Secure the Bag: The New Rules of Raising Venture Capital
These are confusing, often contradictory times to be a startup founder raising early-stage venture capital. Terminology is changing — “Soil is the new seed!” and “Seed is the new A!” — and so are expectations. Multiple tech companies have postponed their initial public offerings this past year or are trading below their opening prices. Many venture capital and private equity firms are wondering what that means for their IPO dreams. Most investors continue to support the merits of blitz-scaling, while others are beginning to espouse a more sober return to profitability. Even Softbank, which has been perhaps the most bullish supporter of hyper-growth in the industry, is reportedly becoming more conservative.
The landscape is rapidly changing. There are 1,000 venture firms today, and 1,900 active funds, according to the National Venture Capital Association. It seems everyone is encroaching on someone else’s turf. This long boom has minted hundreds of new angel investors (wealthy individuals who invest small amounts of money) and angel syndicates (groups of angels who invest alongside one another). Many of these individuals are beginning to raise outside capital and moving up the stack to launch new institutional firms. Meanwhile, a number of traditional venture firms that historically focused on series A investments are now investing in growth-stage companies, and some hedge funds are investing in early-stage startups.
In times like this, it’s hard to know who’s who, what’s what and how to get the money you need for your startup.
With so many things changing, I’ve written a four-post series about how to raise early-stage venture money today.
If you’re a founder of a tech company and you’re thinking about raising capital, but aren’t quite sure how to navigate this evolving environment, this blog series is for you.
So you understand where this advice is coming from: I spent 16 years in product leadership roles at companies big and small, including eBay, Oodle and Stella & Dot. I also helped the founding team fundraise their Series A when I led product and operations at Keaton Row. I’m now an advisor to founders and an investor at Spero Ventures. At Spero, we invest in early-stage (late seed and series A) tech companies building the things that make life worth living — specifically in the areas of well-being, work & purpose and human connection.
In this series, I’m going to try to answer the questions I get most frequently from founders about fundraising. We’re going to start with the most fundamental question of them all:
How do you know if venture capital is right for you?
For founders who want to build billion-dollar tech businesses that dominate their industries, venture capital can be a powerful way to give you an unfair competitive edge and help you scale. If that’s your goal, it will be extremely difficult to get there without outside capital, and it’s exactly what venture capital was invented to do.
Venture capitalists (VCs) provide funding to high-risk businesses, along with guidance, resources, customer introductions, recruiting help and coaching. But in return, they have high expectations.
What do VCs expect?
All VCs are looking for outsized returns. They want to fuel the next rocket ship or unicorn — a company with a market capitalization of $1 billion or more. That means your company will be expected to achieve $100 million in annual revenue — preferably in fewer than ten years. Why ten years? That’s when most fund partnership agreements expire, at which time the VCs need to return money to their investors, called limited partners, or LPs — hopefully at a profit.
Do you expect to achieve that kind of outlier growth? Most entrepreneurs don’t, and that’s OK. Venture capital gets a lot of press, but it’s really only a fit for a tiny percentage of startups.
If pushing yourself and your company as far as it can go, as fast as it can go, with the goal of hitting $1 billion in market cap within ten years, and even further and faster after that, doesn’t appeal to you, don’t pursue venture capital.
If your goals and expectations are not aligned with the goals and expectations of your investors and board members, venture money can do more harm than good. (For more on this, read some of Bryce Roberts’ writing.)
But very few startups make it to become $1 billion-dollar-companies! How does that math make sense?
It doesn’t make sense until you look at the big picture, AKA portfolio management.
The collection of a venture firm’s investments is its portfolio. No VC expects every one of the companies in its portfolio to become a unicorn. You can think of it in thirds. Most VCs expect a third of their companies to die and lose the money they invested. VCs expect another third to get sold to another company for a modest amount — and return maybe 1X–3X their investment. The top third of their companies are the big winners. These should return 5X-10X their investment.
When a VC says a company “returned the fund,” that means the profits from that one investment brought in enough money to the firm that the rest of the portfolio could be full of duds and they’d still deliver a profit to their LPs. Of course, VCs are always reaching for the shiniest golden ring of all: The 100X-er. In incredibly rare cases, like with Slack, Uber, Zoom and Whatsapp, the return on capital could be 100X.
A top-performing firm is expected to return 3X — a feat only 5% of funds achieve. Half of the funds that exist today won’t even return 1X their capital.
If VCs don’t believe you can achieve “venture scale” returns, they will not invest in your company — no matter how cool or impactful your product or company is otherwise. It’s not that they’re greedy, it’s just a really high-risk game. VCs are looking for winners that will be so huge they make up for all the other companies that don’t make it.
The upshot: The odds aren’t in your favor
Fewer than 1% of companies VCs review wind up getting funded. Here’s how it breaks down at Spero Ventures. Between myself and my two partners, we will look at 1,000+ companies this year. We’ll meet with 150 companies and do due diligence on 25. From there, we’ll invest in 5.
Suffice to say: It is really, really hard to get venture capital funding. You’re going to see a lot of rejection if you pursue this path, and that’s completely normal.
What other financing options are there?
- Friends & family
- Angel investors
- Bank loans
- Credit cards
- Bootstrapping, AKA make a profit as quickly as possible and self-fund your growth
If, after all this, you think VC is the right path for you, tune in for next week’s blog post: Am I ready? And how much money should we raise? (Part 2 of 4)
If you can’t wait for my next blog post (a weekly 4-part series), you can watch a talk I recently gave to seed-stage founders on fundraising below or view my slides here.