5 Things entrepreneurs should know about VCs
1. Statistically, you will fail
The venture capital investment process is a “complicated” one (more like a blackbox) and potential companies are vetted thoroughly before they are committed to. With that being said, just because your company is backed by a major VC you aren’t guaranteed success.
Think about this, in 2012 there were around 3,723 deals. In that same year there were only 49 IPOs and 449 exits (M&A) deals. Granted, those exits came from companies that were invested in probably a decade ago, it is still an interesting ratio to consider.
Micah Rosenbloom, a venture partner at Founders Collective, said that historically, only one out of every 10 companies that a firm invests in with a given fund will be successful. That’s not to say that all of the remaining companies will fail, though. According to Tomasz Tunguz, a partner at Redpoint Ventures, “Typical portfolio company failure rates across the industry defined as either shutdowns or returning capital are roughly 40%-50%.”
This isn’t to discourage hopeful founders that are seeking capital, but to ground your expectations. After all, entrepreneurship is about having the courage to fail, right? The fact that you are more likely to fail is a fact of life for venture-backed companies, it is not an expectation for the VCs making the investment.
“You never invest in a company thinking that it will fail,” Tunguz said.
2. There is a timeframe to “Exit”
“Typical venture funds are generally structured as 10 year commitments for the limited partners who invest in the fund,” Tunguz said.
Venture capital firms are 10 year vehicles for investors, but that doesn’t mean that all companies will be ten years old when they return on the investment. Rosenbloom mentioned that initial investments are made in the first three years. After the portfolio has been establish, a firm will typically make follow-on investments over the remainder of the fund’s lifecycle.
Ten years may sounds like a long time, but you have to consider how long companies like Coca-Cola have been around (since 1892) and some companies that were started in the 2000s have a comparable valuation to Coke.
“As a venture capital firm, we are not in the business of funding inventors or inventions, we are in the business of funding fast-growing companies,” Rosenbloom
Considering the first three years as initial investments, a company could only have seven years to “make it.” Some VCs, consider seven years the average age for ROI, and the data from NVCA supports that claim.
The NVCA reported in their 2013 Yearbook that, of the 49 IPOs that happened in 2012, the median age for IPO was 7 years old and the mean age for a company to IPO was 8 years old. While some have argued that it is taking longer for startups to mature.
3. There is such a thing as too much funding
Just like in everyday life, money doesn’t solve all your problems when you’re an entrepreneur. Sure, not having enough can make it hard. It can even kill your company, especially if your company is in a capital intensive market such as healthcare or clean tech. However, having too much can be more detrimental at times.
“All too often, entrepreneurs will think of raising a Series A round from a reputable VC as the end goal and think they cannot be successful without it. So they prioritise raising capital over building a great product or service and usually end up asking for too much money too soon which ends up in a failed fundraising attempt or a raise on bad terms for the entrepreneur,” said Hrach Simonian, a principal at Canaan Partners.
As Forrest (2014) mentions in a previous article, knowing how much money you need can make all the difference in your venture capital experience. It starts by understanding how much money you need and only raising that much money. Raising too much money can force entrepreneurs to make decisions they aren’t ready to make.
“If you raise too much money, you have to swing for the fences,” Rosenbloom
You want the amount of money you raise to coincide with the benchmark you are trying to hit. If you don’t have a specific benchmark in mind (which you really should), a good rule of thumb is to consider the amount of capital it takes to sustain your operations for 18 months, then add 25–50 percent for added flexibility and seek to raise that amount of money.
Raising too much capital is not necessarily the gravest sin to be committed by an entrepreneur, “But having a huge sum of money in the bank can provoke founders to dramatically increasing burn rate, and loose focus over the companies main objectives”. It can be challenging to maintain the same execution discipline created by the scarcity of capital when the bank account is overflowing.
Remember to raise enough to get yourself to the next stage where you can assess whether or not you need to raise more money. Keep in mind that once you choose a firm and raise those funds, that VC will probably get a permanent seat on your board of advisors. Choose carefully, because you are usually stuck with that investor for good.
4. You can’t fire your VC
You have to think of your VC firm as another partner in your business. This leads to one of the single most important aspects of your startup/VC relationship: Make sure your goals for your company line up with your VC’s goals for his or her investment. By aligning your goals with those of your VC, you can help potentially avoid a disaster scenario.
“The disaster scenario is that the founding team wants to do something different than the board” — classical principle-agent problem
The risk/reward curves are different for entrepreneurs than they are for VCs, and board members (including your VC) have a legal responsibility to take into account the goals of the investors. So, if your company is losing steam and an acquisition opportunity comes along that is in the best interest of your investors, they might push you to take it, even if it means you don’t get paid.
But, of course, you can avoid all that potential heartache by not giving your VCs too much managerial influence, A.K.A. stake in your company.
5. Failure isn’t death
Think of VC money is a rocket fuel. If you want to get to the moon, you’ll probably have to drive to the nearest airport first. Then you’ll need to fly to your nearest cosmodrome (fun fact, thats what you call a rocket launch spaceport), and once you get there, you will need that rocket fuel to power that rocket to get to the moon.
Venture capital investors want to know that you will be a good steward of the capital and trust they placed in you . If you can prove yourself a highly competent entrepreneur and someone who will push as hard as they can to make an idea work, failure will not mean the end of your career as an entrepreneur. At that point, even if you fail, past investors and people involved with your company will be far more likely to fund your next project if they trust the way you work.
As an entrepreneur, burning bridges is unwise. Treat people with respect to build social capital, but don’t see them as just a resource either. Other than that, always remember that if you’re going to fail, fail big and go down swinging.
(Data based on original post by Conner Forrest from 2014)
