Duet Partners
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Weekly Briefing Note for Founders

8th July 2021

This week on the startup to scaleup journey:
  • European startup investment is booming, but fewer rounds
  • The race for the top talent
  • The importance of the follow-on investor
  • The power of the pre Board meeting call

1. Insights of the week

European startup investment is booming, but fewer rounds

According to Dealroom data, VCs have pumped an astonishing €47.4B into European startups so far this year, eclipsing the record €38.7B set for the whole of 2020. At this pace, Europe will hit €95B in VC investment by the end of the year, according to analysis by Sifted. That’s a year-on-year growth rate of 143% — the highest of any major ecosystem in at least the past five years. Currently, North America is on track to grow by 98% this year, and Asia by 47%. Late stage rounds are responsible for the boom, taking a huge share of the overall pie. The whole of 2020 saw just €4.4B injected into European startups in the form of €250m+ cheques. So far in 2021, that figure has more than quadrupled to €18.6B. Meanwhile, early stage investments are declining both in terms of absolute value and number of deals.

We are witnessing a huge shift in the European startup funding ecosystem. On the one hand the fuelling of an increasing number of high growth startups, many accelerated by the pandemic, by unprecedented access to capital. On the other, an increasingly high bar for early stage companies to jump over in terms of ever more demanding investment criteria at every stage. In the past, founders that may have struggled to raise sufficient investment with UK investors, would toy with the idea of setting up in the US to tap investors there. No need now. US investors are increasingly active across Europe, partly because their home market has become so competitive, and partly because they have huge funds to deploy quickly. As reported by Dealroom, a record 18.4% of all global investment has gone to European companies so far this year - almost double what it was in 2018.

But not all boats are rising on this tide. Experienced founders that know what evidence is required to graduate from one stage to the next (Pre Seed, Seed, Series A, B,..) are soaking up the lion's share of the funding. And it's not just the pool of capital they are draining. The next critical resource for growth is talent. 'Scaleup execs', those with proven operational experience in driving growth from Series A onwards, are in very high demand. Some critical competency areas that hardly existed 5-10 years ago have come charging to the fore: 'Lean startup' customer development methods; low code/no code development; customer behavioural analytics; product-led growth; and D2C business models. These are some of the key building blocks that are enabling startups to capture beachhead markets faster than ever before and drive heady valuations. Founders with the ambition and funding to create the next category winner are creaming off the top practitioners. This is no longer just a competition for capital.

The race for the top talent

In preparing for each new funding round, founders gather evidence of progress since the last round. A report card of key objectives achieved brings real credibility to the story. One big sign that your business is ready for the next stage is that you've been able to recruit key personnel with the necessary skills and experience to fill the gaps that existed before. Experienced investors know that top companies only succeed if they are able to build out a diverse talent pool. That is people that bring perspectives, insights and qualities beyond that of the founding team. These are the high calibre individuals that will help propel the company to the next level. Their very presence signals that they believe this company can be a winner and they are excited about the role they will play. This is fast track due diligence for any investor.

The cost of bringing in top talent is a major consideration. Too much too soon can blow the budget. At Seed stage, frugality is to be admired. The last thing any founder wants to be accused of is premature scaling. But in the lead in to Series A, that starts to change as you scope out the organisation needed to drive early growth. Whilst the hiring of this cohort will largely be identified under the 'use of funds' for the forthcoming round, one or two key hires ahead of this strengthens the foundations. It also serves as a real statement of intent. This not only creates a buzz for investors but signals that the CEO has the ability to bring in the heavy hitters. That is a critical skill for the next phase. It also gives credence to the growth plans, as the new hires will have helped architect these.

As round sizes and associated valuations grow, so do investor expectations. Startups are generally expected to be much further along at each stage than they were only a few years ago. Speed of execution, particularly in highly competitive markets, has become a critical competency in the short and medium term. It’s the most important competitive advantage any startup can give itself as it gradually builds longer term defensibility. There is no shortage of capital available for startups to accelerate growth plans as we know from the remarkable figures above. Confident founders should not be holding back in the competition for talent.

The importance of the follow-on investor

For any high growth startup, multiple funding rounds will be needed to realise full potential. The initial phases of inorganic growth will rely on some form of 'venture' investment. This can come from many sources, such as private individuals, Crowdfunding, Angel Networks, Family Offices, Corporates and VC funds.  A key consideration for founders when picking investors is their ability to follow-on: The more capacity an existing investor has to support the company with further capital, the less effort the founders will have to put into finding new sources. That's one of the reasons why founders shift from private to institutional capital as soon as they can justify it. But the VC world is a broad church, from £30M boutique firms managed by first-time managers, to the big operators with multiple £500M+ funds to deploy. Founders must consider the size of fund against their anticipated future capital requirements, as well as exit potential.

As expected, it is the most experienced fund managers that manage the biggest funds. What marks these managers out is not just how they select great companies to invest in but how they support them through the lifecycle to create outlier returns. A common approach is to earmark a sizeable portion of the fund - usually termed the 'reserve allocation' - for follow-on investments. Generally, around 1/3 of a fund is deployed into the initial portfolio, perhaps across 20 or so companies, whilst 2/3 is held back for further investment in the same businesses. Unlike most other fund types, the art of portfolio management in a VC fund is not just about trying to pick the winners at the outset, but doubling down aggressively as the 'outliers' emerge. This means that a disproportionate amount of the reserve may be invested in only a small handful of portfolio companies. They will have found the formula for growth and need more capital to fuel their acceleration. Investors will then want to own the largest share of the business they can afford to (or be allowed to) before the valuation really takes off. This is the concept of investing at 'The Flat' when prices are low, 'doubling down' when you detect 'The Elbow', and stopping at 'The Wall'.

The past 12 months have seen a wave of doubling down by active funds via pre-emptive funding offers. As valuations soar, the potential for outlier returns increases. This is an essential element of the portfolio funding strategy as these returns make up for the inevitable losses elsewhere. A fact of life for VCs is that the majority of the investments in any portfolio will not even return the money invested. Even the best firms have their fair share of failures. But the bigger the fund the bigger the return expectations. When any fund evaluates a new investment opportunity, they will ask themselves if this single investment could return the entire fund - this is the threshold that any startup must meet. For a mid-size fund of say £100M with a 25% stake at exit, this implies a £400M exit valuation target. To be assured of follow-on funding, founders must demonstrate that their growth aspirations are materialising and their exit target range is still confidently in sight.

The power of the pre Board meeting call

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 the performance of the company. Not enough time is given to discussing strategic matters, or matters where the CEO could really use some help. But the board should be a key resource and, if managed creatively, can be a huge 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 12 years advising startup founders and boards, there is one particular insight that deserves a special mention. This is the pre-meeting 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-calls are going to take time and effort: I know many CEOs will consider this to be just too much overhead. But this can be such a worthwhile investment. 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.

2. Other pieces really worth reading this week: 

Global Venture Funding Hits All-Time High In First Half Of 2021
Crunchbase reports that "global venture capital funding in the first half of 2021 shattered records as more than $288 billion was invested worldwide. That’s up by just under $110 billion compared to the previous half-year record that was just set in the second half of 2020...The backdrop for all of this activity in the venture ecosystem is strong first-quarter earnings for leading technology stocks as countries slowly emerge from the pandemic. On July 2, both the S&P 500 and the Nasdaq composite index hit all-time highs."

Are We In A Venture Capital Bubble?
In Forbes this week, some great insights into the US market and why investors are seeing so much competition for deals: "Public markets and technology multiples set records in early 2021. 50 venture-backed companies listed publicly in the first quarter of the year, 5x the historical average. According to Pitchbook-NVCA data, average early stage pre-money valuations have already doubled from $60 million in 2020 to $110 million in 2021. Late stage valuations have grown even more dramatically, rising nearly 4x to an average of $1.6 billion."

Why Delegating Tasks Before a Vacation Never Works
In the hope that travel opens up soon, a thought-provoking piece in HBR this week: "The verb 'delegate' means to entrust or to assign responsibility or authority. Fundamentally, it’s about empowering another person to do something. All too often, however, managers confuse true delegation with simply asking staff members to do things. Consciously or not, they feel that the work belongs to them and that staff members are there to help them accomplish that work. This framework for thinking about delegation creates problems.."

Happy reading!

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