This week on the startup to scaleup journey:
What Europe's Q3 VC figures reveal
The latest assessment of European venture investment in 2022 by Pitchbook provides some important insights for founders. As we reported recently, deal value dropped 36.1% quarter-over-quarter in 3Q22 to €18.4 billion, its lowest figure since 4Q20. While pace throughout 2022 appears to have kept up with 2021, thanks to a more robust first half than experienced in other geographies, Q3 has delivered the decline in dealmaking activity that many analysts anticipated. Even so, we could finish the year with deal values comparable to 2021 - if activity picks up in Q4. As of September 30, 2022, €76M in deal value had been recorded across Europe compared with the full year 2021 figure of €103.5M. No small feat when global markets are in turmoil. Dealmaking remained resilient especially amongst angel, seed, and early-stage rounds through Q3 as roughly a third of completed deals were first-time financings. And the proportion of first-time rounds is consistent with recent yearly figures, indicating that the desire by investors to source, evaluate, and invest in new VC deals persists.
Nontraditional investors, which Pitchbook defines as Corporate VC arms (CVCs) and financial institutions including investment banks, private equity (PE) firms, sovereign wealth funds, hedge funds, and pension funds, among others, have formed part of a burgeoning investor pool for startups in recent years. VC deal value with nontraditional investor participation touched €58.9 billion through 3Q22, exceeding 2021’s record figure of €57.3B. Despite markets entering correction territory globally, nontraditional investors have continued to participate in VC rounds. VC has enjoyed a bull run for over a decade with nontraditional investors enticed by high-growth companies emerging in nascent sectors. VC investments have enabled corporates to keep abreast of technological development and leverage expertise from growing businesses via strategic partnerships, while financial institutions have been able to diversify portfolios away from core investment areas and generate stronger return profiles for shareholders or limited partners (LPs).
Looking ahead, Pitchbook believes recent currency parity between the British pound (GBP) and the US dollar (USD) could stimulate additional activity in the UK. Globalisation and VC have been intrinsically linked for several years with US-based investors pursuing cheaper Europe-based investments to bolster portfolios and increase returns. The UK is usually the largest VC deal value generator in Europe annually with a particularly high concentration of startups and capital flooding into London. As UK investments have become significantly cheaper in US-denominated figures in recent weeks, US-based investors may look to benefit from favourable near-term currency shifts. A drastic uptick in deal value or spike in closed deals is highly unlikely, but with costs soaring globally, companies may seek innovative solutions to offset inflationary pressure. US-based companies may look to funnel resources into UK operations and investors may do the same to get better value for money.
Founders must be masters of persuasion
For many technical founders the act of 'selling' doesn't always come naturally. Nowhere is this more exposed than in the investor pitch. Even with a solid pitch deck, if you stumble awkwardly through the delivery, prospective investors will just not engage. The founder's safety zone is then to talk more about the product, but that's the last thing an investor wants to dig into in the first meeting. Investors need persuading that as an investment this is going to be unmissable. And if you can't persuade them, they'll have doubts about your ability to persuade customers. For technical founders who feel that they barely have a single 'marketing' bone in their body, this can seem like a daunting challenge. But it doesn't need to be like this. Experienced founders know that it’s the narrative that really counts. The slides are merely a backdrop to support a presenter-focused story. Get the storytelling right and investors (and customers) will engage. And the good news is that storytelling is a skill i.e. it can be learnt.
Research has shown that audiences are more likely to engage with and adopt messages that make them feel personally involved by triggering an emotional response. Character-driven stories consistently cause oxytocin synthesis in the brain. Oxytocin is a neurochemical that, amongst other things, promotes empathy and cooperation with others. In his book, Insights into Influence, Noah Zandan reveals: "We tend to believe the story more readily than we would believe a non-narrative account. This is because our brains actually process narratives differently. When we’re taking in straight information, we’re paying critical attention to the message - reaching back for our own existing knowledge and opinions and actively analysing what we’re hearing. When we’re transformed by a narrative, however, our single focus is on the story. We absorb it entirely, without pausing to deconstruct or doubt what we’re hearing. We’re truly swept away, and this makes us more likely to embrace the ideals and messages the story is promoting." Oxytocin truly is the storyteller's friend.
Related research by Paul Zak, captured in his article ‘Why your brain loves good storytelling’, shows that character-driven stories with emotional content result in a better understanding of the key points a speaker wishes to make and enable better recall of these points weeks later. As a result, Zak advises businesspeople to begin every presentation with a compelling, human-scale story. For the founder, this could be their own story of discovery, or the story of an early adopter whose business has been transformed. The delivery of this story is key and should follow that classic story arc: This starts with setting the scene, then building tension (the problem) to a tipping point, and then the moment of action that finally leads to resolution and relief. Just about any great movie or book you have read will have followed this pattern. A pattern hidden in plain sight. Founders that are unable to picture themselves as 'salespeople' just need to rethink. Don't worry about becoming a great salesperson, just become a great storyteller instead.
Stop talking and let the investor ask questions
Just as the startups transition through funding stages (Seed, Series A , B..) so too the funding process at each stage is a series of steps. During investor outreach, the purpose of each step is solely to open the door to the next, until the investment is done. The initial approach is usually a short 'teaser' deck. This hopefully leads to the pitch meeting, then subsequent in-depth discussions, then a Term Sheet, then due diligence etc. Through this process the investment proposition is gradually unveiled. But as each step is 'pass/fail' the temptation is to tell the entire story in all its glory as early as possible. This is a mistake. The pitch is only part of the unveiling process. It is there to excite, not educate. There will be time to educate later on, but for now the goal is to create anticipation, to draw the investor in with a compelling narrative, and to trigger the emotional buying decision.
How do you know if this is happening? The biggest tell tale sign is the number of questions the investor asks. Albert Wenger is a partner at Union Square Ventures (USV), a New York-based early stage VC. In his blog he says "..your goal is to get from push mode into pull mode as quickly as possible. What do I mean by that? You want to stop talking and let the investors ask questions. A bad pitch is one where you do all the talking. A good one is where the investors are tripping over themselves to ask questions. So what does this imply? Keep your pitch geared towards being intriguing rather than trying to answer every question upfront." If the technique is to elicit questions, then being prepared for the hardest questions is crucial. Founders should create a FAQ in the preparation stage so they are ready. Answers with numbers in them are the most memorable and credible. And the more succinct the answer the better.
Wenger says, "The crucial art of giving an answer is to deliver it firmly and then shut up. Nine times out of ten that’s it and the conversation will move on to a different question." But if the investor wants to go deep, you have to go deep too. Don't try and skirt the question, as this is a test. In your backup slides have solid reference material on the potentially contentious points. You may never use it but having it there will give you extra confidence. That confidence will radiate. And in the debates that will (hopefully) ensue, engage fully, but don't forget to tie this into to your headline messages: the key customer benefits; why you will succeed; and what's in it for investors. Make these bold, simple statements. Create initial engagement on what you will do and why you will do it. The how can be the reason for the next meeting.