Venture Capital in 6 Minutes
A venture capitalist is a person or a firm who invests in small companies using money pooled from investment companies, large corporations, or pension funds.
Let’s say you have started your own business — you’re passionate about it and it’s all you can think about. The overarching problem is that money doesn’t grow on trees, so where do you get the funding from?
Venture capital, angel investors, the bank, or even Joe around the corner of the street. There are so many potential routes, but in this article, I’m just going to break down some of my findings on venture capital based on a technical session I attended as well as some background research.
When is VC a good choice?
In a common situation (ex. a fashion store, dry cleaner, restaurant), VC is probably not the best choice unless the business happens to be a revolutionary one-of-a-kind, but even then… not great. Owners of common businesses would go to the bank and get a loan. Then they’d use that money to buy some inventory, a lease, hire some employees, and boom! Their business is off and running.
VCs look for unusual companies, a needle in a haystack if you will. And this makes sense! To actually make a profit, a venture-backed company must return about 11x the “useful” money. Therefore, VCs can actually afford to have their investments not work out, thus they take more and more risks.
It’s like the good old saying, “big risks, big reward.” These 4 words essentially sum up a VC’s mindset. 75% of venture-backed businesses fail, but this is ok because the 25% that are successful could be outrageously successful. Like, beyond-your-dreams successful.
Technology is the way forward
Innovation in technology drives traditional industries, and sometimes it actually drives it completely off the side of the road and onto a new path that no one could really predict. Think about the invention of the smartphone — so many things needed to happen before the smartphone, so that the smartphone could exist. Transistors, telephones, the Internet… if a VC can hop on the wave while the wave is only starting, then they’ll make a monumental profit.
This is also one of the reasons why VCs invest in small startups, as opposed to bigger companies that have already got their feet off the ground. Not only is their funding giving smaller startups the opportunity to jump into these new trends, but smaller startups also just move faster than bigger companies, here’s why.
Bigger companies have no incentive to disrupt the current industry — they’re big and successful for a reason. Heading back to the previous smartphone analogy, the New York Times, for example, had no reason to invest in the Internet. It just wouldn’t make the sense with their current place in the industry because of their success with newspapers. Smaller startups, however, saw an opportunity and seized it.
That’s where VCs come in. If they choose and invest in the right small startup, then hello moolah moolaahhh!
What VCs look for
A common misconception is that these startups that skyrocket all start with fancy logos, ideas, workspaces — NO!
These entrepreneurs were college dropouts, or something similar, who were super passionate about solving a problem, that they would do it even if there was no money involved.
Most of you probably know who this is despite the poor quality of the image, and if you don’t, then the poster on the left likely gives it away. This is Jeff Bezos. He graduated from Princeton with a Bachelor of Science in Computer Science and Electrical Engineering. He could’ve got a pretty decent job right after college — instead, he looked at the world and noticed a problem. There was a lack of accessibility for books.
His solution? He wanted to sell books online, and when someone placed an order, he would ship it out from his garage.
All startups start humbly. What started as a small startup in his garage, Jeff Bezos spiraled into a trillion-dollar company, and so connecting this back to VC, investors aren’t looking for the glamorous lifestyle. They frankly don’t care.
From Vivek, I learned that there are three non-negotiables for a startup that will automatically warrant an investment (ps. the earlier you meet the company, the more difficult it is to discern the quality of these non-negotiables).
- 🔑 Quality of the team — most important in the early stage, the next two become more important as time goes on
- Potential in the market
- The product itself — this is the hardest thing when the company is young
The reason why quality of the team holds more weight than the other two is because market potential and the product are both adaptable. This means the market could change unexpectedly, or the team could transition to an entirely different market.
The same concept applies to the product itself. You can bet that after a couple of years, every company’s product will be significantly iterated, revamped, or replaced altogether.
However, the quality of the team is different; everyone has to be aligned and on the same page, each with a similar vision of where the company wants to go. Without a strong team dynamic, even the best products won’t get off the ground.
ps. the founder’s background and passion relates back to the quality of the team.
How VCs find these startups
Well, it turns out with that 300 million dollars, a lot of people actually look to find you. There’s no shortage of meetings and conversations for VCs, and VCs only invest in around 2 to 4 startups per year, but this this begs another question: how do VCs find the right startups?
Instead of understanding each company that applies, understand the industry, and understand how that industry can be disrupted. Analogy: when you’re solving a puzzle, you’re looking at each individual piece first and then deciding where it could go — instead, you look at the bigger picture and see what type of piece is needed to fit in that opportunity.
The same goes for startups. It’s crucial for VCs to understand the problem first so that they can understand how each solution potentially solves or doesn’t solve the problem.
🔑 They look for visions that are different. Visions that have the potential to be revolutionary. But most importantly, visions that actually solve a need in the industry.
Closing Thoughts
Running a company is the ultimate team sport, but like in most sports, plans will not always go to plan. When the bumps in the road come, that’s when VCs need to be the MOST supportive.
Sometimes, companies are forced to pivot and switch directions, but VC should not disappear when the company hits their first bump in the road. I’ll give you an example.
A company known as Burbn that focused on enabling users to meet up with each other and share their experiences. Their initial product was received poorly by the market. It turns out that their app was too complicated, and that the majority of their app was quite pointless. After some reflection, the founders noticed that people were not using the meet-up features, but rather they were using the app’s photo-sharing features.
They took this idea and never looked back at. After constant revisions and the invention if filters, Burbn became known as what we all know today as Instagram.
“The only constant is change, and you have to become comfortable being uncomfortable. Otherwise, you won’t be successful in this world.”
