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Global VC view: Funding startups in the next normal

The boom that tech startups have been experiencing has continued through the pandemic. Two leading venture capitalists talk about how investing in them is changing.

In recent years, startups and venture capital have experienced a boom many say can only be matched by the original dotcom boom of the late ‘90s. But this amount of success has raised all sorts of questions about the future sustainability of these times, particularly in whatever amounts to the next normal in a post-COVID world.

What are the most important changes or developments?

The most obvious one is what’s happened in the last 12 months with COVID, and the way that it’s accelerated the future that Silicon Valley has been building. We’ve seen many companies sort of achieve in 2020 what we thought they might achieve in 2025 as the future got pulled forward.

The specific things I’m excited about are that the grip of big tech on consumer-facing companies seems to be slipping, either because of regulatory scrutiny, or because they themselves are going to moderate their behavior. And then COVID itself has led to a whole raft of opportunities for companies to deliver services to consumers in a very differentiated way.

Startups can just move so much faster, so much more nimbly than the big incumbents. And then the other big trend is cloud computing and the associated explosion of machine learning, because of the abundance of data.

What is the biggest changes and developments?

Over the past year, practically all the startups we look at that address one of the legacy markets that is typically dominated by the financial industry, or retail, for instance, are outperforming the legacy incumbents on pretty much all parts of the business.

The cost of capital is lower for them, they have more access to talent, and they typically have lower customer acquisition costs. Also, their operating costs and their operating structure are far more efficient and effective to solve the needs of the modern consumer. So, unlike any time in the past 25 year, today I see that the future belongs to the startup ecosystem. And they’re scaling at a pace that I’ve never seen before.

There is opportunity for consumer- focused startups to compete more effectively but startups faring well not just against industry incumbents but also tech incumbents?

I think one of the differences is that Silicon Valley is at the forefront of developing new technology, new businesses, and new business models. Whereas, I think many of the very successful entrepreneurs coming out of the European ecosystem are addressing existing markets with disruptive technology solutions that in many cases have been proven in other settings.

So it’s a different version of innovation, I would say. Big tech obviously has a tremendous impact on, for instance, cost of customer acquisition if you’re a consumer company. It has a tremendous impact on how you market. But I think that is only a small part of the market that these promising European companies are actually addressing.

Diligence and deal making in the Zoom age

In my mind, whenever you make a decision the goal is to make it with high conviction, a high conviction “No,” or a high conviction “Yes.” So the way we’ve tried to do that, given the compressed timelines, is to have more of a prepared mindset.

We did this by developing two dozen “landscapes” last year. These aren’t a Ph.D.

thesis. It’s a couple of pages of somebody’s thinking on a particular category that we then present to the rest of the partnership. And everybody’s attuned to an idea, such as what’s happening with the emerging data stack, what are the services in and around cloud data warehousing that may emerge?

That was one of the landscapes we developed. So when we meet a company, we already have a framework in which to position them. And that way we can make a much faster decision.

It doesn’t mean that we come up with the precise nuances of the right idea. That’s part of the brilliance that you look for in the founder. Then once you’re in process, I think the biggest challenge is the inability to go visit somebody, to walk around their office, to get a feel for their culture.

You have to substitute for that by being even more diligent with customer references, off balance sheet references. So if it’s an enterprise technology company, for instance, you have a network of CIOs to call to understand what they think about this company’s value proposition. And I’d say we’ve done a lot more with personal references than we may have in the past as a substitute for that in-person judgment.

What are you looking for in a startup these days? Are there things startups should be doing to win you over as an investor that are any different in the past, or is it still all about the fundamentals?

I think it’s pretty much the same. You can simplify the concepts here. We really like a team that has this capacity to recruit world-class skills, and to capture the hearts and the minds of the people that really matter in their industry. You can diligence that even remotely. But you sort of feel it immediately when you sit in a room and talk to someone who really knows their stuff.

The second thing for us is that the market is big enough that it can create a massive business over time.

And the third one is that we would like to see a fundamentally different shaded product, one that has the capacity to really stand out with just a modest amount of marketing. Those three very simplistic arguments held five years ago, and they still hold for me today.

Funding and fundamentals

Talk about a funding bubble. How do you see the massive amounts of capital in the industry impacting startup priorities and decision making?

I think there has been this very popular concept of “blitz scaling,” the idea of extremely fast decision making and building capabilities.

The flipside of that is there was a lot of sloppiness, such as poor company culture, that started to happen. And I think now we’re in a situation where we have even more money coming into the market, but also very strong KPIs have been produced thanks to the increase in digital usage and demand during the pandemic.

You can also see a lot of false positives in this environment that might not sustain for the long haul. So the challenge for us as investors, I think, is to see when you’re building something really quickly, with so much access to capital, that is quality can vary greatly between different opportunities.

It can be a little harder in this environment to know what is truly sustainable. Is that something you and your team have to think about a lot?

the business fundamentals are the same. The shape of it is different, just like the shape of businesses today are different from the ones we funded 20 years ago.

Because the market has changed, the opportunities have changed. The two questions I like to ask typically are, “Who cares,” and, “Why now?” And, “Who cares,” sounds a little whimsical, but the idea is, what is the problem you’re addressing, and why do you have a compelling solution?

It has to be compelling. You want to build a product or a service where your customers find you, and you don’t have to go find them. That’s when you build something truly distinctive. And then the next question obviously is, is it a sustainable advantage?

And “Why now” is just, what are the environmental reasons that make it propitious to start this company today? Because big companies have so many advantages. You need to have some kind of disruptive change.

In terms of sustainable advantage and durability, I think it’s something we wrestled with more in the second quarter last year, right after COVID struck. Because we had companies like DoorDash and Instacart who were benefiting tremendously in food delivery and grocery delivery.

And the question obviously is, does it sustain, or is this a blip? And conversely, we had companies like Airbnb and Eventbrite that obviously saw enormous decreases in revenue because of the curtailment of travel. I’d say, given that COVID has continued for 12 months, and we’re likely in for at least another six to 12 months, it actually creates an environment for behavior change to become more set.

And I think that is really interesting in terms of the opportunities we get. So, take tolerance for working over Zoom, for example. Maybe it’s something you endured for a few months, and you were looking forward to going back to the way things used to work. But now I think maybe you’ve gotten used to it, and you see the advantages. You also see the disadvantages, of course. But my guess is that Zoom is going to be a firmament in how people operate from now on. There are so many companies that have had to embrace inside sales instead of direct sales.

Because obviously, their salespeople couldn’t travel. And now they understand the benefits. There are services like Gong that help you record your phone calls with customers, that help with training the rest of the sales team. You can analyze what works, what doesn’t. Productivity has just been raised for everybody. And, so, I think a lot of these things are going to be much more durable than we may have imagined six months ago.

Judging the soaring valuations

When you look at the future, or even the present, do you feel that there’s enough economic value creation to justify the number of unicorns or decacorns?

There are some signs that the entire market is sort of on zero interest rate steroids. We have a situation where the valuations are high, there is no doubt about that. But then the question is, will they produce returns at the scale that we were hoping for?

And you know, for most of the startups that we have looked at over the past 25 years, very few of them actually get even close to their plans. Some of them do. And they become these unicorns or decacorns, or even more.

But I think this time it’s like a change of scenery for the digitally-powered, innovation-powered economy. I think many tech startups get more bang for their buck, they scale more, they create higher returns on their business models.

And since many of these business models are also going from sort of selling units to selling a subscription that’s like software-as- a-service (SaaS), for instance, that it’s also a totally different profile of earning. So I think there are certainly arguments for this being frothy, absolutely. But I think also that there are companies that are growing at the rate now that we haven’t seen before.

Startup fundraising pitfalls

When you look at so many startups and pitches constantly, what do you see as the most common mistakes or pitfalls as they try to raise capital?


Well, I would say one of the most common mistakes is that you haven’t really thought through how much you can achieve with the money that you’re thinking about raising.

So it becomes almost like a circular reference in the conversation, and then an unproductive discussion. What we would like to see more about is, okay, what is the big next big inflection point that you can reach? And how much capital do you need to get to that big inflection point –where you can get access to customers more easily, or you can scale at a different speed, or you can start to prove your business model?

And when that is not thought through, then it basically starts to sputter really early in the conversation. So when I get the question, “What do you need to hear in a pitch,” well, I want to see what can you achieve in a reasonable timeframe. And what is the kind of capital you need to do that, in order to sort of really be a different company at that point in time?


The first is substance versus form. You need to be authentic. You need to just tell your business story, and explain what it is you do, and try not to make it performance art.

The second one is choosing your business partner. I spoke about it earlier. Fundraising is a recruiting exercise for your future business partner. There are people like PJ or myself who have decades of experience, who can help you see around corners. I’m sure that between the two of us, we’ve made more mistakes than any of these founders hopefully will make.

And the goal is to learn from the mistakes we’ve made, which means you don’t have to repeat them. And so you’re recruiting a business partner. Don’t just take the highest valuation. Don’t just take the easiest money.

Find somebody whom you trust, who’s going to be at your side, somebody who you can call on a Sunday night when something blows up at the company, when you have a squabble with your cofounder, when your biggest business partner goes sour on you. Who are you going to turn to for advice to help you navigate those moments? That is what you’re looking for. And, so, take the fundraising exercise a lot more seriously as a recruiting exercise.

Source: McKinsey on Startups

Roelof Botha is a partner at Sequoia Capital and Pär-Jörgen (PJ) Parson is a general partner at Northzone. Daniel Eisenberg is a senior editor in McKinsey’s New York office.

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