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

Weekly Briefing Note for Founders

11th April 2022

This week on the startup to scaleup journey:

  • Founders must radiate a winning mentality
  • Startups increase due diligence on VC funds
  • How well funded are your competitors?

1. Insights of the week

Founders must radiate a winning mentality

Founders are usually driven to raise capital because their startup is running out of cash. But this is not why early stage investors invest. They invest because they buy into you and the opportunity you present. They do this after first building conviction. Successful founders are able to 'transmit' their inner conviction to investors. We are conditioned to think that the vehicle for conveying this is the investor deck. But this is only partly true. It is the founder themselves that is the real vehicle. This may sound obtuse, but no matter how great your deck is, if you don't radiate conviction that you believe the business will be a success, you won't convince investors. They will initially assess the viability of your conviction on the basis of whether they think you're a winner or a loser. That brutal decision gets made in the early stages of the investor meeting. This might sound callous, but first impressions count - a lot. Does this mean the founder that is slicker at pitching will get the money? Not always.

Investors will typically characterise a 'winner' as a founder that has a bold vision, a resolute belief in the opportunity, and the determination to see it though. These are all cues for conviction. Serial founders that have been down this road before know a secret about communicating conviction. They contextualise the 'vision', the 'opportunity' and the 'determination' in terms of the market. This is because investors, especially VCs, think in terms of markets. Markets have scale and value, they define how the various players interact, they contain customers and competitors, and, above all, they can be won (or lost). This is the battleground that investors can most immediately relate to. Even if they don't understand your technology innovation or how the product works, they will almost certainly understand the go to market approach and the business model. If this puts you on uncomfortable ground you could be at an immediate disadvantage.

Experienced investors are very good at pattern recognition - they have seen it all before, many times. One pattern is the technical founder that has developed a product or solution 'obsession'. They may struggle to radiate conviction as they don't naturally think in terms of markets. They lack this more holistic view and even though they believe they have developed a killer product, growth remains elusive. Conversely, technical founders that operate with a 'market-first' mentality can be highly investible. Think Steve Jobs. They combine an ability to build with the perspective of a user and a clear view of how to service that user. And lots of users with the same problem equals a market. You may not be the world's smoothest presenter but if you can confidently unpack your unique market insight, you will be off to a flying start. Demonstrating that you deeply understand the opportunity space and have a game plan for grabbing it will then cement your winning mentality.

Startups increase due diligence on VC funds

Experienced founders know the value of undertaking VC due diligence prior to investment. Ensuring close alignment of ambition is essential for such a long-term relationship. But this is not always easy to test. Most institutional investors, especially the major VCs, provide clear signalling on their investment thesis. Many prefer certain stages (Seed, Series A, etc.), or certain market sectors, or even specific business models (B2B, B2C, B2B2C...). This much is clear from the outset and is used by founders to create their investor target list. What is often less clear is the investment horizon of the fund: In what timeframe will returns be sought? For a typical 10-year VC fund, where the initial investment period is usually the first 3 years of the fund, the return period will often be stated as '5 to 7 years'. But this is not information investors feely offer, so founders must ask. This is a crucial piece of information when finally selecting an investor, especially when founders anticipate multiple follow-on rounds. It also explains why funds that are coming to the end of their initial investment period seek more mature businesses than they did when the fund was initially minted.

But there is another key point of diligence that founders are increasingly paying attention to and that is who the Limited Partners (LPs) are. The LPs are the investors in the fund and these typically include pension funds, sovereign wealth funds, insurance companies, family offices, university endowments, and high net worth individuals. This topic has been brought into sharp relief with the war in Ukraine. Boards have become increasingly sensitive about funds that are backed by Russian oligarchs. As reported by Insider, the scale of Russian investment in Europe's tech ecosystem is difficult to quantify due to the opaque nature of LPs. Even so, some Europe VCs have moved to distance themselves from Russia following the invasion. If a VC fund has an LP that becomes a sanctioned person, the fund is required to freeze that LP's assets. Given that it is estimated that only around 1.2% of commitments from European funds come from Russian LPs, the overall impact is likely to be small. The bigger funds should easily be able accommodate this and move on. But those with significant Russian backing, such as London-based Redline Capital and Impulse VC, will be heavily impacted.

Awareness of LPs extends beyond the Russia question. It is well known that different LP types will have different aspirations depending on their investment horizons. But it is increasingly apparent that they also differ in financial sensitivity or the magnitude of how their funding cash flows are affected by changes in underlying financial or economic factors. For example, many institutions are restricted by a set of predetermined rules, such as being able to invest only in funds with a clear exit plan or being forced to reduce their contributions, or drawdowns, below certain public equity valuation multiple thresholds - now becoming a hot topic. As a result, 'patient capital' is more likely to come from VC funds that have a strong element of strategic (e.g. Corporate or Government) or Family Office backing. When developing a relationship with lesser-known VC fund for example, it is therefore important for founders to do some research into their LP base as part of their own due diligence. If the answers can't easily be found from desk research, this is a question for the VC partner. If they are not immediately forthcoming, this should raise a red flag.

How well funded are your competitors?

Last week we discussed the importance of competitive positioning when building the investment proposition. The key takeaway was that competitive leadership requires clear differentiation on two fronts: First, a USP that will open up the market to drive early growth, and second, the creation of a long-term defensible position - a 'moat'. But there is a third aspect to competitive positioning that can rear it's head and that's understanding how your competitors are funded. Aside from this being valuable intelligence from an operational perspective, this can also have a critical bearing on your company's funding strategy. If there are already well-funded companies active in your space, this will influence how prospective investors measure the challenge that lies ahead. It could even dissuade them from progressing investment if it looks as though you are going to be heavily outspent.

Investors that have already funded another company in your space, even one that is only tangentially competitive (same sector, different 'category'), will be unlikely to invest in your business. Unless they are a very narrow sector specialist this will simply mean too many eggs in one basket. i.e. an unnecessary risk. The first step is therefore to figure out which investors have already made their move on your sector and strike them off your target list. Second, look to see if any important trends emerge from the data you dig up. If you can research a large enough cohort of direct, indirect and even partial competitors (sometimes referred to as a 'peer group analysis') this could reveal some key insights. For example, assume your selected cohort closed their Series A rounds between 2 and 3 years ago. The median deal size was $10M at a $30M pre money valuation. You are going out for your Series A in a few months, looking to raise around $6M at say a $12M valuation. What awkward questions can you anticipate from investors you approach?

Having competitor funding insights at hand for the investor pitch and follow-up discussions can really set you apart. Beyond the key metrics, understanding the type of investors that have taken to this type of proposition (VCs, Corporates, Growth funds etc) and where they are based geographically, can be illuminating. For example, just about every founder we have worked with over the past couple of years has been keen to know more about US investors. Startups that are currently planning their Seed or Series A rounds might be interested in seeing the type of competitor analysis we perform here at Duet. We are happy to provide a demo of this capability to any founder that is looking for a leg up on this topic. [Just email john.hall@duetpartners.com to book a slot. During the demo, we will create a competitor comparison chart containing a range of useful investment metrics that you can take away].

2. Other pieces really worth reading this week: 

Global Venture funding down in Q1 but up year on year
Global venture funding reached $160 billion in the first quarter of 2022, Crunchbase data shows, "..marking the first time in a year of records when startup capital fell quarter over quarter. The first quarter of 2022 jumped 7 percent compared to the first quarter of 2021, but fell 13 percent, from $184 billion, in the fourth quarter of 2021, which notched the largest funding amount raised in any quarter last year, and for all time."

How to lose your best employees
From the Harvard Business Review, a reminder not to take high-performing employees for granted. "You want to be a great boss. You want your company to be a great place to work. But right now, at this very moment, one of your key employees might be about to walk out the door. She has consistently brought her best game to work and has grown into a huge asset. But her learning has peaked, her growth has stalled, and she needs a new challenge to reinvigorate her. As her boss, you don’t want anything to change. After all, she’s super-productive, her work is flawless, and she always delivers on time. You want to keep her right where she is.....That’s a great way to lose her forever."

Rippling and the return of ambition
From the blog of John Luttig, a compelling perspective on how incrementalism is hampering startups. Grab a coffee, sit down and read this remarkable piece. Luttig's counterintuitive insights are an inspiration for founders everywhere.  "SaaS wisdom teaches us narrow lessons: start by conquering a narrow market and expand from there, add at least as much in ARR as you burn each year, and build your product either horizontally or vertically. Rippling rejects these norms entirely. It ignores the mimetic warfare of the Gartner quadrant. Its wedge was a data asset, not a narrow product. It doesn’t let SaaS metrics dictate its strategy."

Happy reading!

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