Duet Partners
Tel: +44 (0) 20 7416 6630 / Email: partners@duetpartners.com

Weekly Briefing Note for Founders

26th September 2022

This week on the startup to scaleup journey:

  • Scaleup challenges in European DeepTech
  • Can corporates play a greater role in DeepTech funding?
  • Founders must adapt as the team grows

Scaleup challenges in European DeepTech

On the face of it, things seem to be improving across the European DeepTech landscape. Over the past 6 years, investment has been growing at a rate of about 50% a year according to research by BCG. This analysis shows that in 2016, European DeepTech startups raised one-eighth as much VC equity as their North American counterparts; by 2020, the difference had dropped by half. But today, Europe’s DeepTech startups - those taking breakthrough technologies like synthetic biology, quantum computing, and advanced materials from laboratory to market and using them to address large-scale fundamental problems - continue to face significant challenges. These are most acute as startups begin to demonstrate technology, seek commercial partnerships, and look to begin early scaling. The BCG research identifies four Europe-specific challenges for DeepTech companies entering the scaleup phase: 1. Securing financing and, in particular, a lead investor. 2. Building and leveraging a strong and productive board of directors with independent members. 3. Developing a compelling business strategy and investment narrative, and 4. Navigating European institutional challenges.

The BCG report assesses all four challenges but it is clear that funding remains the biggest hurdle - in particular securing a lead investor for the early institutional rounds (primarily Series A and B). There are still relatively few DeepTech investors in Europe. They include a handful of funds that regularly invest strategically in DeepTech and a few more opportunistic funds that explore advanced technologies from time to time. The specialist funds that only invest in DeepTech tend to be small. Since large lead investors frequently anchor the initial scaleup rounds, this shortage remains a significant problem. In the US, by contrast, several large and established venture capital funds regularly take the lead position. On strategic technologies, especially in the light of China's growing dominance in semiconductor manufacturing, the recently passed CHIPS and Science Act will boost US investment even further. European DeepTech founders have often had to turn to US investors to lead scaleup rounds. But now, with the Russian invasion of Ukraine further exposing national and regional fragilities from food security and energy to defence, there is a risk that US funds will become much more inward-looking.

Then there is the European attitude to risk. In the survey, executives from multiple companies put it this way: “While European investors typically ask, ‘How small can the investment be? How can we minimize the risk?’ US investors ask, ‘How big can the investment be? Would the impact double if we doubled the investment?’” Layered on top of this is the lack of DeepTech knowledge and experience among European funds. Only a fraction of European generalist investors have a strong grounding in advanced technologies. This lack of knowledge leads to a mismatch in expectations, especially in relation to investment stage criteria. VC funds in Europe often require solid proof of revenue or market traction before they invest in large rounds. But because the development timelines of advanced technologies are longer and less predictable, few DeepTech companies have sustainable revenues by the time they are ready for larger funding. In the face of these and other challenges outlined in the BCG research, European DeepTech founders are increasingly looking at corporate investment as an early stage accelerant. Indeed, stronger collaboration between startups and corporates could aid Europe's long-term prosperity and strategic autonomy. But how viable is this funding route?

Can corporates play a greater role in DeepTech funding?

A recent report from McKinsey on 'Europe's corporate and technology gap' makes sobering reading. Although Europe has many high-performing companies, in aggregate European companies underperform relative to those in other major regions: they are growing more slowly, creating lower returns, and investing less in R&D than their US counterparts. This largely reflects the fact that Europe missed the boat on the last technology revolution (centred on the internet and software) lagging behind on value and growth in information and communications technology (ICT) and on other disruptive innovations. But this is a story we have heard before. The earlier revolution in semiconductor technology - and the many associated supply chains - was a key enabling force for the internet and software eras. Today, semiconductors produced in Europe meet just 9 percent of European demand, and European companies have only about 10 percent of the market across the semiconductor value chain. Even more alarmingly for the future, the McKinsey research looks at ten 'transversal technologies' - those that spread across sectors such as AI, the cloud, and next generation computing - and finds that Europe leads on only two of them.

Critically, value creation is shifting away from traditional industries to these horizontal areas, with winner-takes-most dynamics and network effects in technology creation and scale advantages in technology adoption. For example, ICT used to be a sector; now it is everywhere. In Quantum Computing, one of the key horizontal technologies for the future, 50% of the top ten major tech companies investing in this transversal technology are in the United States, 40% are in China, and none are in the EU. The World Economic Forum estimates that 70% of the new value created in the global economy over the next ten years will be digitally enabled. The effects can already be seen: An examination of 2,000 US and European companies with revenues over $1B shows that between 2014- 2019 European companies were 20% less profitable, grew revenues 40% more slowly, and spent 40% less on R&D than other companies in the sample. If Europe is not able to improve on transversal technologies, European firms could miss out on a value-added opportunity of €2 trillion to €4 trillion a year by 2040, says McKinsey, adding: "European decision makers and companies need to go on the offensive for a step change on technological capabilities and competitiveness."

What does this all mean for founders seeking corporate investment? For companies in traditional industries, the mantra must now be 'innovate or die'. A great example is in automotive. Already US manufacturers account for close to 70% of all kilometers driven by level-4 fully autonomous vehicles. But European automotive manufacturers and their supply chains are now accelerating, looking to build competitive advantage wherever possible. As a result, collaborative investment into startups is rising and M&A is also ticking up as established firms look to buy in critical capability. The signalling that even a relatively small investment into a startup can send to the VC community can act as a real catalyst for further investment: it is an endorsement of the market need, especially if it is accompanied by a commercial engagement. In the very early stages this might be a pilot project to prove the technology in a real application. Corporate investment is also patient capital - unlike VCs who are typically looking for a financial return within 5-7 years. And corporates can also be an excellent source of board-level advisors and non-execs, providing valuable industry insight if the founders don't have this first-hand experience themselves. Corporates that are truly embracing the startup world can create real win-win outcomes. We now need more of them.

Founders must adapt as the team grows

The transition from startup to scaleup typically begins when you find product market fit (PMF). You shift from running experiments to building a company. This is often the moment for the Series A round. In the current uncertain market, investor expectations of what happens next have risen to new levels. This is a period of major transition, not just for the business but for the leadership style of the CEO/founder. Much of this is driven by team size. In the small startup huddle, ideas - and the execution of those ideas - take priority. The team, as well as the founder, are all goal-oriented domain experts that need little management. As the team grows, not everyone will be such independently minded individual contributors, and 'softer' management skills will be required. For the CEO whose highly self-confident 'take no prisoners' approach to finding PMF has been validated, this can be a particularly tough transition. Just being aware that a change of gear is now needed can be a huge help. New investors will test for this self-awareness and the ability to adapt.

The first big challenge is usually recruiting an extended team that can execute the business plan. Many CEO/founders have never hired big teams, managed large organisations, or set up international businesses. This can all be daunting. As a result this whole process often moves forward too slowly. In the hunt for the 'perfect fit' candidates, inertia sets in. This is deadly. Experienced CEO/founders know how to build a recruiting engine - how to go from 10 heads to 50, then to 100 in 1-2 years. This engine requires a 'driver', someone to manage the process, funnel in candidates, lead the interviewing steps, and even close the deal. The CEO has the final say, but sometimes needs cajoling. The driver can come in many forms (Head of HR/Head of Recruitment, Chief of Staff, COO etc.) but the title doesn't matter - the seniority does. Someone who can spar with the CEO and debate each candidate's suitability. They may not be a fit for the role, but if they're awesome, a role should be found for them. The driver, who must be a trusted confidante of the CEO, can help make this all happen.

The next equally difficult challenge is practicing real delegation. Most CEO/founders will have been into every detail of getting the company started and it's really hard to let go. Inevitably, as the team grows - especially as you add a layer of management - things seem to slow down. The reality is that with some particular tasks it's often true that no one else can do them as well as you. The temptation is to bring things back under your control, but this is a trap. CEO/founders must work out how to delegate, coach, and empower. VC and former operator John Danner says"Surround yourself with people who are as good at execution as you are with ideas. Hopefully they are good enough with ideas and you are good enough with execution to give each other rigorous feedback."  CEO/founders often get in the way of progress by becoming the bottleneck. Back yourself to hire the right people. Then step out of the way.

Happy reading!

Subscribe to our mailing list

Stay informed. We will email you when a new blog post is published.

* indicates required

To subscribe to our Newsletter click here