The ABCs of VCs
“That which is simple can still be hard.”
You should only take other people’s money to maximize opportunity. If taking $1M can get you to $1B market, go get it! But if you are hoping to find $50,000 before you quit your day job, “IDK”.
Know the difference between VCs and “Angels”
VCs are professional investors with very specific criteria and a fiduciary duty to their limited partners. VC = Institutional money and equity. An “angel” could be anybody who writes you a check. There are also angel groups where angels come together, pool their money and vet deals. Angels are usually active very early at seed stage.
Know what VCs are looking for
Snapchat just received a $10BLN valuation because they had something a VC was looking for. In addition to 100 million unique monthly users and previous VC validation to the tune of $160MM, Snapchat provide an opportunity to invest in a modern high growth B2C startup. Kleiner Perkins has missed some opportunities after focusing on clean-tech post bubble, so this was an ideal $20MM investment that they were looking for. Supply and Demand. It’s about what you are worth to the VC not only the market.
VCs invest in a very specific kind of start-up if they are smart: one that is poised for hyper-fast growth. The good VCs “shoot for the stars.” Your startup must have a very huge potential for VCs to be able to fulfill their fiduciary duty to their LP’s. VCs have a short list of must-haves in the ventures in which they’ll invest and if you don’t satisfy those criteria, you either need to change your strategy or don’t waste your time chasing that VC.
Here’s a general list for typical VCs:
1. $1B market potential. If yours is not that big, then you need to broaden your horizons and think bigger.
2. Experienced management team. The good news is that VCs have great networks that can help you round out your team. But you’d be better served to get close to a rock star team as possible on your own.
3. Sustainable competitive advantage. If your venture is not built off of some protected and scalable technology, VCs won’t usually be interested. They love IP.
4. Scalable business model. You have to be able to grow big fast.
5. Solving a clear real problem. You must demonstrate that you are in touch with your customers. Customer Interviews are KING.
6. Clear exit strategy within 3-7 years. If you are planning to run your business forever, don’t bother VCs. They must exit to provide a return to their LP’s Raise more, sell or IPO.
Plan on future rounds of investments
Most entrepreneurs think they can “get there” with only one round of funding. You’ve been trained to bootstrap. You need to start thinking of how you could grow the fastest, with almost unlimited resources. If you accept one round of VC funding, that means you are on board for several if necessary and they often are if you are pushing hard enough. It might look like this:
• $2M early stage round to get to prototype or perhaps get first customers;
• a year later, another round of $3-7M to test the business model and whether it can scale, milestones of $1M in sales or some # of customers or some agreeable valuable metric;
• then maybe 18 months later, $10-20M to go BIG.
Understand pre-money, post-money
If you receive a $1M investment and you negotiated a $1M pre-money valuation, you just sold half your company. The value of your company after the investment is $2M (= pre + cash), and that is called “post-money” valuation. 20 – 35% is a good deal from the startups perspective. If you want to drive the valuation up get multiple term sheets and drive the competitive interest from multiple VCs.
There’s so much more to discuss like; Comps, Negotiating, Lead Investors, Syndicate Rounds, % of ownership, Exits, Fund Structures Valuations, Term Sheets, Cap tables, Pitching, Decks, Financials, Board seats, etc, but this is enough for now.
Raising money is more of an art than science although there are certainly some best practices on how to hold the brush and stroke the paint. This article is very general and not absolute in any way, but hopefully it can serve as a good starting point for those interested in asking a VC for some cash one day.
Here’s a list of Dallas VCs, PE and Angels I got from the DEC info graphic.