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Venture Capital

Extremely rapid early growth opens the path to venture capital

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“Venture capital is only appropriate for the small percentage of businesses that want to go loss making to grow very fast.” is a sentence I say a lot. As Jeff Bussgang notes in his recent post Growth vs. Profitability and Venture Returns and Fred Wilson has noted before him successful venture funds have a small handful of big winners, and the only way for a company to become a big winner in the 7-10 year lifetime of most funds is to grow really fast – which isn’t for everyone.

Jeff puts some numbers around ‘really fast growth’ in his post, showing that if a company does $1m revenues and then grows at 100% per year for six years straight then it might sell for circa $400m and generate a 10x for investors.

His analysis is spot on, and most investors would be happy if they ended up with a $400m exit with the level of investment he assumes, but in practice they are targeting much bigger exits. Usually $1bn+. In our experience that means they are looking for revenue growth in the early years of 3-4x pa. Moreover, the best companies grow much faster than that. As we know, growth off a small base is easier than growth of a larger base, but when companies have revenues around the $1m level then 5-6x growth is where it gets really exciting for most investors. When revenues reach $10m that drops to 3x growth.

The thing we focus on more at Forward Partners is how fast companies have to grow in their first year in order to get on the venture path in the first place.

Running the maths it becomes clear very quickly that the short answer is ‘very fast’, although it’s sensitive to the size of the opening month, as you can see in the table below.

Screen Shot 2016-05-23 at 12.20.46

For the majority of the commerce and marketplace startups that we work with getting as high as $15k revenues in the first month is tough, so most are looking at average monthly growth rates of 40-50%+ to get to a £1m run rate in twelve months. The way they get there is usually a couple of months of 100%+ growth and then slowing to 20-30% monthly growth.

We pick these numbers (£1m+ run rate and 20-30% month on month growth) because they are benchmarks used by investors. That said, it’s critical to remember that many other variables go into investor decisions and it’s very possible to raise with much lower figures, or to fail to raise with higher revenues and growth if there are other mitigating factors. It will just be harder. There’s more detail in this Path Forward post about Series A benchmarks.

Fundraising tips for companies that have to work it

By | Venture Capital | 2 Comments

Some companies find fundraising easy. That’s usually because of work they’ve done at some point in the past (truly amazing growth, serial entrepreneur, some other magic) but when it comes to the actual fundraising process they’re courted by multiple investors and raising cash is quick and easy.

We have a few of those companies in our portfolio (and hope to have a lot more), but we also have companies that have to work much harder. Many of them still succeed in raising great rounds (we’ve got two like this closing imminently), but they find fundraising time consuming and laborious. One of our founders recently said that he wished we had prepared him better. This post is the result of the thought process that followed.

A couple of weeks ago I published our dealflow stats for the first four weeks of the year. The headline conclusion was that we had 24 first meetings for every deal that we did and I drew from that to advise CEOs to plan on having a similar number of meetings if they want to have a good chance of closing a round. For us the 47 first meetings led to 8 second meetings and two investments.

There was a bit of pushback from some quarters asking how typical these numbers are, but I’ve been doing some more asking around since, and for companies that have to work hard at their fundraising process it’s prudent to expect similar ratios.

If your startup is likely to have to ‘work it’ I’ve come to the conclusion that the best practice fundraising preparation has the following steps:

  1. Decide on your target investor group
  2. Build a list of names
  3. Start building relationships and qualifying for interest
  4. Ask for a first meeting

If you are raising money from VCs and don’t have prior relationships then I would target having a long enough list of names at step 2 that you will get 20-30 “yes’s” when you ask for a meeting in step 4. If you are targeting VCs and angels then you should make sure you have enough angels in the pipeline to close the round if none of the VCs come through.

All of this is a lot of work and in an ideal world would start well before the 3-6 months you should allow to close the round once the fundraising starts in earnest. If you have existing relationships which allow you to straight in at step 4 (or even further through the process) then you can proportionally skip the earlier steps. E.g. if you have two relationships which you know will get you a first meeting and two strong relationships where it is more like coming straight in at a second meeting (e.g. the investors have previously expressed strong interest in investing) then you can work it back and see how many new relationships you need. If the stronger relationships are each equivalent to five first meetings (we see that approx 20% of first meets convert to second meetings) and you get enough new names in the pipeline to get 13 first meetings then you will be in good shape with the equivalent of 25 first meetings in total (13 new, two existing first meeting relationships and two existing second meeting relationships that between them are equivalent to ten first meeting relationships).

If you follow this process you will be sending lots of emails over a few months and will have to be on top of remembering what you’ve said to who and following up efficiently. If you are diligent you can manage the process in a spreadsheet (which is what most entrepreneurs do), but a CRM system can be a big help, particularly if you use one on the sales side of your business and don’t have to pay for an extra license to use it for fundraising. We use Prosperworks. If you don’t get organised with a system you will drop balls and make an already difficult process more challenging.

You might be wondering how many names you need on your list at step 2 to get to 20-30 meetings at step 4. Unfortunately there’s too much variation between companies for me to give you a helpful answer. It depends on how hot your startup/sector is, how much progress you’ve made, how well you tell your story, and the investing climate more generally. You should just start gathering names and testing their interest in your company.

Not many CEOs follow a process as disciplined as this. As noted, it takes a lot of time and before fundraising gets pressing most founders have other priorities. If you do prepare thoroughly then you have minimised the role of luck, and the less well prepared you are the greater your chances of delay and/or failure.

There are of course a host of other things that impact the success of fundraising processes, most importantly the strength of the underlying business, but also including short term momentum, the quality of the deck and the quality of the pitch. These all need to be worked on in parallel with the process above, but my point here is to highlight the volume of networking and connection making necessary to go from a cold start to a well prepared fundraising process. Then with a bit of luck the well prepared fundraising process is as quick as the easy fundraising processes enjoyed by startups lucky enough to have found that bit of magic.

 

Key elements of a brand

By | Startup general interest, Uncategorized, Venture Capital | No Comments

Brand is on my mind this morning. Mat Braddy, formerly CMO of Just Eat and now founder of Rock Pamper Scissors gave a great talk on building challenger brands at our FP Live last night and this morning I read OpenView’s brilliant teardown of how they re-invented their brand.

OpenView are one of my favourite venture capital funds, largely because they are one a small number of VCs globally pioneering a similar model to Forward Partners. Like us they have a bigger team than most other VCs so they can offer a better service to their portfolio companies, and, critically, they have chosen to be very focused so they can build expertise and offer better support. They are focused on expansion stage SaaS companies in the US. We are focused on idea and seed stage ecommerce and marketplace companies in the UK.

I don’t only like them because they think similarly to us, I also love their insight, rigour and clarity of thought, which shines through in the way they went about rebuilding their brand and the way they tell the story.

For me, these are the key insights from last night’s talk and the OpenView process.

  • Strong brands are built from the inside out – they begin with great products and cultures
  • Brands can’t be externally crafted and then applied, they must be truly aligned with what the company does and how it does it
  • The goal of a brand is to articulate the company story in a clear, focused and consistent way
  • A brand is both what the company stands for (mission, vision, values) and how the company is presented (messaging and visual identity)
  • The brand should be informed by both inside and outside perspectives – employees, customers and partners (not just the exec team)
  • The brand can lead and shape how people think about the company, but it needs to be congruent with existing perceptions
  • The best companies present consistent, but different brands to customers/partners, employees, and maybe investors
  • Above all, authenticity is the goal

Just Eat is a great case study for all this. In his talk last night Mat described how they made sure their brand was aligned to the core values of the product (convenience, simplicity), the culture of the company (fun and mischievous), and how they developed it with an inclusive process. Because they were a challenger they wanted to be controversial and that took them to the tagline “Don’t cook, Just Eat”, with the positioning that take-away is better than cooking. His advice to other challengers is to adopt something similarly controversial and then really commit. Just Eat pushed their commitment to the tagline and mischievous positioning as far as forming the Don’t Cook political party and putting forward a candidate in the Corby by-election (check out the jet-pack…).

OpenView followed a similar process but they’re a VC in the serious business of helping companies succeed, so they took a more serious tone. Their tagline is now “Powering Expansion”, which neatly captures what they do for the Series A and B companies they back.

Lessons for startup ecosystems from the history of Silicon Valley

By | Venture Capital | 5 Comments

I just read Nicolas Colin’s Brief History of the World (of Venture Capital). It’s a great romp through the history of entrepreneurial ventures and how they were financed – starting with loan deals brokered in coffee shops and ending with the PC boom which established venture capital as an asset class in 1970s and 1980s. The bit I liked the most described the role of Stanford in getting Silicon Valley going in the late 1950s. Provost Frederick Terman (who I hadn’t heard of before) went after large military research budgets as part of his mission to make Stanford a leading university in the sciences, and created a four pillar system that kicked off entrepreneurialism in the Bay Area:

  1. reach out to military prospective customers to better understand their needs, then offer to craft them a prototype in Stanford’s research laboratories—this generated substantial revenue for the university and strengthened its trusted relationship with key military figures;
  2. if the prototype satisfies the customer, encourage one of your students to found a company and manufacture the product at a larger scale—this inspired an entrepreneurial spirit among the students and contributed to stimulating their hard work in the university’s laboratories;
  3. make sure a member of the Stanford faculty (if not Terman himself) becomes a board member or consults with that newly founded company—this contributed to training Stanford scholars in business and turned them into better teachers and researchers;
  4. provide office space in the Stanford Technology Park, which was made possible by the fact that the university was the primary land owner in Palo Alto—this ensured that the upstart company stayed close and helped the nascent entrepreneurial ecosystem reach a higher density.

We can generalise this into a blueprint for ecosystems generally:

  1. Find a vertical market where there is a comparative advantage – Silicon Valley started with military technology, in London fintech and ecommerce are good candidates. We focus on ecommerce and marketplaces.
  2. Inspire entrepreneurialism – highlight the positive effects of startups and make ‘founder’ a popular career choice. The UK government’s support has been important for our startup ecosystem.
  3. Promote learning and knowledge sharing – startup ecosystems only work if old-timers pay it forward by sharing content, speaking at events and taking meetings with newer entrants.
  4. Encourage entrepreneurial density – business becomes more efficient and 2 and 3 above work best when startups congregate in the same place. Silicon Valley started in the small district of Palo Alto and the emergence of Tech City here in East London has been similarly important.

This is a ‘do the right things and the money will follow’ plan, which is a bit simplistic, but better that way round then pushing to much money out before the ecosystem is ready.

Fundraising is a numbers game

By | Startup general interest, Uncategorized, Venture Capital | 6 Comments

These are Forward Partners dealflow stats for the first four months of 2016

  • 832 leads
  • 47 first meetings (6% of leads)
  • 8 second meetings (17% of first meetings)
  • 2 deals (25% of second meetings)

We met an additional 53 companies at FP Office Hours. In some ways they are like first meetings and they do sometimes lead to deals, but they are only 15 minutes long and many of them are speculative in nature so I excluded them from the analysis.

I imagine other investors have a similar leads:meetings:deals ratios and the headline here is that it’s only once you’ve got to a second meeting that there’s a reasonable chance of getting investment, and even at that point it’s only 25%. Getting a first meeting is an achievement in itself which often makes it feel like the prospects of getting investment are better than they are, but that feeling can lead to dangerous complacency. The numbers say you need four second meetings and as many as 24 first meetings to have a good chance of a deal.

Raising money is best thought of as selling equity in your business, and the fundraising process is a sales process. Unless you have strong relationships it’s a numbers game.

If you do have strong relationships then it’s about how strong they really are – e.g. if you know investors well enough that you are in effect coming in at second meeting level then you only need 4.

The smartest founders have a strategy for their fundraising and build a plan which they execute with discipline. They know who their targets are and which investor is their favourite, and they make sure they have enough names in their pipeline.

 

The danger of over-funding and herd investing

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I’ve just found time to read Bill Gurley’s On The Road To Recap. I won’t add to the volume of good posts saying that he’s right to point out that the unicorn financing market is entering a dangerous period where all manner of pressures and biases will cause people to behave badly and mistakenly put off adjusting to the new reality in late stage funding.

Instead I’m going to highlight his warning about what happens when markets get over-funded:

Loose capital allows the less qualified to participate in each market. This less qualified player brings more reckless execution which drags even the best entrepreneur onto an especially sloppy playing field. This threatens returns for all involved.

In 2014-2015 the unicorn market was over-funded, sparking intense competition, high burn rates, and as we are starting to see now, ultimately damaging returns.

This is a movie we’ve seen many times before, although it is usually an industry sector that gets over-funded rather than a stage of investing.

I first noticed it in late 2000 when the fund I was working for was invested in one of six high profile and highly funded enterprise portal businesses. It seems crazy now to think that software for enterprises to build intranets (remember them) was such a big deal, but we all piled into these companies giving acquirers multiple options to acquire similar businesses and driving M&A valuations down for everyone. I think one of the companies made it to IPO but even they struggled when IBM and other large tech players bought their competitors.

Other examples include mobile games, DVD rentals, and cloud storage. It’s likely to happen in bots and AR/VR next.

The most commonly repeated pattern is for VCs to over-invest in sectors that are obviously going to be big. It’s most egregious when there’s a long period of elapsed time between when it’s obvious a market will be big and the market actually takes off. Most everything that moved from the internet to mobile looked like this, and was hard to make money from as a result.

The lesson here is to not invest in the obvious stuff, either by investing before it’s obvious (but remember that being too early is as bad as being too late) or by giving it a miss altogether. Instead it’s better to look for less popular areas that you understand well, that are growing, and where the fundamentals are strong. That takes the courage to be different and the confidence to hold your nerve, but if you’re short in these areas maybe investing isn’t the best career for you anyway.

The decline in venture is bottoming out

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Screen Shot 2016-04-15 at 16.09.37

Reading the tea leaves to predict where the venture capital market is heading seems to be everyone’s favourite hobby at the moment, and I’m no exception. Last week we had data from tech.eu which showed that venture investment in Europe is roughly flat quarter on quarter (excluding Spotify’s $1bn raise). Now we have Mattermark and PWC data on Q1 in the US and, surprisingly, the picture there is similar. As you can see from the chart above there was a precipitous decline from Q3 to Q4, but the rot stopped in Q1. Moreover, we are still at a high level of investment when compared with any period except the last couple of years and the 1998-2000 bubble.

It will be very interesting to see where this goes next quarter. I’ve been saying that I think the underlying growth in venture and startup activity here in Europe will balance out the correction and my best guess is that investment levels for the next few quarters will be roughly flat on where they are today at €3.5-4bn, but that I expected the US to keep falling. Now I’m wondering if I should revise my expectations upwards.

The other interesting thing to emerge is that investment in the Bay Area is falling faster than everywhere else – Q1 2016 is 20% down on Q1 2015. The capital overhang is greater in the Valley than anywhere else whilst at the same time it’s getting easier to start and finance your business in multiple other places (including London) so I would expect this trend to continue. That would be good news for startup ecosystems all around the world.

European tech investment is holding up

By | Venture Capital | 3 Comments

Tech.eu just published stats for European VC investment in Q1. We used to wait months for this kind of data and it’s great that it’s coming through in the first week of the new quarter. Faster data enables better decision making.

EU-and-Israel-Tech-funding-without-Spotify

As you can see, if we ignore the $1bn debt round in Spotify, the value of investments in Q1 was roughly the same as in Q4 at €3.5bn. However, the number of deals continued to rise sharply, and hence, as you might have figured out, the average round size was lower – falling from €5.8m in Q4 to €4.6m in Q1 (ex Spotify).

The increase in deals came, therefore, at lower round sizes:

Distribution-of-funding-deals-EU-and-Israel-1024x452

This data matches with what we’ve seen in our portfolio. Some of our companies have found it takes longer to raise, but they are all still getting their rounds away.

I think the big picture is that whilst it might be decreasing sharply in the US investment by value is holding flat in Europe. That’s what the first chart shows (ex Spotify). There are two related reasons:

  • The 2015 and H1 2016 exuberance in the US only came across the Atlantic to a limited extent
  • The supply and demand of capital vs startup opportunities in Europe here still favours capital

Because of these reasons the European market was less inflated than in the US and any correction effect is being balanced by natural growth in the market.

It’s also interesting to note that over the last three quarters the numbers of €0-1m deals and €1-5m deals has been roughly the same, implying that most companies raising a seed round are successfully raising their next, larger, round. The big drop off, and implied failure point, comes between raising €1-5m and €5-10m.

UK venture deal volume surpasses 2000 peak

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Screen Shot 2016-03-10 at 14.43.41

Yesterday Stuart McKnight/Ascendant Corporate Finance published their regular report on activity in the UK venture market. As you can see from the chart above, 534 investments were made in the UK (above £0.5m) beating the previous high of 463, which was set back in 2000 at the height of the dotcom bubble madness. As you can see, our ecosystem has been growing fast since 2011, giving more credence to the notion that we we are finally reaching critical mass.

Whilst deal volume broke records last year, deal value did not. By Ascendant’s numbers, in 2016 £2.6bn was invested in the UK and Ireland, up 76% on the £1.5bn invested in 2014, but still well below the 2000 peak of £3.5bn.

London saw more of the action than other cities with 207 of the 534 deals. Edinburgh was the next biggest city with 25.

It’s also interesting to note that only 19% of the deals were in fintech (21% by value).

Critical mass and the London startup ecosystem

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Often results are not linear. You get a little bit more mass, and you get a lollapalooza result.

Charlie Munger

Critical mass is a term that gets bandied around a lot in the startup world. A common use case is to describe the point when a company reaches sufficient scale that it achieves profitability. Another is the point where a network or ecosystem has sufficient supply and demand that the user experience starts to work. Most networks crack this chicken and egg problem by using a hack of some kind to get either supply or demand in place. AirBnB famously scraped Craigslist to get their business started and here in London Hailo built a social networking app for cabbies as a way to get drivers on the platform before they had any users.

Without hacks like these networks and ecosystems grow slowly, and that’s what’s happened with the startup ecosystem here in London. There have been many successful government and Brussels sponsored initiatives to help get us towards critical mass, but there’s no getting away from the fact that it takes time to build a startup ecosystem. Silicon Valley got properly started in the 1950s and 1960s whereas we have only been going since the late 1990s.

Inevitably we have been sub-critical mass for much of that time, and it’s been painful. Many of our best entrepreneurs have taken the difficult decision to leave their home country and go to Silicon Valley because the startup ecosystem is stronger (most importantly, because there’s more finance) and the companies that remain have, on average, found it more difficult to raise capital, often resulting in smaller raises, less ambitious plans, and slower growth.

Over the last year or two I’ve felt that changing. It’s not possible to define critical mass and therefore to pinpoint the moment it’s been achieved, but the recent proliferation of new startups and new funds (including ours) feels like Munger’s lollapalooza result. High failure rates are part of the model, so it should never be easy to create a company or build a fund, and that remains the case, but it has definitely got a lot easier recently, at least in part because the volume of investors and high quality founders reached a point where there was lots of opportunity for everybody and confidence spiralled.

The other reason financing companies got easier recently is because the markets were hot last year. They are less hot now. It will be interesting to see if our ecosystem has the depth and resilience to stay at or above critical mass, or whether we will dip back below.