Weekly Briefing Note for Founders

20th September 2022

This week on the startup to scaleup journey:

  • Global VC investment down sharply in August
  • VCs using latest tech to screen hot startups
  • Founders must think more like scientists

Global VC investment down sharply in August

Global venture funding reached $25.2 billion in August 2022, the lowest monthly funding amount recorded in the two years since August 2020, according to a Crunchbase News analysis. This past month is down 52% year over year and down around 10% month over month. Fewer startups are raising funding at every stage. And with that comes a slowdown in hiring, more layoffs and companies shutting down. US start-ups have borne the brunt of the downturn: Companies with layoffs announced this past month include Snap which laid off 20% of its workforce—around 1,300 employees. And Robinhood laid off 23% of its workforce with about 800 losing their jobs. And for companies that need to raise funding, extension rounds are on the rise as companies look to raise bridge financings to extend their runway. Late-stage fundings saw the biggest drop of around 65% for the most recent month year over year. Early-stage financings are down by around 35%, and Seed by 19%.

Crunchbase analysis shows that the trends differ by stage: Series A rounds were the least affected by the funding slide; funding remained flat in August 2022 compared to August 2021. Series B rounds, on the other hand, fell by 55% in the same timeframe, and Series C funding dropped even further by 77%. This year started out quite well for Series B and C rounds, with more funding raised compared to 2021 in the earlier months. But then from March onward, Series C fundings trended well below 2021 amounts, and Series B fundings followed suit and were down more dramatically in July and August 2022. For early stage, especially across Europe, some cautious optimism is warranted. There is no doubt that fundraising is taking longer; round sizes are a little smaller and valuations overall are a little lower. But deals are still getting done and the reality is that many startups are doing well despite the difficult macro climate.

As we highlighted last week, UK & Ireland deal activity has remained strong during 1H22, despite increasing macroeconomic uncertainty. Pitchbook data confirms £15.4B invested across 1,879 deals in the first 6 months of this year. This compares very favourably with the £28.2B invested for the whole of 2021 over 3,857 deals. It seems as though a looming recession and surging inflation are not (yet) curbing investor enthusiasm. September marks the traditional launch point of new funding campaigns, aimed at early 2023 closure. Back from an unusually quiet holiday period, investors are already inundated with new funding propositions that have been diligently crafted over recent months. Meanwhile, preparations for early 2023 campaign launches are underway with a vengeance. January marks the next significant launch moment following the Christmas period where investor focus is on closing out deals presented this past Spring. This cadence continues to repeat even though completed transactions are trending down.

VCs using latest tech to screen hot startups

Innovations in technology are the enabling force behind many startups. But founders might be surprised to learn that these same innovations are also changing the way in which VCs themselves operate. Just as startups use technology to create differentiated propositions that will open up new markets, so too VCs are using technology to identify, qualify and help pick their future portfolio winners. With ever greater numbers of founders chasing fewer venture cheques, deal flow management is becoming a significant headache for investors looking to make the process of deal sourcing and screening much more efficient. In this more competitive environment, VCs are employing data-driven sourcing and intelligent ML-based screening to identify and engage with hot startups even before a deal is on the table. For those that don't have the brand recognition of the big multi-stage funds, the adoption of advanced tools may become critical in the race for survival. Being able to reach out to founders and start building relationships at a very early stage has become an essential tactic. Simply waiting for inbound deal flow will (eventually) become a losing strategy.

Earlybird Venture Capital is pan-European VC based in Germany. This firm is particularly forward thinking in the re-engineering of the VC investment process. In an article, The Future of VC: Augmenting Humans with AI, Principal, Andre Retterath, describes how the process is changing. The use of data and intelligent algorithms is now central. There is a huge range of online sources VCs use to first identify new startups. APIs into all the major commercial dataset providers (such as Pitchbook, CBInsights, and Crunchbase) are then used to suck in key company data points.  Web crawlers then identify changing information from other sources such as LinkedIn, Twitter, Google News, App Store, product review sites, payment sites, website traffic sites, and dozens of others to provide insights on various 'growth metrics', such as headcount. This is all becoming fairly standard procedure for VCs today. But with over 10,000 potential investment opportunities arising across Europe every year, the battleground is now moving from sourcing to screening.

Screening methods employed today are used to 'score' companies on a range of growth metrics. This approach filters out companies that won't be a great profile fit for a specific VC fund. As the sheer volume of growth metrics rises, VCs are experimenting with ML-based approaches to more intelligently 'filter in' companies to target for closer assessment. Some of the early results here are remarkable. Retterath says, " It's clearly time to trust the algorithm as it significantly outperforms human VCs in screening European early-stage startups."  But a key element is still missing and that is the human factor. The relationship between VC partner and founder is a chemistry that can't be determined by an algorithm (well, maybe not yet!). VCs agree that using ML techniques to augment the human VC will likely provide the optimum result. In the meantime, founders must pay the greatest attention to ensuring that key sources of public data are kept up to date. If your 'growth metrics' aren't tracking, even the algorithm will ignore you.

Founders must think more like scientists

One of the foundation stones of modern startup theory is the experiment. Taken from the scientific method, the business strategy starts out as a theory. Prior insight and customer discussions enable the development and early testing of the problem/solution hypothesis. Finally, a fully fledged MVP enables experiments to validate the core solution with early adopters. Results are measured to determine if the hypothesis is supported or refuted. Small changes are then made to zone in on the beachhead market that will provide the strongest cohort of initial customers. But when the evidence indicates that the foundational hypothesis is flawed, a pivot may be required. Research shows that entrepreneurs that have been taught to think like scientists pivot twice as often. They are more at ease rethinking their business models to find high growth opportunities.

Yet many founders step back when faced with the prospect of a radical change to their business model. In Adam Grant's Think Again, he cites some remarkable research that shows how entrepreneurs who are not cognisant of lean startup theory, will typically stay wedded to their original strategies and products. They are more likely to preach the virtues of their past decisions and prosecute the vices of alternative options. Some of this may be due to founders believing that to waver shows weakness. Grant says; "We typically celebrate great entrepreneurs and leaders for being strong-minded and clear-sighted. They’re supposed to be paragons of conviction: decisive and certain. Yet evidence reveals that .. the best strategists are actually slow and unsure. Like careful scientists, they take their time so they have the flexibility to change their minds."

But this is not an open-ended experiment. Research by Startup Genome reveals that there is a limit to how much fundamental rethinking is good. 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. Founders should ideally prosecute any pivot(s) before investing in scaling activities. Pivoting at Seed stage is almost taken for granted by investors, whereas later-stage pivots are often much more expensive and disruptive. For this reason, Series A investors will want reassurance that the company is through pivot territory and onto a clear growth path where strong and sustained value creation is underway.

Happy reading!

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