds of $100M+ in 2021 versus just 12% of rounds between 2017 to 2020. As markets re-adjust in 2022, overseas investors - in particular those investing at later-stage - are operating with much greater caution. This is putting a new squeeze on UK firms seeking growth rounds.

For those startups that are successful in securing scale-up finance, the next step if often the public markets. But for UK tech companies the question over where to list throws up even more anxiety. According to the Economist, the London Stock Exchange was, until relatively recently, an international hub for raising equity capital. In 2006 18% of the funds invested in initial public offerings (IPOs) globally were raised in London. Over the five years to 2021 that figure collapsed to 4%; so far in 2022 it is below 1%. "Tech firms perceive mainstream British asset managers as being somewhere between indifferent and hostile, prizing earnings today over the promise of growth tomorrow." Of the £6T of assets in British insurance funds, pension schemes and retail holdings, only 12% is invested in Britain’s stock market. Hence the NASDAQ has become the favoured listing target for UK entrepreneurs. But with IPOs now effectively on hold, scale-ups requiring more cash are suddenly finding they have very limited options. Even though their earlier-stage cousins are having to jump ever higher to meet more stringent investment criteria at Seed and Series A, there is still investment appetite out there if they can tick the right boxes.

Pivoting is not failure, it's normal

For many startups, some form of pivot is essential before finding product/market fit. This is a change in one or more of the fundamental aspects of the business model. Pivots are vitally important 'devices' that founders must feel confident using. They ultimately ensure early-stage companies do not pursue unrealistic dreams or indulge in premature scaling. Used judiciously, they enable significantly better outcomes. According to the Startup Genome Report extra on premature scaling, startups that pivot once or twice raise 2.5x more money, have 3.6x better user growth, and are 52% less likely to scale prematurely than startups that pivot more than 2 times or not at all. But whilst pivots are viewed positively in the US venture market, there seems to be less support across Europe. Founders say there is still a stigma attached to pivoting and they want this to change.

In our article, Why do some startup founders fail the pivot test? we discussed the reasons that pivots can be so difficult. First, the realisation that a pivot is even required. Founders are conditioned to strive for success even if it seems they are fighting against all the odds. Understanding the key signs that the course needs correcting is vital, so action can be taken before it's too late. Second, is just having the courage to take the pivot on. You are about to press the big red button labelled "massive upheaval to our current plans" and this is never an easy step to take. But what makes both of these more difficult than necessary is the negative attitude of some investors. They will view a pivot as a path of last resort, a last-ditch effort to save the business, and in that sense, an admission of failure. This just adds to the stress. But it shouldn't be like this.

Ann-Tho Chuong Degroote is CEO of Lago, a B2B software startup with offices in both the US and Europe. Following a recent pivot, she experienced quite different reactions between her US investors (positive) and European investors (negative). She found that the differences were especially marked with angel investors. She says "..some of the European reactions showed us that pivoting in this region is still seen as a definitive failure rather than a step in the journey. Clear answers and proof that we would “nail it this time” were expected immediately." The biggest takeaway from founders who have navigated difficult pivots is to start the process of communicating with investors early, and if necessary educating them along the way. if European tech wants to survive the slowdown that has already begun, more teams will need to pivot. This will require more understanding investors who don't treat pivots as taboo.

Pre-Board 1/1 calls are a power tool for CEOs

Board meetings can be one of the least loved moments in any CEO's schedule. This is because they can often default to simply becoming updates on company/team/CEO performance. Not enough time is given to discussing strategic matters, or matters where the CEO could really use some help. In the current climate, founders are eagerly looking for that special value-add across a whole range of topics. The board should be a key resource and, if managed creatively, can be a valuable asset to tap. US VC Mark Suster has written a great series of articles on the topic and UK VC Notion Capital also has some excellent resources that can be used. But from my 7 years as CEO of a tech startup and the subsequent 13 years advising startup founders and boards, there is one particular insight that deserves a special mention. This is the CEO's pre-board 1/1 call with each of the non-exec directors.

The non-execs will either be investor directors or independent non-execs. As these people are not involved in the day to day operations of the business, the board meeting will usually be the most important touch point they have with the company from month to month. As investor consent can be required on certain strategic matters - over and above Board approval - it's particularly important that there is an active and open dialogue with the investor directors on such topics. As CEO, you will then have greater visibility on how these matters are likely to play out. By having a call with each of the non-execs ahead of the board meeting, you can ensure that non-execs are fully briefed and feel more engaged. You will be able to gauge how strongly they feel about a topic and how much support or resistance you can expect. Also, if there are any contentious matters, discussing these 1/1 ahead of time will ensure there are no surprises in the meeting - a golden rule for all CEOs.

Clearly, pre-board calls are going to take time and effort: I know many CEOs will consider this to be just too much overhead. But the payback can be immense: If any of the non-execs disagree with an idea, your plans, or a decision that you believe needs to be made, you are much more likely to hear it and understand it in a 1/1 setting. If they need to solicit the views of their colleagues before giving you a formal response then you are giving them more time to do this ahead of the board meeting. On big or difficult topics, making people feel they are part of the solution is more likely to foster goodwill. But most importantly, by soliciting their views ahead of time you will be building rapport, enabling you to be more in control of the room when you’re all together. Then you might find these are moments you begin to look forward to.

Happy reading!

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