Help a VC Fund You
If you are an entrepreneur trying to raise money, help the VC help you. What? Isn’t it the other way around? Isn’t the VC supposed to be the value-add investor helping you get to that IPO faster?
Yes, but first, you have to get a VC to be your VC — -to invest in you. Understanding the demands on VCs, will help you better articulate how your start-up is uniquely positioned to meet those demands. It’s a “help me help you” proposition. Show VCs you can help them meet their needs, and you’ll increase your chances of receiving venture capital funding and reaching your goals.
Your prospective VC’s Goals
Most VCs need to see a potential for investment returns of at least a 10x on any given investment (later-stage investors have lower thresholds since failure rates are lower). A minimum of a 10x return is necessary because the successful investments must balance out the failed ones. No investor plans for failed investments, but it happens; start-ups are really hard.
VCs are portfolio managers and a typical General Partner will aim to deliver a 2.5x — 3x return (of a fund) in 7 years which corresponds to a 14% — 17% IRR. If it takes 10 years to deliver that same range of multiple-on-invested-capital (MOIC), then the IRR drops to 10% — 12%. These are the metrics that VCs are measured on. How much money did they make for their investors and how fast?
Be Specific in How You Articulate the 10x Return Potential
As an entrepreneur, be specific in demonstrating how your business presents that 10x return probability. While certainly not an exhaustive list, here are a few considerations:
- Is the size of your opportunity / the size of the market big enough? Be as specific as possible and be rigorous about your methodology. Investors see through exaggerated market sizing and you can lose credibility.
- Is your start-up addressing a big enough opportunity and is your product vision and roadmap sufficient to grow a stand-alone company? Some start-ups are building important features and functionality, but venture capital may not be a suitable funding source if the opportunity isn’t big enough.
- Can your business grow fast enough, cost-effectively enough? VCs need to fund fast-growing businesses that can get big quickly.
- What numbers, evidence, proof, metrics, research, etc. can you present to paint a connect-the-dots story? Rarely do VCs fund an idea or a concept from a slide deck (unless it’s a well-known, proven team). Try to demonstrate that there is market pull, market demand for the offering. There are ways to quantify ‘dependence’ beyond revenue.
- Why is your founding team exceptionally qualified? What knowledge, insight, expertise do you and your team possess that will out-compete the incumbents and substitutes, or overcome buyer inertia? Why will your team be able to build and scale? Why will your team be able to attract exceptional talent to join your start-up? Who is already on the roster lending credibility to your ability to attract talent.
- How will you market the offering? The “how” shows the level of detailed thinking behind your execution plan. Same with sales: how will you sell? As hard as it is building your product, it’s harder to sell it.
Step Inside a VC’s Fund-Raising World
The realities that VCs face affect you and your ability to find VC investors. As an entrepreneur, you should understand that a relatively small amount of private capital gets allocated to early-stage companies via VC funds. I spent 3 years as an institutional Limited Partner (LP), investing in PE and VC funds, and my firm managed $2.7Bn in commitments. I saw first-hand how many of my peer LPs did not allocate capital to VC. Instead, most of their capital gets committed to infrastructure, real estate, real assets, and PE funds — -funds that produce cash flow.
Why? Because the capital that could go into VC funds comes from pension funds, insurance funds, endowments, foundations, and other long-term pools of capital. This capital is relied upon to deliver critical cash flow: cash flow that funds 50% of a college’s annual operating budget or 100% of payments to pensioners. As a result, many institutional investors that could invest in VC funds, don’t. Venture is perceived as too risky and unpredictable.
Just as it’s hard for you to raise capital, it’s also hard for many of your prospective VCs to raise capital too. And 2016 will see increased pressure on VCs who are fund-raising as they compete for limited capital. According to Prequin, at the beginning of 2016, there was a total of $941Bn seeking commitments (to private capital funds) globally. VC funds seeking commitments this year amount to $84Bn (9% of private capital funds seeking commitments), and that’s nearly $20Bn more than last year. This intensified competition among VCs for investor capital will transfer down to you, the entrepreneur.
When you can articulate the criteria that will likely drive a minimum of a 10x return for a VC, you are “helping your prospective VC help you.” As a result you’ll increase your chance of receiving venture funding. Meet their needs and they’re far more likely to meet yours. Moreover, you’ll be better positioned to build a valuable company, faster.