The Growth Potential Gap: The 'Missing 6%'

Achieving startup success has always been a formidable task. Research from McKinsey indicates that in both the U.S. and Asia, only about 20% of startups that secure Seed funding eventually reach an exit or attain Series C. In Europe, this figure is even lower at just 14%.

This lower advancement rate does not imply that European startups are more prone to failure; indeed, their failure rates are comparable to those in the U.S. Many European companies may be profitable and self-sustaining. However, there exists a 'missing 6%' that could be tapping into significant growth opportunities and the potential to emerge as global category leaders, where substantial exit returns can be realized.

Various factors contribute to this disparity across the three major regions. For instance, market fragmentation is more pronounced in Europe, requiring startups to navigate 28 diverse countries to access markets comparable in size to the U.S. Additionally, access to capital, especially in later stages, has traditionally been more limited in Europe.

Yet, as startups increasingly pursue global growth ambitions earlier in their journeys and as international funds invest cross-border, these disparities are gradually diminishing.

Nevertheless, challenges remain. Europe accounts for only 7% of the global public tech market capitalization, in stark contrast to 70% in the U.S. However, with 98 new European unicorns emerging in 2021 alone, the ambition and optimism in the startup landscape have never been stronger.

Support for early-stage founders is also on the rise. Successful entrepreneurs are reinvesting in the ecosystem, and numerous incubators and accelerators are facilitating the early development of startups. Entrepreneur First, an accelerator catering to aspiring founders from diverse backgrounds, has emerged as a significant positive force.

At Duet, we play a crucial role in guiding UK founders through the critical transition from Seed to Series A. According to McKinsey data, this is where a disproportionate number (77%) of startups falter or drop off the high-growth funding trajectory.

The potential to increase graduation rates from Seed to Series A is tangible, but founders must navigate specific challenges before Europe can achieve parity with the U.S. or Asia. Some of these challenges are tied to macroeconomic factors, while others are within the control of startup founders and their early investors.

Crossing the Chasm: Understanding Market Dynamics

In Geoffrey Moore's seminal work, Crossing the Chasm, he elucidates that the journey through the product adoption lifecycle is neither linear nor gradual. Moore challenges traditional lifecycle theory by introducing the concept of a significant gap—"The Chasm"—between Early Adopters and the Early Majority.

Simply put, the desires of Early Adopters, or 'Visionaries', differ vastly from those of the Early Majority, or 'Pragmatists'. Visionaries view new products as transformative, capable of providing immediate competitive advantages—even if they are not fully developed. In contrast, Pragmatists seek proven, reliable solutions.

Consequently, moving from early adopters to the mainstream market necessitates a fundamentally different approach. Moore suggests that the initial step should involve concentrating on a specific market segment or niche, establishing dominance there to create a "beachhead" for subsequent word-of-mouth marketing. This strategy indirectly builds confidence among Pragmatists through the endorsement of Visionaries.

This concept aligns with the lean startup methodology prevalent in today’s high-growth markets, particularly for businesses aspiring to lead their categories. The creation of a Minimum Viable Product is one such tactic employed to gain early traction with early adopters.

However, just as a chasm separates the expectations of Visionaries from those of Pragmatists, a similar divide exists between what qualifies a Seed stage business for investment and what is required for a Series A investment.

While the transition may seem straightforward, it is anything but. If it were truly linear, many more startups would successfully graduate.

To better comprehend this nonlinearity, we must first explore a fundamental principle of the venture capital landscape: The Power Law of VC.

Understanding the Power Law in Venture Capital

In his renowned book, Zero to One, esteemed founder and investor Peter Thiel articulates a critical insight that many founders overlook: venture capital returns do not adhere to a standard distribution. Instead, they follow a power law, where a small number of companies significantly outperform the rest. Thiel emphasizes, "The greatest secret in venture capital is that the best investment in a successful fund equals or surpasses the entire rest of the fund combined."

He outlines two unconventional rules for venture capitalists: firstly, only invest in companies with the potential to return the entire value of the fund. This rule is daunting as it disqualifies most prospective investments, even those that are relatively successful. Secondly, due to the restrictive nature of the first rule, there cannot be any other rules.

Consequently, VCs are on a quest to identify future category leaders, where rapid and sustained growth is crucial for achieving a winner-takes-most outcome. Without the outsized returns offered by these leaders, the economic model of venture capital simply falters.

Navigating the Funding Landscape: Key Considerations

Ambitious founders aiming to maximize their growth potential will likely find themselves pitching to VCs during either the Seed phase or Series A. This landscape now includes not only traditional VC funds but also certain private equity, hedge, mutual, and corporate venture capital (CVC) funds increasingly participating in the venture capital space.

Seed stage pitches typically emphasize market needs, innovations that meet those needs, early customer engagement, and the founding team. VCs assessing Seed investments will also consider whether there is a viable path to securing Series A funding in the future. If they harbor serious doubts, they may withdraw from the Seed round. Therefore, founders must proactively prepare for this early scrutiny.

When it comes to Series A pitches, the focus shifts significantly toward customer traction, solid evidence of product/market fit, an effective go-to-market strategy, and a scalable business model. The data presented must demonstrate that the startup has successfully crossed the chasm.

However, analysis of graduation rates reveals that few of these VC pitches achieve success. While they may address the right topics, they often lack the compelling evidence needed to persuade investors. Not every startup can become a category leader, but some come exceptionally close.

These marginal cases are particularly noteworthy. They represent the 'missing 6%' that could potentially graduate with some refinement in their underlying propositions. Unfortunately, this realization often arrives too late for these founders. Investor feedback may highlight significant gaps that they are unable to address within their limited cash runway, leaving insufficient time to rework their proposals. They may have believed they understood investor criteria, only to discover significant misunderstandings.

"A year from now you will wish you had started today." — Karen Lamb

The most common error is placing excessive reliance on commercial momentum alone. For instance, startups that assume crossing the $1 million ARR threshold automatically qualifies them for Series A funding often face harsh realities. Stories of such misjudgments are increasingly prevalent. Recent insights from Asheem Chandna, a partner at Greylock Partners, exemplify this:

"I recently met with an ambitious entrepreneur whose new venture boasted an impressive roster of customers and strong initial billings. However, I chose not to invest because, despite my admiration for the team and their concept, I couldn't envision a path for growth beyond $20 million in revenue."

The Path to Series A: No Formula for Success

A critical mission for leading incubators, accelerators, and early-stage advisors is to ensure that founders comprehend the broader context of what venture capitalists seek and how each aspect will be evaluated. This understanding should be established as early as possible, ideally during the Seed phase, ideally 9 to 12 months before the Series A.

Time must not become a limiting factor.

We propose a general framework for this early self-assessment in the form of a gap analysis: "This is where we need to be for Series A, and this is our current position." The outcome should clearly outline the priorities necessary to become investment-ready. Some of these priorities will be sector-specific, while others will be more generic, yet all should align with the critical success factors for category leadership.

Such a framework for investment readiness is invaluable in shaping future funding strategies. This is particularly relevant for startups solely backed by private investors, who may need to evaluate the implications of involving VC investors versus alternative funding avenues.

Founders who can establish early alignment between themselves, their existing investors, and the anticipated needs and aspirations of venture capitalists will navigate the late Seed and Series A funding cycles more smoothly.

Taking Action: Implementing the Funding Strategy

The real test occurs when the funding strategy is put into motion. Many incubators and startup accelerators facilitate connections with investors at the conclusion of their programs. However, most startups embark on a solitary journey during their formative stages, relying on their self-education and networks to prepare for and execute a funding campaign.

This process can be intricate and challenging, particularly for first-time founders, often marked by uncertainty and trial and error. This is where Duet steps in, offering personalized guidance through live funding campaigns—from crafting investor target lists and developing pitch decks to finalizing deals.

The startup ecosystem has evolved significantly, fueled by a surge in venture capital. We now find ourselves in an era where tech entrepreneurship has become a recognized career path. However, while initiating a business is relatively straightforward, successfully navigating it to completion is often far more complex.

By equipping founders with the skills needed to cross the Seed to Series A chasm effectively, we aim to help more of the 'missing 6%' realize their true growth potential.

John Hall is the CEO and Co-Founder of Duet Partners Ltd., a startup-to-scaleup advisory firm dedicated to supporting ambitious founders in the development and execution of funding campaigns at the Seed and Series A stages. Over the past 12 years, we have collaborated with some of the UK’s most exciting startups, helping them raise millions in funding. Our client list is available here.

We also publish a newsletter titled Weekly Briefing Note for Founders and share occasional essays and articles on our blog. You can subscribe for free here.

Key Insights from "Crossing the Chasm"

In this insightful video, Geoffrey Moore discusses how to effectively bridge the gap between early adopters and the mainstream market, highlighting strategies for startups.

Visualizing the Chasm in Consumer Markets

This visual example illustrates the concept of crossing the chasm in consumer markets, providing practical insights for founders navigating their growth journeys.