What are the chances of a company going from seed investment to a growth round? Pretty slim. In fact, worse odds than the apocryphal Charge of the Light Brigade, when sword-wielding cavalrymen rode to their deaths in a frontal assault on well defended artillery.
The cavalry attacked, bravely carrying out their orders, regardless of the obvious outcome and out of 670, 110 were killed, but incredibly 400 survived unscathed. This is now well entrenched as a common British short hand for crass stupidity. But the odds for seed funded start-ups by contrast are far worse, and every VC worth their salt knows them by heart. Of 2,500 European start-ups between 2009 and 2014, only 6% of seed went on to receive Series A and of those, 23% went on to achieve a Series B (i.e. 1.4% of the 2,500). If we assume that 50% of companies that receive Series B receive Series C (what we call growth capital) then the likelihood of successfully navigating the path from Seed to Series C is a whopping 0.7%.
This is all summarised well in Stephen Piron’s “The State of Investments in Europe: A Review of the Last Five Years” on Crunchbase.
Source: Crunchbase, 2014.
And so despite this evidence, the start-ups still charge, and still we invest.
Not because we are misty-eyed unicorn hunters and not because we are ignoring the evidence before our eyes. We meet hundreds of founders for every investment we make. We meet with those founders over extended periods, often way before they are ready for our money or time. And we focus on the isolation of the critical characteristics that define – for us – a great investment opportunity and then work hard with the teams we invest in over a long period to help them realise their vision.
I need to answer two questions. Do I want to build a company with this team? And do my partners believe that we can build an iconic business & a big return? Chris Tottman.
Do I want to build a big company with this team?
There are broadly two key aspects at play here.
The conventional stuff: how the problem realisation happened and why they want to solve it; their unique in-depth domain knowledge, expertise and connections; their ability to learn super-fast; their ambition, drive and resilience to realise their vision.
And we look for the unconventional: a brilliant mind, a deeply held conviction, an ability to see around corners, their – as Peter Thiel puts it – belief in something that no one else believes. Thiel’s principle is that what makes a company great and gives them the ability to create a ‘monopoly’ and generate significant value for the world and the company is always something that has not been done before. The very essence of the great company is their difference.
What we believe…
You cannot cookie-cut investing, and you cannot cookie-cut company success. But we know from our experience that, while it is hard, it is possible to build a great company based upon a contrary view of the world, a great team and a relentless focus on fundamentals of business and execution.
Once we have made the decision to invest this then comes down to the systematic application of a way of working designed to help (not tell) the founders we invest in to be as good as they can be; to become great CEOs; and to build great teams and big valuable businesses. How? By working with them proactively along the journey; surrounding them with like-minded people from within our community who can help and advise them along the way; and by pointing out some of the key challenges they will face.
We understand the start-up journey is not a linear path. And that each company is different. Start-up success is not a line with a 45 degree angle from bottom left to top right, but one that is difficult and challenging, yet exciting and rewarding.
But we also believe that once a company has achieved product-market fit then it is possible to mitigate risk, while maximising scale, at every stage.
At each stage of the lifecycle our intent is to help our companies demonstrate progress while mitigating risks associated with product market fit and execution to reach the point at which they can raise the big growth round. That’s the equity and skills gap we aim to fill.
We encourage the narrow approach required to dominate markets and create natural monopolies, while creating a new investment hypothesis at each stage based upon lessons learned from the previous.
Start-up? From problem to product-market fit
The road to product-market fit starts with pain is a premise that we validate with our early stage investments. You can read a recent article on this topic here.
Understand, explore and solve the most critical challenge facing your target market, what we call ‘the industry defining problem’. This dialogue plays out over a few months or quarters, but is the critical stage and is not about revenue but about proof, data, evidence.
We help our companies tune their antennae for the pain they are addressing – user, company, market or industry and engage our companies on a consultative basis with independent specialists acting as proxies for their market, competition or partners to assist and fast track this process.
Isolating the ‘industry defining problem’, something unique with no direct competition, is the foundation of this phase and arguably every great business.
With the clear focus on “solving the problem, not selling the product”, the company harnesses the demand to rapidly iterate the product in order to achieve market fit. Don’t think solution push, think problem pull.
We know they are starting to get it right when the demand they are experiencing far exceeds their capacity to fulfil it.
The value exchange of solving the problem is the essence of any successful business. The bigger the differential between the cost of your solution and the success of your customer the better. And we know this is resonating when we start to see higher initial order values, increased ACV, revenue expansion.
Returning to Peter Thiel, really valuable businesses create a great amount of value for the world and effectively take a cut.
Grow up? A material shift of human capital from validation to execution
On the basis of product market fit this next phase demonstrates the ability to nail two key fundamentals of scale – evolving beyond a stand-alone product or app to a platform with multiple dimensions of value and the ability to execute a repeatable sales strategy. This is manifested by a distinct shift of people and resources – human capital – from the early stage validation to scale.
Many companies believe a wide application of their product is one of their greatest assets. Their solution can scale across multiple industries, sizes of organisations and geographies and this is a good thing. Right? Ultimately, perhaps. But in the short term definitely not.
The reality is that every business, no matter what size, has finite resources, and those resources – engineering, sales, marketing – should always be pointed at the problems and markets with the greatest rate of return, the greatest ability for repeatability and revenue expansion.
One of the single most important skills to drive growth repeatable and capital efficient growth is the ability to determine to choose the customers you want to do business with at every stage:-
- With a close affinity to your product/market fit at every stage of growth
- That are accessible and will move fast enough
- And are the most valuable – ultimately in terms of repeatability and revenue expansion over time.
The process of selecting ideal customers is well covered but critical, and one we will be returning to in the future.
Once the ideal customer profile is established, then the next step is to narrow focus to the smallest number of customers / segments that will rapidly deliver the highest return / achieve your goals for the stage of business.
And then align all resources to support those choices – marketing and sales of course, but – as importantly – customer success and R&D.
The company is in essence laying the foundation for the monopoly effect of dominating a small market.
The routes to market is also an important consideration – direct / indirect – multiple choices – and needs to align with the product / market / segments you have chosen.
As previous this is rarely a straight line but bumps on the road as the company isolates
NB – as the business grows both the ideal customer profile and the go to market strategy must evolve and become far more nuanced with data on CAC / ACV / Gross Margin / Revenue Expansion / Payback etc.
Two key watch words for us of the go to market strategy and of the grow up phase in general are repeatability and expansion:
- Repeatability – to what extent are the sales repeatable – same product to an adjacent customer
- Expansion – to what extent does revenue generated from a client increase after the initial sale?
The days of SaaS businesses – even in B2B – that could grow a big business relying on a single subscription model are long gone. Today the most successful businesses understand the value of the platform and one of the most critical characteristics of these companies is their ability to use demand pull combined with business agility to rapidly iterate a product and turn it into a platform.
For tech companies who want to achieve rapid growth, strong economics and high valuations the transition from a product to a platform is not an option.
Product management and pricing expertise are two key disciplines we look for at this stage. Placing product management expertise at the heart of the business is a critical step in the scale up process, managing stakeholders and prioritising development for short and long term goals. Introducing pricing expertise and discipline is another critical step – starting with an understanding of the difference between what customers use and what they value will allow an optimisation of pricing and directly inform sales, marketing and product decisions.
However neither of these are sufficient to develop the network effects incumbent on successful two sides marketplaces or platforms.
Frictionless entry for users and producers into or onto the platform are the critical factor.
Make no mistake, this phase is the hardest yards, with many slip ups along the way and takes a relentless focus on customer choices, product development and execution.
Ready for the growth round
Going from Seed to Series C – the growth round – is hard, but it can be done and is done by many companies each year. It isn’t a cookie cutter by any means, as each company is different with their own unique challenges.
Picking out just three elements at each stage through start up grow up to scale up is clearly a gross simplification but hopefully goes some way to helping explain how we help companies on the journey, while avoiding the mechanised death of the charge of the light brigade.
Posted by Stephen Millard, Chief Platform Officer, Notion Capital.