When VCs Fall In Love With You
If you’ve never raised VC funding, you are probably finding it hard to figure out exactly how it works. Who invests in what, when, and why is not really clear from the outside. Reading mainstream news or even some of the tech news sites, it can seem like the reason that some companies get investment is completely random or just luck.
There’s actually a lot more to it.
Even though there are a number of factors,
the stage of your business and your industry are two of the most important three factors that will enable your business to raise VC investment.
The third is the founding team. But we aren’t going to get too much into that in this article.
Why? Because VC firms specialize in investing in companies at specific stages and specific industries.
For example, a firm may specialize in investing in early stage software companies. If you are not an early stage software company, then this VC firm is not going to invest in your company.
Understanding the who, what, when and why of VC investment can help you to plan your business and make sure you are spending your time wisely. To get an understanding of business stages of a company and the rounds associated with it, check it out here.
Let’s examine the funding rounds of a business and see what it is that investors are looking for at each stage. Remember, these are general rules. Each firm may have specific requirements that the company must meet in order for them to invest.
Angel Round. Sorry, no.
This will not be love at first sight. VC firms do not invest in companies in the Angel stage. It is called the Angel round of funding because Angels or Super Angels invest in companies at this stage.
Angels are individuals who invest in companies with their own personal cash. It may be a one time investment or they may be professional Angels and invest in a number of companies. The main difference between Angels and VCs are that Angels are individuals investing their own cash, and VCs are firms that invest from funds, which they have raised from other people, companies and banks.
At the Angel stage you have just an idea and an assumption about the market. You probably do not have much more than a PowerPoint and maybe a simple prototype, if that.
What do Angel investors look for? Well, since they are individuals there really isn’t a hard rule, but I would say that Angels are likely to have interest in specific areas. Maybe they previously founded a company in the same industry or they are really into a certain technology. At this stage founders are really important. Afterall, you don’t have a business at this stage so you need to be judged on something.
VCs don’t care too much about you now.
It becomes a different story, though, once you have closed an Angel round and your business is starting to grow. Seed VCs will start to have interest. It is never too early to start talking to those VC firms that invest in your industry. Start reaching out now.
Seed Round. Now, we are talking.
So you have a working product or service and some customers (probably not paying :( unfortunately). Your customers are early adopters, which is great because all it takes is a handful of early adopters to jumpstart your business.
Seed VCs are looking for a working product and some amount of customer traction. Revenue is not important here. But, you need to paint the picture for the VC that your business could become a large scalable business.
Also, throughout all of the stages, remember that VCs are looking for huge markets. If there is no possibility that you will have a huge market, then there is no upside for the VC. Read about market size here. A huge market size is in the billions of dollars. If you estimate your market size to be tens of millions of dollars and want VC investment, go back to the drawing board and figure out how you can have a broader reach.
Series A. Yes, ma’am.
Err...I mean sir. Let's be realistic, most VCs are men. (It is estimated that 4% of senior venture capitalists are women.)
Congratulations! You are now consistently getting paying customers.
What are VCs looking for in a Series A? Consistent growth in customers and revenue.
Check out the Series A deck for Mattermark. You can see in the Quarterly Revenue slide that their revenue is pretty low, but it more than double in in twelve months. Paying subscribers and Enterprise Seats also went from almost none 500 thousand in six months. No, Mattermark was not making a ton of cash at the time, but success at this point is measured by consistent growth.
Series B. This. Just. Got. Real.
When you were in your Seed and Series A you didn’t have much to prove to VCs. A lot was based on your founding team and some amount of market traction. VCs (and their associates) probably weren’t scrutinizing your numbers too much.
Now you are have some real numbers and customers and revenue is building. You can paint a picture of the future that seems attainable and profitable for the VCs.
Check out LinkedIn’s Series B investor presentation. I’m not a huge fan of this presentation because I think their financials are weak, but hey LinkedIn is awesome and they deserve leniency here. Without LinkedIn (or something like it) business would be in a very different, and much worse place today.
LinkedIn’s Series B investor deck is from 2004. Some things may seem a bit outdated and even cheesy, but check out their network growth vs projections. This is a great story: they beat their own projections by more than 2X.
LinkedIn’s financials are weak: they project going from $0 to $261 thousand to $7 million, which sounds tough. But their expenses to support their business seem to be missing something. They go from operating expenses which are 15X revenue, then one to one the next year. That seems pie in the sky.
LinkedIn does, however, paint a picture for the future: the market is trending better than projected and revenue grows over 200X in four years. This shows prospective investors that if LinkedIn can deliver on their plan, they will be in a good place to exit either via acquisition or IPO in the future. That's the whole point of VC investment.
Series C. Absolutely!
Congrats if you have reached this round. Only about 10% of VC backed companies get to the Series C stage.
You may have gotten away with your sexy up-and-to-the-right-graphs for some time. They were awesome and your board loved them. But now, you are running a real business and being measured on things that were not important before.
How is your COGS? What about gross margin?
Wait a second, you aren’t a finance expert, how are you supposed to know about this stuff?
Somewhere after Series B, startups start to get the seasoned management team in. In terms of running a business there is a big difference between the founding team, which is typically a group of people who have an idea and are able to get customers and attract employees and having people who have experience running large departments and scaling operations. You are in a totally different ball game now.
All along the way you need to remember that VCs are in it for the 100X return possibilities.
If you think your business could possibly produce that, you have to show it and tell them about your assumptions. Otherwise, there is no point. VC firms are businesses, not charities.