VC investment is tied to risk acceptance
In Spanish (and French) Venture Capital is called «High Risk Capital». Not the best marketing term when you’re trying to convince potential investors, but appropriately reflective of the product, technical and execution risks faced by the companies we back.
As an entrepreneur, you should know that we come into each meeting with a need and desire to asses and accept as many of the risks as possible to get to a point where the level of risk is acceptable relative to the size of the opportunity for us to commit. Your job should be to help us knock down the nos to get to a Yes!
As my friend and fellow VC Cem Sertoglu mentioned in a tweet today, over time with operational and investment experience, good VCs can drill into each of the risk items to gain conviction and come in willing and able to change their mind.
The risks are varied but below are some general areas we tend to focus on
Founder-market fit: Does the founding team have both the sector insight or experience and technical competence to deliver on their vision? If there is gaps in their skills, have they identified key hires to fill those (ex: VP of Sales)
Product-market fit: Is there some level of validation from the market on the need for this product? This does not imply a fully deployed offering. It can be validated by data and insights that validate a pain point and a solution. It could be proven by analogous offerings in other geographies.
Execution risk: Assuming that both of the above are tackled, what barriers might hinder the execution of the founder’s plan. One example might be regulatory approval in FinTech where, for example, the FCA approval is out of the full control of the company. Another might be customer acquisition assumptions where the CAC has not been validated enough to understand what it might be at scale.
Funding risk: How much money will the next stage of the plan require, and if something goes wrong, or a pivot is needed (as is often the case) how much money must I mentally allocate to this opportunity in a worse case scenario. A fellow investor recently described a startup he was excited about as «long burn» meaning it would require some time (and therefore cash) to get to market. We sometimes address this risk by partnering with other as «deep pocketed» VCs to share the risk.
Competition risk: Are you going into a market against a Series D funded US competitor? What happens if Amazon decided it wants to enter your space? Can you prove that you’re winning clients against or from your competition?
Ambition risk: High risk capital is tied to a power law model where a small number of the firms we back will provide the majority of the returns. We have to, therefore, get comfortable with the market size, the execution to scale and the exit path represents *at least* a 10x return on our money. Tied to this, however, is also the conviction that the founders are also aligned on this sort of outcome. Should a compelling offer come in one or two years in that provides each founder with a few million in the bank, will they take that or will they swing for the fences? Tied to this is “Cap Table Risk”: do the founders have enough ownership to make the outcome 5 to 6 years down the line acceptable for them and their families.
At the point of investment, Venture Capital, I have discovered, is a business of risk mitigation, or at least a mental acceptance of risks. Your deck, your pitch, your team, your data room should, ideally, help me get comfortable with those risks to gain conviction to join your voyage.