Duet Partners
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Weekly Briefing Note for Founders

8th April 2021

This week on the startup to scaleup journey:
  • Timeline of a Series A round
  • Insights from second-time founders
  • Measuring Capital Efficiency in SaaS
  • Why pre-emption rights matter

1. Insights of the week

Timeline of a Series A round
The biggest practical consideration when deciding on any funding round is the amount of runway available. But a funding timeline that assumes the round will close just before the company runs out of cash is a very high-risk approach. Several months of cash buffer is critical when planning, to allow for the unexpected. Experienced founders will aim to close their Series A round with at least 3 to 4 months of runway remaining, and 6 months or more for later stage rounds. At the start of the process, it’s prudent to allow 1-2 months to rally current investors and prepare materials, then 6 months to undertake the Series A campaign itself (pitch ready to money in the bank). Ideally, this means that the funding plan for Series A should be agreed and given the green light with 12 months of runway available.
In developing the funding plan, experienced founders will first research potential investors and re-evaluate typical investment criteria for their sector and business model. Things may well have moved on since everyone last looked. This preparatory step can take several weeks but is vital in assessing the state of investment readiness. In particular, is the company on track to hit the key metrics required to excite Series A investors? This critical preparation is done before work starts on the deck. Series A investors will be very unforgiving if you ‘pitch up’ too early, so feeling confident that you will nail the key investment criteria on the day is vital. If the funding plan to deliver this is not converging with 12 months to go, experienced founders take immediate action to extend the runway. Avoiding what some investors call the Fatal Pinch is always top priority.
Running a successful campaign is then all about leverage. The tussle between founder and investor is played out in a time window where the longer things take the greater the leverage swings in favour of the investor. They will drag you towards and (sometimes unwittingly) into your cash buffer zone to reassert their own leverage. This will give them a greater chance of getting the terms they want, which at the end of the day is their job. Founders mitigate this risk by; i) Ensuring they plan for a strong cash buffer, ii) running an efficient campaign by only talking to well qualified investors, and iii) pitching a proposition that will create serious FOMO. The easiest part to lock in is the cash buffer; this just means starting the process at the right time. With this 'banked', all efforts can then be devoted to executing a well-planned campaign.

Insights from second-time founders
The first time around can be brutal - one of the steepest learning curves that any entrepreneur can travel. Whatever the outcome, the experience is invaluable as second-time founders testify. The priority list of activities changes and things that may have seemed counterintuitive first time around are elevated. The biggest learning is to maintain a strategic perspective; that 30,000’ view of why we are doing this and how we intend to win. First time founders will ponder this long and hard before getting their startup up and running, but once operational they get quickly engrossed in the day-to-day. Before long, they no longer have an outside view of their company and can’t see the wood for the trees. Second time founders ensure they dedicate time to deliberately reflect on their strategy and, where necessary, undertake managed pivots rather than forced pivots.
Recruitment is often cited by second-time founders as another key priority that changes. A critical moment is in the approach to the point of early scaling when customer engagement increases. A founder who has led the business from inception may have had the vision, drive and creativity to launch the business and bring it to this point. But now another form of leadership is required; leadership to ensure that day to day operations run smoothly. Sheer will, passion and brute force won’t take the business to the next level. Investors know that ‘visionary leadership’ and ‘operational leadership’ rarely reside in the same person. That’s why experienced founders hire a senior executive with a complementarity skill set to help lead the business forward. By sharing the load in this way, founders make time to maintain their 30,000’ view.
The most counterintuitive habit to adopt is to write things down. When travelling at the speed of light anything that slows down the experiment is quickly jettisoned. But second-time founders believe in the ‘more haste, less speed’ mantra, and as soon as practicable start designing everything for scalability. Really basic things like; i) how we plan and run meetings (agendas, action taking); ii) how we do things (the processes we employ, the checklists and guidelines we use, rather than just relying on implicit knowledge); and iii) keeping a 'decision log'. This is not just what we decided but how we decided it. By capturing the rationale, it’s much easier to revisit decisions during the early experimentation phase of the business. On the way to product/market fit, many things are iterated. Speed of iteration can be really enhanced by writing things down so the collective memory is never in dispute.

Measuring Capital Efficiency in SaaS

The last 12 months have brought increasing focus on capital efficiency. Investors have asked founders to really maximise the value of every $ invested - to keep the runway as long as possible until the tipping point of growth emerges. Even then, startups whose burn is too high relative to their growth will find it difficult to raise more capital. At the point where early revenues really start to flow, investors have become increasingly interested in measuring capital efficiency. The Efficiency Score used by Bessemer Venture Partners and others, has become a key metric for SaaS businesses. Some flip this ratio to create what is known as the ‘Burn Multiple’. Burn Multiple = Net Burn / Net New ARR. In other words, how much is the startup burning in order to generate each incremental dollar of ARR? (For non-SaaS businesses, ‘annualised revenue run rate’ is sometimes used as a proxy for ARR).
Highly respected VC David Sacks of Craft Ventures provides great insight into the value of this metric. The higher the Burn Multiple, the more the startup is burning to achieve each unit of growth. The lower the Burn Multiple, the more efficient the growth is. In its application, Sacks says: “For example, Q1 just ended and it’s time for a board meeting. The startup reports that it burned $2M in the quarter while adding $1M to its ARR. That’s a 2x Burn Multiple — reasonable for an early-stage startup. On the other hand, if the company burned $5M in Q1 to add $1M of net new ARR, that’s a terrible Burn Multiple (5x). It should probably cut costs immediately. That company is spending like a later-stage company without delivering later-stage growth.”
The beauty of the Burn Multiple is that it's a catch-all metric – it illuminates issues with gross margin, CAC, churn, and low revenue growth. Of course, a startup needs to be consistently generating revenues for this metric to even work, but at the point of initial scaling (i.e., product/market fit) this will start to apply for SaaS. Investors will have their individual expectations of Burn Multiple by stage, but it should be clearly improving as the startup progresses. Craft models a Burn Multiple of 3 for company approaching Series A. After the Series A, it might drop to 2. After the Series B, when the sales team should be operating at scale, the expectations for efficiency increase even more. Eventually, for a company to become profitable, net burn must reach 0, which implies that the Burn Multiple should also approach 0 over time.

Why pre-emption rights matter

A pre-emption right gives an existing shareholder the right to participate in a future financing round to the extent necessary to maintain their percentage stake in the company. Pre-emption rights are usually ‘pro rata’ to a shareholder’s existing holding, i.e., if a shareholder holds 20% of the issued share capital before the round, they will be entitled to 20% of the new shares being issued. This mitigates the natural dilution that occurs with an equity financing. Such rights are usually essential for institutional investors, such as VCs, so they can continue to invest in the business if it is doing well. VCs will nearly always plan to invest over multiple rounds, thus providing the capital required for growth whilst maintaining their % ownership share of the company for as long as possible.
But what happens when a shareholder does not take up their pre-emption rights? Founders must be aware of the ‘signalling risk’ here as this could send a negative signal to the new investors that there are potential issues in the company. Some smaller funds may not have the ‘fire power’ to take up their pro rata, so the sooner this is known the more time a founder has to position this carefully with prospective investors. These incoming investors will also have target ownership levels. As a very approximate guide, Seed investors will typically expect 20-25% of the equity post round, Series A investors around 25-30% and Series B around 15-20%. Enough of the newly issued shares must therefore be available for new investors, otherwise the company must issue more new shares, causing further dilution. [Sometimes an existing investor who is not taking up their pro rata can actually help the cause in this sense, but the optics must be right!]
If founders give too much of the equity away in the early rounds this can have big implications downstream. New investors always want to see founders strongly incentivised for an exciting return at exit, so they will also care about founder dilution. For example, if a founder is pitching to Series A investors and only holds a small % of the shares due to several heavily dilutive Seed rounds, this will be a red flag to new investors. In addition, the creation of a meaningful ESOP (employee stock option pool), often in the 10-15% range, will further dilute existing shareholders when created and subsequently topped up. Incoming shareholders will often seek to have the option pool increased to normal levels before they invest to maximise the holding available to them when the new round is completed.

2. Other pieces really worth reading this week: 

Money is not enough
Startup founders are after more than just funding from VCs — but the majority of them feel they don’t get it anyway. That’s according to a new report by Forward Partners which surveys 500 founders and investors in the UK. 92% of VCs interviewed described themselves as value-add investors, but 61% of founders said the VCs they worked with brought less added value than they’d promised.

The great acceleration of seed investing.
From the Angular Ventures blog, Gil Dibner asks whether seed funds and accelerators can work together? "I’m not yet 100% sure this is true, but I am starting to think it might be: seed funds and “accelerators” basically can no longer work together. Choose one path and you self-select out of the other."

Here’s what you need to know about European SPACs
Sifted reports on the latest in the SPAC craze. "In February alone, SPACs, which are set up in order to acquire other businesses, struck 50 deals globally, signing off on $109bn worth of transactions, according to data from Refinitiv. In the US, SPACs have raised $58bn in the first two months of the year — compared with $78bn across 2020 as a whole. Europe has so far been slow to join in the SPAC trend, and while VCs are still hesitant, there are a growing number of high profile entrepreneurs looking to invest."

Focus on Your First 10 Systems, Not Just Your First 10 Hires
A chief of staff shares his playbook on First Round Review:“While I definitely agree that people are your most important asset, I’ve noticed that most content doesn't talk as much about the systems. What I don't come across as often is a read about how the systems that those first hires build are the manifestation of the culture.”

Happy reading!

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