Duet Partners
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Weekly Briefing Note for Founders

7th November 2022

This week on the startup to scaleup journey:

  • Founders must 'begin with the end in mind'
  • Crossing the Chasm - from Seed to Series A
  • The supremacy of 'category power'

Founders must 'begin with the end in mind'

Startup CEOs must approach fundraising in a very different way to the CEOs of established businesses. If a company is self-sustaining through trading, capital raising is usually an accelerant to drive some form of 'inorganic' growth. Without funding, such a business is still 'default alive' and not in peril due to a diminishing cash runway. In the startup, capital raising is an essential, time-critical objective. Such a business is 'default-dead': If it doesn't raise capital it will almost certainly cease to exist in any meaningful way. The established business can pick the very best time in the market cycle to raise capital. A startup often has little choice on timing. These circumstances produce very different pressures on CEOs at these different stages. But this is only half the story about why the fundraising approach must be so different.

An established business has the time to develop a funding strategy once the business strategy is underway and delivering results. In the startup, experienced founders know that when the runway is finite, these strategies must be interwoven in time and executed in parallel. The funding strategy is thus an integral part of the business strategy from day 1. Why? Each funding event is essentially providing the resources to ensure the company is fundable again at the next round. The pathway from initial idea to early scaling therefore consists of a series of milestones that are aligned with certain investment criteria. Founders must develop a deep appreciation of what these criteria are, or likely to be. Naturally, they will evolve with the funding market and will vary between investors. But the 80/20 rule generally prevails here. And whilst the criteria for an established business are mainly financial, they are necessarily more diverse for a startup that may only just be starting to trade.

In the The 7 Habits of Highly Effective Founders, our take on Steven Covey's best selling book The 7 Habits of Highly Effective People – Powerful Lessons in Personal Change, habit 2 is 'Begin with the end in mind'“To begin with the end in mind means to start with a clear understanding of your destination. It means to know where you’re going so that you better understand where you are now and so that the steps you take are always in the right direction.” Experienced startup founders get ahead of the game as soon as they have closed each round by reviewing the investment criteria likely to be tested at the next round - and baking these into their plans. They set clear goals, distribute ownership across the team, and monitor progress. A formal checkpoint several months before the funding campaign starts is a perfect moment to test the state of investment readiness and finalise the funding strategy. If shortcomings are found, there is hopefully still time to make adjustments. These should all be put to bed before the new investor pitch is drafted.

Crossing the Chasm - from Seed to Series A

In Geoffrey Moore's classic work, Crossing the Chasm, he reveals that the journey through the product adoption lifecycle is neither smooth nor gradual. Moore challenges classic lifecycle theory by introducing the idea that between the Early Adopters and the Early Majority there is in fact a major discontinuity - "The Chasm". In simple terms, what the early adopters or 'Visionaries' are searching for is significantly different to what the early majority or 'Pragmatists' seek. The Visionaries see the new product as a change agent, a disruptive force that can be used to enable immediate competitive advantage - even if incomplete. By contrast, the Pragmatists are looking for something that is proven, complete, and dependable. As a result, transitioning from the early adopters to the mainstream market calls for a fundamentally different approach. For example, Moore tells us that the first step is to focus resolutely on a specific segment or niche of the market and dominate this first - to secure a "beachhead" - from where word of mouth becomes the initial marketing strategy. In this way, the Visionaries are used (perhaps unwittingly) to give confidence to the Pragmatists.

We can see how this concept has influenced lean startup thinking in the mainstream markets of today - especially for high growth businesses with category-leading aspirations. For example, the creation of the Minimum Viable Product to establish early traction in the beachhead with the early majority. But just as a chasm exists between the expectations of the Visionaries and the Pragmatists, so a similar chasm exists between what makes a Seed stage business investible and what makes a Series A business investible. The transition might appear linear and gradual, but it is not. If it were, then far more startups would graduate. Research by McKinsey has shown that in both the US and Asia, only around 33% of all startups that successfully secure Seed funding then manage to graduate to Series A or some form of exit. Across Europe, this figure is significantly lower at 23%. This is why experienced founders start Series A planning early, often shortly after their Seed round completes. We consider this further in our blog post: Crossing the Chasm - From Seed to Series A.

McKinsey maps the entire company life-cycle across private funding stages. In the US around 20% of Seed funded companies eventually reach growth stage (Series C) or exit. In Europe this figure is only 14%. This lower level of advancement doesn't mean that European companies are more likely to fail. Failure rates across Europe and the US are actually comparable. Rather, European companies are more likely to stall after a fundraising round, meaning they simply don’t advance to the next stage of funding or don’t manage a successful exit in the form of an IPO or some sort of acquisition. Of course these companies could be growing organically and be happily profitable. But this 'missing 6%' could also be sacrificing a real growth opportunity and the potential to become a global category leader, where the biggest exit returns can then be realised. As a result, experienced founders know that when pitching to US investors they must articulate the most compelling growth plan, irrespective of funding stage. This must be a plan full of ambition that will ultimately propel them across the chasm and beyond.

The supremacy of 'category power'

The works of Geoffrey Moore, celebrated author, business consultant and now Venture Partner at Wildcat Ventures, are a constant reference in our work. His most celebrated book, Crossing the Chasm, that we refer to above, has become a canonical work for companies trying to unlock new markets. It is as relevant today as it was when first published back in 1991. His other books, especially Inside the Tornado, have been thumbed eagerly by scale-ups on high growth trajectories now for many years. Moore has a particular gift for deconstructing and then analysing the challenges faced by entrepreneurial leaders. This is why so many VCs follow his work and adopt so much of the terminology that he has brought into common usage. For example, his insights into the supremacy of 'category power' explain why the most successful disruptors seek out and then unleash 'trapped value' in new categories. This potential for huge value release is the ultimate founder insight.

For those looking for a primer on Moore and his work, his interview on the recent Colossus podcast is inspirational. One of the most enlightening topics is the Hierarchy of Powers, where 'category power' trumps all other forms of economic power. The most powerful business is the one that defines and owns the new 'category'. As a category becomes established, competitors gradually move in. But if a company has cemented its category-leading position it will continue to reap the greatest profits (until someone else redefines that particular category). That's why thematically-driven VCs study the potential emergence of new categories as this is where future unicorns are often birthed. Importantly, in the formative stages, new categories spring from quite narrow use cases that are exploited in the beachhead and then expanded out over time. Eventually, startups often transition to become 'platform' companies where they are gradually able to support many use cases - sometimes across multiple industries.

As a VC assessing new categories, one of the first questions Moore asks founders is, "Where is the trapped value?". This is the economic value that cannot be released in the current definition of the category. Travis Kalanick (Uber) found the trapped value in the back seat our cars; Brian Chesky (Airbnb) discovered we had trapped value in our spare bedrooms. The second question is, "What is trapping the value?" and the third is "What (disruptive solution) unlocks this value?". VCs pay most attention to where high concentrations of trapped value can easily be found in the very early stages. For example, at launch, Uber concentrated on one city only, San Francisco. But not all trapped value sits in existing 'suboptimal' categories. In DeepTech businesses, where pioneering technology development can take years, the initial use cases that prove trapped value can be released are often not even known. Everything is much more speculative to begin with. For example, early pioneers in quantum computing only had a vision for what might one day be possible - and this remains very much still in the future. But so compelling is this vision (that dozens of industries could be disrupted beyond recognition within the next 10 years or so, creating many new categories) that investors now simply can't ignore it.

Happy reading!

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