This week on the startup to scaleup journey:
Your Board is probably going to fire you
Building an effective board is a challenge every founder faces. There is plenty of advice out there on how to do this but a majority of it skirts around the most contentious part. When not managed properly, boards are dangerous to you as the founder/CEO of the company. If you don't carry the board with you and fail to meet their expectations, they may wield the ultimate sanction and fire you. Boards are of course necessary and have important fiduciary duties. But the dynamics of the startup board, where new investor directors invariably appear with each major funding round, are driven by other motivations. The biggest misconception that founder/CEOs have is that the VCs they bring onto the board are there to 'add value'. As founder and investor Jerry Neumann puts it in his blog: "The VCs are not on your board so they can help you, they can help you without being on the board. They are on your board for one reason: to monitor their investment so they can do something if things aren’t going how they want." That's not an unfair expectation. It may sound too narrow or cynical a view, but founders that don't grasp this reality lay themselves open to surprises.
Neumann offers 5 pieces of advice to ensure founder/CEOs carry the board and lock in their support. 1. Control the board composition. This means the common shares control a majority of seats. This may work for the initial round or two but as bigger rounds are closed the investor directors end up occupying more seats. The addition of more independent directors can help, but the effect can largely be illusionary as the VCs have many ways of exerting 'soft power' over the independents. 2. Be the hub of the board. That means being involved in all conversations involving the directors. If a board member voices an issue and you are in the conversation, you can talk about solutions. If a board member has a problem and the only other people in the conversation are other board members, the only fix they may have is replacing you. 3. No surprises. As we highlighted in our piece, Pre-Board 1/1 calls are a power tool for CEOs, the board meeting is not the place to convey important information for the first time. Reactions can be unpredictable, so always handle this 1/1: Tell them the news, tell them what you think the company should do about it, and then listen to what they have to say. You will present the exact same information in the board, but everyone will have heard it already. You will present your plan to deal with it, as informed by the comments of the board members you previously heard. And you will give them credit. As Neumann says, "They love being recognized in front of their peers for adding value."
Beyond these preparatory steps, there is the board meeting itself. 4. Do not make your board members think in the board meeting. This is about controlling the agenda - not just the formal agenda but the investor's informal 'agenda' of monitoring their investment and deciding if they still want you to be CEO. Make it clear the company is doing the things that will make it quickly increase in value. If this is not (yet) the case, present them with the bad news but couple it with the actions you are taking to fix the problem. Neumann observes: "Of course, you have already told them all this 1/1, so you know how they will react....no surprises." Finally, 5. Lean on your first board members. These very early investors will know better that others that there is no company without the founders. They essentially backed you, not the company. They helped coach you at the outset and feel more vested in your success. They will likely be your biggest allies right until the end. Neumann concludes: "There is no value-added board. There are no value-added board members. There are value-added people. Some of them are your investors and board members. Definitely talk to those people. But remember that their role as board member is not to add value to you, but to add value to the company, which is a different thing. Do not confuse the person with the board member."
Teach GPT-4 how to create a startup
Our thanks to investor Phil Morle for an inspiring post this week on using GPT-4 to create startup scenarios. The results provide a compelling foretaste of how VCs will evaluate prospective investments....
Paste this text into the Chat GPT-4 interface:
COMPANY NAME: [give it an imaginative name]
PROBLEM: [the problem it is solving and the scale of the problem]
SOLUTION: [a product that could solve the problem with strong science behind it]
RESEARCH FOUNDER: [a university with world class research related to the SOLUTION. Ideally also supply a specific department and researcher]
INDUSTRY FOUNDER: [an existing company with supply chain and customer knowledge that could deliver rapid advantage. How would they help?]
TEAM FOUNDER: [an individual on Twitter who thinks a lot about these topics.]
Then type in the problem scenario. For this example, we used: "The problem is how to increase the recycling of single use plastic in the UK."
This is what GPT-4 produced within a few seconds:
COMPANY NAME: ReCycle UK
PROBLEM: The problem ReCycle UK is solving is the low recycling rates of single-use plastic in the UK. In 2019, the UK used around 4.9 million tonnes of plastic, with only 1.15 million tonnes being recycled. This low rate of recycling is leading to significant environmental damage, including pollution of the oceans and harm to wildlife.
SOLUTION: ReCycle UK has developed a product called Recy-Loop, a closed-loop recycling system for single-use plastic. Recy-Loop is a technology that uses advanced sorting and cleaning processes to turn single-use plastic into high-quality plastic pellets, which can then be used to make new plastic products. Recy-Loop's closed-loop system ensures that single-use plastic is recycled and reused, reducing waste and environmental damage.
RESEARCH FOUNDER: ReCycle UK has partnered with Imperial College London's Department of Chemical Engineering, which has world-class research in plastic recycling and circular economy. Dr. Andrew J. Hunt is leading the research and has published numerous papers on plastic recycling technologies and their environmental impact.
INDUSTRY FOUNDER: ReCycle UK has partnered with Coca-Cola European Partners, one of the largest beverage companies in the UK, to help deliver Recy-Loop to customers across the country. Coca-Cola's supply chain and customer knowledge will help ReCycle UK bring its product to market quickly and efficiently.
TEAM FOUNDER: Mark Johnson (@markjohnson) is a sustainability consultant and thought leader on Twitter. He has a deep understanding of the circular economy and recycling, and regularly tweets about innovative solutions to reduce waste and environmental damage. Mark will be a valuable addition to the team, helping to drive awareness about ReCycle UK and its mission.
Quite impressive as a first step. Now imagine how VCs will use GPT-4 to evaluate your startup idea. By experimenting with this basic construct, VCs will be able to dig further into your entire thesis. At the very least this will help them prepare some interesting questions for your pitch meeting. Get ahead of this by first running your own scenario to see what emerges. It will take less than a minute to get this initial feedback. VC Analysts are already starting to create much more complex evaluation models using both Generative and Predictive AI. This will layer into new commercially available AI tools aimed at helping VCs and other investors identify, research and qualify potential investment opportunities. For example, an 'Exit Predictor' tool is now available within the Pitchbook platform and CBInsights also uses predictive analytics to 'score' the quality of a startup’s founding and management team. And with deal flow volumes reaching unprecedented levels (even relatively small Seed stage investors in the UK are receiving over 1,000 approaches per year) deal filtering is the next big challenge. The days of the warm intro + teaser deck now seem limited. A number of investors are already asking founders to first complete a qualification questionnaire via their website as an initial (mandatory) step. Today, these submissions are reviewed by a human...but it's not hard to imagine where this is all going.
Make something a lot of people want
As we highlighted last week, analysts are saying that 2023 could be a vintage year for VC. This means more emphasis on early-stage investing across the venture landscape. At this formative stage, investors take a bigger gamble that their bet will pay off. But if it does, it can reap much greater rewards. The due diligence risks here are higher as there is going to be less evidence of progress than say at Series A or B. As a result, investors will dig much more deeply into the 'fundamentals'. What are these fundamentals and what can founders expect to be grilled on? Legendary investor, Paul Graham, of YC fame provides some useful context in his essay 'Billionaires Build': "The first thing [we] will try to figure out ... is whether what you're making will ever be something a lot of people want. It doesn't have to be something a lot of people want now. The product and the market will both evolve, and will influence each other's evolution. But in the end there has to be something with a huge market." His point is that the YC partners have to guess both whether you've discovered a real need of significant scale, and whether you'll be able to satisfy it.
Most investors will say that the crucial feature of the initial market is that it exists. "There have to be some people who want what you're building right now, and want it so urgently that they're willing to use it, bugs and all, even though you're a small company they've never heard of." As Graham points out, there don't have to be many users, but there have to be some. As long as you have some users, there are straightforward ways to get more: seek out more people like them, get them to refer you to their friends, build new features they want, and so on. Cultivating this initial group of users or 'early adopters', by means of an initial product, is a viable strategy for a software business and helps navigate the path to product/market fit. But for a hardware business, this is far less straightforward. The early product may only be a basic prototype and not yet in the hands of customers. Here, a much greater burden of proof falls on the shoulders of the founder to explain why people will want what they are building. The founder's market insight therefore carries significant additional weight in due diligence.
Founders that have lived and breathed their industry from the 'inside' have a particular advantage. They will already know the entire food-chain, all the incumbents, the technology and market drivers, and so on. Investors will rarely be domain experts to the same level. It's not unusual for investors to use outside experts to undertake due diligence but where the founder is the domain expert, this isn't necessary. Graham says that "if it's clear that the founder (a) knows what they're talking about and (b) aren't lying, they [YC] don't need to consult outside domain experts." In our experience, the founder will appear credible if they can combine an in-depth assessment of the new market (down to the use-case level) with a comparative assessment of potential solutions, and why those solutions will fail to meet the market needs. Once these early-stage investors gain conviction that you're making something that a lot of people want, they'll be open to hearing how you intend to satisfy this need.