Weekly Briefing Note for Founders

25th April 2022

This week on the startup to scaleup journey:

  • Early action by founders gives greater control over funding strategy
  • Attracting talent as demand outstrips supply
  • When shaping the narrative it's better to come clean

1. Insights of the week

Early action by founders gives greater control over funding strategy

In early-stage investment rounds (Seed, Series A) investors typically look to provide sufficient capital to cover 24 months of expenditure. Whilst exact timescales will vary depending on circumstances, the idea is to give the startup around 18 months to demonstrate real progress - then 6 months to raise the next round. Boards usually start discussing the funding plan around 9 months before the round needs to close. Hopefully, some cash contingency is in place so the target close date is not the same month the bank balance hits zero. Having a buffer of at least 3 months of cash burn is highly desirable. With an outline plan agreed, founders then begin assembling the investor deck. Informal discussions with current investors take place to test their appetite to participate. With around 7 months to go the board approves the funding plan and ‘blesses’ the investment deck. The founder then begins reaching out to new investors.

This 9-month lead-in point can often be a sobering moment. It may be the first time there has been a serious overall assessment of progress in the context of the next funding step. This usually incorporates a review of the key objectives agreed at the prior funding round. Current investors will still be strongly wedded to these. If things have not gone according to plan, this retrospective analysis - and what it implies for the next round  - can lead to some difficult board-level discussions. Out of necessity, a funding plan is eventually born. But it can sometimes feel like the product of an unhappy marriage if there is weak alignment between the board, the main investors (some of whom will be on the board) and the founder. In such circumstances it can take a great deal of haggling to converge on the amount to be raised, the use of funds, and a target valuation. By which time many weeks may have passed and the pressure to get out in front of investors will have become intense. The overall investment proposition can then feel like a compromise compared to the founder's original ambitions.

But it doesn't have to be like this. Founders can put themselves in a stronger position to control the funding strategy by taking the initiative ahead of this 9-month point. Ideally, with around 12-months to go before fresh funding is required, a 'stock-check' of investment readiness should be made. At Duet we call this Investment Analysis. Progress is assessed but the reference point is less about the earlier objectives set and more about what new investors will be looking for. This is a classic 'gap analysis' and poses 3 key questions (in order of priority): 1. Who is our target investor audience? 2. What criteria will they use to assess our business? and 3. How do we currently measure up? With time in hand before the board starts raising the topic, founders can address the most critical gaps identified. A funding plan can then be developed by the founder in the light of all findings. Presenting a well-thought-out proposal on the funding strategy, the target investors, and the overall investment proposition, will imbue confidence and put the founder in a stronger position to deliver on their funding ambitions.

Attracting talent as demand outstrips supply

The ability to hire top talent is a key indicator for investors when evaluating a startup. As VC Hunter Walk says, "In my mind there’s no greater indicator of success than the quality and characteristics of the [first 20] individuals you’re able to bring on board. Success is a signal of two meaningful truths: you have the talent you need to execute your roadmap and A+ people have decided that you are worth working for."  But in the current hiring crunch, where demand for top candidates exceeds supply, founders are in a war for talent. In a recent survey, the abundance of capital in Europe was shown as one of the key drivers of these current recruitment woes, with VC investment in Europe hitting record levels in 2021. As some tech companies have found themselves able to offer far higher wages than they previously could following outsize rounds, others are getting priced out. And as funding continues to hit new highs in the UK during early 2022, many founders are finding it even harder to recruit the talent they need. For many startups, this is now becoming the biggest drag on growth. As a result, Investors have significantly elevated talent acquisition as a specific topic in due diligence.

But competing on salary alone has never been the battleground favoured by startups. Whilst in the end everyone has a price, recruits that come for the money will just as easily leave for the money - as soon as someone else dangles a fatter carrot. Instead, the lure has been more about getting behind the mission, imbibing the culture, and seeing the potential for exciting returns on stock-options. For many founders, the office itself has historically been an integral part of the hiring strategy because the atmosphere reflected the culture of the business. For many startups this was part of 'the offer' - the look and feel of the physical office, the other like-minded people mingling together, the general buzz. Those that resonated with the overall office vibe to a certain degree self-selected themselves in the interview process. Hiring managers could get an immediate sense for 'fit'. But since the pandemic the landscape has shifted. Remote working has impacted this connectedness to the culture. The general 'return to the office' push does not seem to offer much respite. Many candidates are now prioritising remote working with a high degree of flexibility on working hours as a priority in their job search criteria. In addition, candidates are seeking greater alignment between the ESG elements of the mission and their own personal values.

As talent becomes an increasingly valuable resource, the movement of key people around the industry is being tracked by all the main institutional investors - even if founders are blissfully unaware. VCs use investment research tools that monitor joiners and leavers in the main leadership roles, building up a 'location map' of key personnel. For example, to make sure Accel doesn’t miss any future superstars, it has catalogued the top talent of 200 leading European startups, across sales, engineering and product. The belief is that as soon as those individuals emerge with their own startups, Accel can recognise and back them instantly. Some VCs also have dedicated talent teams, intended as a resource for founders that are trying to identify top candidates. VCs appear keener than ever to understand the founder's hiring strategy - how they will attract, convert and retain the very best there is to drive the business forward. VCs can help fill the funnel here too, but it will be the founder's vision that ultimately gets candidates over the line - and keeps them there.

When shaping the narrative it's better to come clean

In the early stages of the startup, experimentation loops provide essential feedback. You are testing ideas on people, using an MVP to solicit feedback from early adopters, engaging with different cohorts of users, and trying out different product features. Through a process of trial and error, sometimes many steps back for only a few steps forward, a repeatable formula emerges. A formula that enables a product to efficiently reach a market where there is clear demand and real opportunity to make money. This process may take years, but eventually you are ready to start early scaling. This is typically the moment of the Series A round. As you craft your investor pitch, you try hard to build a compelling narrative around the journey and where you are headed. But there is an issue: Some of the experiments that didn't work out so well have created a legacy that just doesn't align with this narrative. This may be customers you picked up along the way that don't really fit this future vision; early products that you would now like to kill but still need to support; revenues from these sources that bolster your top line but aren't representative of your future market opportunity. How do you factor all this into your story?

In VC Gil Gibner's blog, he talks about this 'messy reality' of the things that don't align. "My advice is to get out in front of these discrepancies. Own them. Wrap your narrative around them proactively."  The message is clear:  Don't make it sound as if everything has just fallen into place, as you will almost certainly get found out. Instead keep things straight and build a more realistic insight: “Our total ARR was technically $700K, but we’re really only counting $300K of true on-thesis ARR because $400K of it was really for a different use case from two big customers that don’t really represent where we are going.” Or even: “Our biggest customer is actually Acme Inc, but I really don’t like talking about them because I don’t think they represent our real business going forward. They found us, and we could easily meet their needs, but we are not pursuing customers with that profile.” Rather than confuse things, this openness helps an investor see how you have gradually built a single coherent story. You may be anxious that in stripping back these non-aligning items you may be left with little that does align! If that's the case, you are probably not ready to build an investment case.

Sometimes, even the best intentioned plans hit a roadblock. A pivot may be needed. Perhaps some form of financial restructuring may be necessary. If the bank balance is crashing and fresh capital isn't in sight, 'clean' narrative building must be put on hold. Survival requires going where the money is - what can we sell and to whom? Just live to fight another day. Even these unplanned moments become part of the story, and in some cases become an integral part of discovering where the true demand really is. As the narrative is then rebuilt, it will give shape and direction for the team. It will help set new priorities, organise and motivate people to find the Series A jumping off point once again. As Gibner adds: "As a company scales, the ability to control and shape a narrative only gets more important, not less. (If you doubt this, just read some IPO prospectuses.) Series A investors are not just judging the quality of a narrative — they are judging your ability to shape your narrative and communicate it effectively."

2. Other pieces really worth reading this week: 

Remote work is here to stay, but it’s not all or nothing.
To complement our piece above, this article by Luke Beseda of Lightspeed Venture Partners assesses startup thinking in the US. "We asked companies within our portfolio and outside of it from across the startup ecosystem how they will operate in a post-pandemic world. What we heard might surprise you: while the traditional office model is indeed broken, it’s not dead. Offices remain an important driver of company culture and employee connection. At the same time, employee’s have greater flexibility in how they work and more leverage in compensation decisions, regardless of location."

The Tactical Guide to Making Better Decisions When Starting and Scaling Companies
Annie Duke is a retired poker player, bestselling author, and Special Partner for Decision Science at US VC First Round Capital. In this article she discusses mental models for reducing bias and boosting company-wide decision hygiene. "Even though experience is necessary for learning, our own experiences can often interfere with learning. If we’ve developed subject matter expertise, or we've been doing something for a long time, we get trapped in those models of the world — and when new information comes in, we'll tend to interpret it to fit our model.”

Can We Reimagine The Future Of The Semiconductor Industry?
In Forbes this week, serial entrepreneur Scott White, CEO of PragmatIC Semiconductor, sets out how proposed legislation in the US and EU could boost homegrown semiconductor industries. "With so much at stake, we need to consider novel approaches that can transform how we think of the semiconductor industry. Instead of massive silicon fabrication plants that need billions to fund and use huge amounts of water and energy, it is now financially viable to create smaller, more cost-effective fabs that can be set up in every state or county."

Happy reading!

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