How to Find a Good Venture Capital-Business Fit to Fund Your Growth Plans
Amid the gong, cowbell, and foosball table here at Fusebill’s Ottawa headquarters, we have also a poster of animals floating around our kitchen. Why? It’s a pictorial from SaaS thought leader Christoph Janz depicting the different kinds of customers and how many of each customer type it would take to build a $100M business. For us at Fusebill, it aids in creating focus.
Janz, a former angel investor and now a partner in Point Nine Capital, an early-stage venture capital (VC) firm, is well-versed in the world of investment and what businesses need to do in order to thrive. The premise of the poster is simple. It asks: Which animal is your company hunting to build your $100M Business? If your typical customer spends $10 a year, then you are hunting ‘flies.’ Your business will need to attract 10 million active customers to build that $100M business.
On the other side of the spectrum, if your typical customer pays you $100k per year, then you would need 1,000 ‘elephants’ to hit that glorious $100M mark. Both seem so far away for anyone who is just starting their company. (Christoph, if you are reading this — we have to meet in person one of these days!!)
In order for your business to succeed, you need to identify what kind of customer you want to attract and try as best you can to focus your team on what is needed to attract and retain the animal of your choosing in a consistent and repeatable manner. Imagine preparing a huge ditch trap to catch an elephant when your business is more tailored to a housefly. It does not make any sense and this level of focus should help in making important strategic decisions along with focusing your startup.
Using Christoph’s “What animals are you hunting lens” can greatly help in your product and hiring decisions. With this lens, you can also help to avoid the pitfalls that many startups face: chasing any animal that comes across their line of sight.
The same could be said for a business looking for investors to help fund and partner with their vision.
When my business partner, Greg, and I launched Fusebill and started with our seed funding process, we were very fortunate to have just come out of a highly successful exit. Protus, the company Greg and I worked for previously had many VCs that had a fantastic return from the Protus sale. The VCs that had invested in Protus saw some of the more dynamic members of that team spin out into Fusebill. The Protus investment team had deployed $8M and they had a $200M-plus outcome, so they were eager to invest in our venture.
I only realized just how green we were when we started the Series A funding process in 2016.
Part of that naivete was familiarizing ourselves with different types of VCs. There are VCs that specialize in different company stages and investment round sizes. It definitely took us some VC education to differentiate one type of VC from another.
Here is the skinny on different VCs, where they fit into the different funding rounds, their expectations, and what they can do to help your business scale.
Seed funding VCs
The sweet spot for seed VCs are startups with revenues at nil or very, very early. As an estimated 60% of startups fail, the risk is higher for investing in startups at this stage.
Many VC funds break investments down into thirds: 1/3 will be successful, 1/3 will be a ‘break even’ situation, returning only what was invested, and 1/3 will fail altogether. Consequently, financial investments at the seed stage are usually between tens of thousands to a few million dollars, comparably lower than other funding rounds.
Many VCs at this stage hedge their bets and ensure they have a pro-rata clause, which allows them to protect their level of ownership in future rounds. Based on the paragraph above, can you blame them for wanting to double down on their winners?
In the SaaS world, angel or seed investors are looking for a strong founding team. A business may not even have customers yet; just a solid concept with which to go to market.
There is a fair share of homework to be done before talking to any seed VCs for investment. Ask for referrals from other founders that you know, network within your local tech scene and ask around for what VCs are active in your area or sector. A solid business presentation is essential at this stage and could include a comprehensive business plan and an executive summary. You really have to nail your elevator pitch here when you are networking and a well-organized pitch deck always helps. At the Seed stage you are selling the vision more than anything.
As far as compensation at this stage, the only route you should go here, in my opinion, is to invest dollars for equity in the company or employ a tool known as SAFE, or Simple Agreement for Future Equity, which gives the investor the ability to buy shares in a future funding round in exchange for investing money into your company today. In essence, it is neither equity nor debt; instead, it gives all parties involved the ability to postpone the valuation until a future date.
There is no sure bet in the seed phase, an investor expects 50% to have less than a 1X ROI. Investor Marc Andreessen summed up his experience in noting that his investment company receives about 3,000 referrals every year, and of that, about 200 are fundable. “About 15 of those will generate 95% of all the economic returns,” he said. “Even the top VCs write off half their deals.”
Series A VCs
Once a business is up and running with customers and some sort of revenue model they may opt for Series A funding in order to scale their company further.
For the majority of companies looking for Series A investment, this is the make or break decision for your business. If you do it right, you have the backing to scale your company. If you approach it wrong, you’re going to have to answer to angry investors that put a lot of faith (and money) into your business.
Preparing for Series A funding requires a higher level of planning from a process perspective and you really feel like you can see a big business being built here. Remember a new VC is placing a bet on you, believing that you will be one of their winners.
If you are successful in getting investment at this stage, there is going to be a tremendous amount of legal documentation going back and forth with investors. So a good lawyer versed in these types of transactions is absolutely essential. (Shout out to Mike Dunleavy and his team over @ LaBarge Weinstein.)
If your business has made it this far, you are obviously doing a lot right, but make sure you are able to back up your success with a strong go to market plan and define what you will use the money for. For example, “we are planning to raise $5M to take the company from A to milestone B,” or “$2M in ARR to $10M in ARR in which we plan to then raise our Series B.” You need to demonstrate you know your market opportunity inside and out and that you have started to build out a solid leadership team.
Prepare thoroughly before you talk to VCs for your Seriues A round. Develop a list of “A” level VCs and a “B” level VCs. A’s are the VCs you really want to work with. B’s are the ones you want to use as practice. Start your process out by soliciting your B list, practice your pitch, see what works and what doesn’t work. Then and only then work your A list.
Without planning in advance and having proper diligence information ready to share, VCs will at best, laugh at you; at worst, completely ghost you. (I personally had easily 20+ ghosts from VCs during our Series A raise.)
It is also important to do your homework on potential investors to make sure you are going to be a good fit because the stakes are a lot higher in this round. Think about what might happen if your well-built business plan takes the scenic route between milestones. Do you want to partner with someone who demands results, no excuses, or someone who you can work with when things go off plan? And trust me… they will go off plan.
In the Series A funding round, between $2M and $15M is generally invested, although some industries, such as tech and pharmaceutical sectors, can go higher. In exchange for investing in a business, VCs are looking for shares generally in the range of 10 to 30% of your business. Additionally, they expect to see returns as early as 2 years of investing as the company grows, so you need to go into this funding round with your ARR showing that you are growing at 100%+ or more. Or at least a logical path to get there. Remember VCs expect returns!
Series B (and beyond) VCs
It’s time to talk Series B and beyond. First of all, the general rule of thumb for any capital raise is to raise 18–24 months of runway, accomplish your key milestones and then raise again… rinse, wash, repeat.
At Series B, you know you can build something generational. In today’s SaaS world your business should have a minimum run rate of $5M with a clear path to $10M in the next 12 months. Key SaaS metrics should be pretty close to nailed and you are investing in further growth.
Beyond what information you need to have on hand for earlier funding rounds, your forecasting needs to be world class, as this could help you ratchet valuation up during your negotiations. Also, expect the investors to dig into your historical finances with at least three years of income statements and balance sheets.
At Series B, it is quite possible that when you close the round, Investors could own 60–75%+ of your business, so it is essential to make sure you are absolutely able to support their contributions and be willing to keep moving forward to maintain an unwavering presence in your market.
Things to keep in mind when working with VCs
Admittedly, we were very fortunate when finding seed investors when Fusebill was starting out, but that does not mean we are as wet behind the ears today as we were 8 years ago. I’ve gleaned a lot about relationships since Fusebill got its start. Here are some things I have pulled together from past relationships and future considerations with VCs.
1. Network. Here in Ottawa, we have many events such as Tech Tuesdays, which can be very beneficial for any SaaS startup. In other locations, i.e., the “Valley”, it essentially rains VCs.
If you do not take the time to put yourself and your company out there where the VCs can spot you, you could miss out on some potential partnerships. Network, network, network.
2. Talk to other founders. Although startups may seem highly competitive — and they are — all founders have been in your shoes. More often than not, they will be willing to drop some very choice tidbits of information. But again, you have to be in contact with them, and be willing to ask for advice.
Rule of thumb, try to find a founder that is 1 to 2 stages ahead of you to act as an advisor.
3. Do your homework. Businesses in this day and age are very fortunate to have some great tools right at their fingertips. One place that has amazing data is PitchBook, a robust database that covers private capital markets, including VC, private equity and M&A transactions. Learn about historical investments, how much dry powder they have and what people are saying about these firms.
PitchBook includes information such as active investments, historical investments, and the amount of “dry powder” a VC has on hand. That is, how much capital each fund has left to invest in you. You need to know that an investor is at a point in their lifecycle to be receptive to your pitch, reserving money for your next round.
4. Do not discount who you know. At the end of the day, one of your best sources for new VCs is your current investor group. You’ve worked with them, they have worked with you, and you know their nuances. If they are willing and able to make future introductions to your next financing partner, it is a lot easier to work with people of a known quantity.
5. Don’t limit yourself. When you are first starting out, it makes sense to keep things closer to home for practical purposes. But as you grow, there really is no geographic limit as to where you can go to find a VC, as long as they are jurisdictionally able to work in your geographic location. There is no cap with where you can go and how you can network.
6. Look at a VC’s other investments. Is this VC strategic? Can they help with introductions to potential partners/customers? There are going to be times that you might reach out to a VC cold, or VC contacts you cold. (I personally receive at least 20 cold introductions a quarter.) Do some research. If they already have a connection with a competitor of yours or an adjacent vertical, it’s worth taking a few extra steps to learn if there is something of value for you there.
VC red flags: Are they waving or bursting into flames?
Along with the good, comes the no-so-good. You might be on the edge of your seat waiting for VCs to come along and invest in your business. Interest does not necessarily mean they are a good match for you, especially when one considers that the relationship with a VC is going to be long and at times arduous, particularly when challenges arise.
1. Do your homework. I know, I’ve said this same thing in the last section, but the same advice applies here. Do your own due diligence with any investors. Talk to other founders and CEOs and get their honest opinion.
Ask potential VCs for references. Have they ever fired a founder? How often have they started into the process before they backed out, and why? A great question here is: “How many times have you issued a term sheet that did not close?” Your goal with this question is to see how thoughtful they are with respect to the companies they choose to invest in. If they send a lot of terms sheets out that do not close — red flag to dig in more. It’s okay to ask these questions, and you can bet they are certainly going to be asking around about your business, too.
2. Look at the terms. Generally, the first step in entering into an agreement with a potential investor is to meet with them and tell them about your company. If you are both mutually interested in taking the next step, they will likely put together a term sheet after a few more discussions. The term sheet will outline key levers of the investment, which will include a valuation of the business, what they are interested in investing, if they want a board seat, etc.
There are going to be times that these terms are ridiculously punitive. If your gut starts to cringe, that is a red flag you might want to consider. Talk to your advisors and legal before you start your negotiations.
Be Nice. Even if interest wanes (Yes, this may be very Canadian!)
As the CEO of a growing FinTech business, I receive calls and emails from all types of investors quite often. Some, I take with a grain of salt; others, I mentally earmark for future investment opportunities. For a select few, I actually engage with for a discussion.
Oftentimes, it is an associate that will generate the initial email to determine if your business would be a good fit for them. The first call with the associate may sound like a match made in heaven. As the relationship progresses, and your company’s details start going up the chain of command, the interest might fall off. It happens; deal with it.
That said, treat these associates like gold. They have the ear of the VC funds leadership team, who can action or kill a potential deal. I know of several VCs who specifically ask their associates how a potential investment company’s founder treated them as they were going through the due diligence process. You do not want your own ambivalence toward an associate to be the reason a potentially good deal goes south.
Associates turn into directors and more — shout out to Bram, who is now on the Corp Dev Team @ Shopify, Gideon, who is crushing it @ Leaders Fund, Narbe, who is now president @ Canopy Rivers and Michelle, who is now principal @ OMERS Silicon Valley.
There are a lot of moving parts when a business is going through the investment process, whether it’s seed funding or beyond. Look around, do not shy away from asking questions and do your own diligence to present your company in the best light for any potential VCs.
