Recently, whilst speaking with a VC friend, we discussed the startup fundraising mentality and how the venture capital industry thinks about startups in broad strokes.
It would be great to share a “silver bullet” with you today, but that’s perhaps too optimistic. Rather, I’m going to discuss some of my thoughts that I shared in response to these questions. Here’s a breakdown of the conversation:
Dear <Venture Capitalist>,
My birds-eye view of VC:
First off: I think venture capitalists and investment bankers are a breed apart… But some of the lessons imparted below are shared mutually.
I think that the venture capital industry and is actually an industry that is driven by an intersect of thesis, mandate and emotion.
Ultimately, it’s a checklist and like Greg Moore says: money doesn’t like to think. It likes a simple checklist.
Obviously, people invest firstmost, or the majority of their capital, in what they know from their professional experience. They invest algorithmically. The startup fundraising mentality should be geared to not only raise from the right VC, but from the right partner at the fund who has done similar deals.
For example: you go to Fred Wilson (one of the gold standards in venture capital) to pitch an investment in mostly consumer-facing (B2C) startups. That’s what Union Square ventures specializes in. They don’t focus on b2b, not because they don’t respect the space – it’s just that they understand B2C space because they have had success (and fails! – those are important too, as smooth seas do not a good sailor make) with these companies and are in the best position to know the signals that predicate fast growth and which are likely big opportunities. They’re also in the best position to advise these companies to grow fast and make the best decisions that will lead to profitability, scale and exit/ IPO.
Another great example is Bessemer Venture Partners that really specialize in marketplaces – they’ve invested in everything from Fiverr to Pinterest – so their view on metrics is completely different from USQ. It’s much more about marketplace metrics and scalability on both sides of the market. Retention, acquisition and growth in repetition as well as cheque size. This is relevant for the client side, but equally for the workers that power the marketplace. (if you’re interested in some thoughts on spec work and bidding marketplaces as well as why I’m not a big fan of those type of exchanges, read on in this LinkedIn post I wrote recently).
Of course… They know how to spot a great team… And that trumps the product every time.
Investors like to invest in companies that are similar to what has made them successful in the past and in finding new efficiencies in an existing business model or expanding an existing market.
So if you can offer a product that is either faster, better or cheaper that’s can disrupt an existing very large market they already know about, it doesn’t make hard to think about.
Is it a big opportunity? How much can you capture? No VC wants to back an unambitious startup or one that doesn’t look to capture a chunk of a huge opportunity. Eg: with Indigogo there is over $300Bn each year in charitable giving / causes / supporting small projects and prototypes.
A lesson I learned worth sharing regarding startup funding is that whilst a VC wants to see a decent sized TAM, they also don’t want to see an unrealistically large TAM claimed by the entrepreneur or hear: “If we were able to close a small percentage of the TAM…”. What they want to see is that the entrepreneur has taken the time to investigate the market thoroughly and backs their statements up with reliable links (not Quora). From there they want to see a business plan that lays out very clear steps to securing a foothold in the market opportunity.
Going in with a massive TAM claim that’s unrealistic just gets people’s eyes rolling.
When entrepreneurs think about a business, they often first consider: how can I make things faster, cheaper or more sophisticated. Finding new efficiencies in existing market plays is always welcome… however true disruption is often found in expanding the market size.
Here’s a great example: Uber is very disruptive. Why? Because Uber expands the market size of people who can make money from being a professional driver without being a part of a taxi company (that may have spent $1m on a medallion per taxi). nother good one is Box and Dropbox, which allowed people and businesses who could never afford cloud-based storage with enterprise-quality tools to have access for free, if not a few dollars.
These are markets which grew substantially due to disruption from these technology startups. That’s exciting to hear from the perspective of scale and how it fundamentally changes how people work every day.
MONEY LIKES COMPANY
There is no doubt in my mind that’s when you see another investor you know and respect invest in a company it is exponentially easier for you and your fellow investors to become involved.
Moreso if there is a strong lead, confidence in the deal is high. There are many smaller sources of capital (yes! Even some smaller VCs and funds that don’t have time nor resources to do an extensive due diligence) whose mandate dictates that they only follow. This means that they look for a larger funder or leader to take up a significant piece of the funding round and do the due diligence.
A caveat: if a smaller and well respected VC is committed and offers the intro / helps close the deal with big investors in their network, many deals are sealed this way.
Why? The first reason is Trust. When a deal comes from one’s own network and the deal is already backed (terms sheets singed and capital is deployed) the level of trust is very high and the deal is generally done quickly.
There is a second underlying aspect: often larger firms/ investors know that the smaller firms are their source of good deals (whilst there is no end of capital available, there is a shortage of food deals). Rejecting deals from a trusted source threatens the flow of future deals. It’s a dynamic that no one talks about but is certainly present.
This post by no means covers all the dynamics of the startup fundraising mentality. I would love to hear your opinion and see what I’ve missed out on. Comment below and share your thoughts, advice and experience.