Duet Partners
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Weekly Briefing Note for Founders

4th July 2022

This week on the startup to scaleup journey:

  • Founders must spell out the upside scenario
  • Creating FOMO is more art than science
  • The power of the Customer Development credo

Founders must spell out the upside scenario

The dramatic change in private market sentiment over recent months has provided a big reality check for startups. Many funding plans for 2H22 and 1H23 have been hastily reworked. Expectations on round sizes and valuations have been reset - down. Late-stage companies have seen the greatest impact. Even so, the jitters are being felt at every stage including Seed in anticipation of what happens next. But it is also clear that this need for greater conservatism in 'the ask' is also permeating deeper into the founder mindset. As a result, the excitement factor of some investment propositions is (inadvertently) being diluted and this is negatively impacting pitch meetings. Yes, the market has cooled but if you had a stand-out investment proposition before, that likely won't have changed - so don't hold back on making your case to investors. VCs are still in the hunt for the outliers - the investments that will return the fund many times over later down the line. A founder's job is to communicate that outlier potential.

The most successful VCs will say that they can sense if there is the prospect for a big outcome as soon as they meet the founder. Some will even claim this happens in the first 30 seconds to 3 minutes of the meeting. When questioned on this they will say that they could quickly see the real upside potential if all the stars were to align. That's why some VCs love asking the question, How big could this be? But founders shouldn't wait to be asked. They should have this answer scoped out and ready. Having such a scenario easily accessible in the financial model helps quantify this - the revenues, the costs to get there, the investment required to make this happen. Of course, this is just a scenario - everything at this stage is no more than an educated guess. But somehow it takes on a certain power when written down. Spoon-feeding the upside scenario in this manner also helps the investor ultimately write their own investment memo, which is the single most critical document in the investor's internal decision-making process.

The upside scenario also gives investors greater confidence that new investors will also be enticed at the next round. As markets tighten, this is becoming a major point of anxiety for investors who don't want to find themselves as the only source of capital at the table next time. The other consideration for investors is the pure opportunity cost. If a VC sees two great startups but only one is able to paint a truly exciting upside opportunity, this could be a deciding factor in where they chose to invest and spend their time. But perhaps most important of all it talks to the confidence of the founder. Why would a founder model an upside scenario if they didn't have at least an inkling that this might eventually turn out to be the reality? Remember, you aren't committing to anything here but you are planting seeds of hope. Even in the current market, the buzz around such 'hope value' can still be infectious.

Creating FOMO is more art than science

Running a successful fundraising campaign is part science and part art. The science part is the overall process -  understanding the steps that are required and how they fit together. These will include deciding on the funding strategy, identifying potential investors, preparing investment materials, undertaking investor outreach, negotiating term sheets and finalising investment agreements. Understanding how to set up and manage these steps is vital knowledge for all founders to acquire as part of their core skill set. But the 'art' part is more nuanced and doesn't fit so neatly into a checklist of things to do. It revolves around the selling of the proposition, the gathering and interpreting of investor intelligence, and most importantly, creating FOMO. The main driver of success in any fundraising is creating competitive pressure amongst investors - the fear that if they don’t move fast and put forward good terms, then another fund will.

Selling is not a skill that comes naturally to all founders. But a fail-safe place to start even for the least practiced is what sales people call 'understanding the mind of the buyer'. Being able to look at your proposition from the investor's (external) perspective is critical. What are their needs and perspectives? How does your proposition align with these? When crafting your story for investors you can’t change who you are and what you do. But you can understand the experiences, trends and patterns that shape their worldview and how you can best match your story to that view. This is one of the reasons why investor intelligence is so vital. Understanding the investment history of both the fund and the partner you are going to reach out to enables you to tailor your approach and make it relevant to them. Other intelligence that can be really powerful later in the campaign is identifying the regular co-investment partners of the potential lead investor. Investing is usually a team sport and founders can use this to their advantage in creating FOMO. If an investor starts hearing news of a hot deal from trusted partners, they are more likely to show interest.

The most powerful method to drive FOMO is to create a sense of urgency around your fundraise. As VC Finn Murphy says"Your raise shouldn’t shouldn’t feel like something that’s happening over the next few weeks. It’s happening right now. Investors should be hearing about it from many different sources."  This is why the term 'campaign' is so apt. VCs talk to each other far more than founders expect. Some have regular catch-up sessions and even have WhatsApp groups with other investors, so word can travel fast. Information is currency in the VC network and intel on a hot deal ranks top. Smart founders understand how to leverage this and will intentionally approach some select funds one stage beyond their current position. If it's a Seed round they'll approach some Series A funds, if it's an A round they'll approach some Series B funds. They are unlikely to invest now but they will trade the intel they have on your round in their network (a good thing). If you're really hot they may even make an exception. If not, you'll certainly be on their radar for the next time.

The power of the Customer Development credo

As the MVP takes shape, founders seek out the first early adopters. The objective is to test the core elements of the value proposition, to obtain feedback, to learn. The proposition is built from the special insight the founders have and the MVP is the first serious test of this proposition. Selecting the right early adopters is vital, especially in B2B models. Some will share the founder's vision - they are living in that future now and can already feel the pain. The MVP provides the pain relief they so desperately seek. But some early adopters will not necessarily share the founder's vision. They may be more conventional thinkers that live in the present. Their mindset is to provide the shopping list of enhancements they want to see before they will consider the MVP. Many of these requests won't relate to the creation of the new future that the founders seek. They don't flow from the special insight that the founders have. In that sense, these customers will just become a liability and should be avoided. This selective approach is the essence of the Customer Development process. To some founders this can feel totally counterintuitive: After all, we were brought up with the notion that customers select us, not the other way around.

Mike Maples Jr. is co-founding partner at Floodgate, one of the most prolific seed and early stage VCs in the US. Before becoming a VC, Mike himself was a founder. In a recent interview, he describes how he would approach prospective early adopters. He calls this 'going for the no'. "This may not be a good use of your time, but we do this [explain what we do]. If you don't need software that does this then I can save you 45 minutes of your time." Unless the customer then tried to pull him back in, to sell him on why they should work together, he would step away. He says bluntly, "You can't waste any of your energy on people who don't value your advantage."  Qasar Younis is co-founder of Applied Intuition, a Floodgate portfolio company. Maples cites Younis as a CEO that fully embraces this counterintuitive approach. His thought process is: "We're not going to try to convince customers to buy from us, we're going to pick our customers based on their fitness to the different future we are designing. We're going to select them and convince them to move with us."  Maples adds; "You are building what's missing for them in that different future. It's going to give you a huge learning advantage and an acceleration because they tend to be bellwethers for other customers."

As a VC, Maples is drawn to founders that espouse the customer development credo. In his investment evaluations he starts with the 'secret', the special insight the founders have that underpins the customer proposition they are building. If this is utterly compelling - he describes the moment he gets 'the shiver' - he interrogates the inflection points; the points of convergence that demonstrate the timing is now. He then wants to see which early adopters a founder has chosen to target. What research has been undertaken? Why have they been selected?  Why do we believe they will share the same vision of the future? Picking the right early adopters is not easy. A direct conversation is needed to carefully qualify and often it requires more, such as a demo. But then their intent must be clear and they should be starting to sell you on working together. The real test is will they pay for the privilege, for a product that is far from complete? If they are, then you are over the first major hurdle. As Maples would say, "You have started to bend the arc of the present to a different future". 

Happy reading!

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