Part 1: Understanding the VC industry as a founder

The order in which you build an ambitious company

There is traditionally a specific order in which you build an ambitious, venture-backed startup. If you follow these milestones, it should help you focus, make appropriate trade-offs, and ideally increase your chances of successfully raising a venture round by aligning your stage to the right investor, right capital, and right diligence process.

Evolution of a company:

1. Idea and team
2. Minimum Viable Product (and willingness to pay)
3. Product Market Fit (and quantify the total addressable market, or TAM)
4. Early Growth (and demonstrate more money will increase the company valuation)
5. Scale (and TAM expansion)
6. Profitability

The venture market aligns to this order

The good news is, there is a thriving venture market that is designed around this order. Each investor or fund has capital structured around the duration, risk and return profile for each segment.

1. Idea and team (friends and family, angel investors or pre-seed)
2. MVP (seed)
3. PMF (series a/b)
4. Early Growth (series b/c)
5. Scale (series c/d/e)
6. Profitability (public markets)

There are always exceptions to this rule. Drug companies and hardware require more upfront capital to get started. Experienced or well connected founders can raise more capital earlier and easier. Strategic investors might have additional motivations beyond just return on capital, or have evergreen funds that need to be deployed annually (for example). Family offices have more flexible capital. Private equity can prefer controlling investments.

But for the most part, this is the order.

Why does VC structure matter when pitching? As with most things money, it’s ROI(C)

Investors at each stages (can) have different limited partners, portfolio construction and motivations. and once you understand those motivations, you will find a place where your business fits into the motivations of each investor.

There are (at least) 3 cases where this matters.

1. Founders waste time on investors who are unlikely to invest
1. Startups are pitching investors that don’t align to the current milestones of the business.
2. Pitching a growth stage investor at a formation stage will typically result lots of due diligence and them unable to match the risk profile of the company.
2. Founders have a mismatch of ownership expectations (ie dilution) by stage
1. Pitching a pre-seed investor after traction will likely not result in an ownership structure that enables their fund structure to hit the VC power laws.
3. Capital duration mismatch
1. Angel investors vs venture funds vs private equity vs family office have different fund durations. The duration of a fund will add pressure for investors to return capital, which in turn will add pressure to founders to sell their business not when the business is ready, but when the investors are ready.
2. Expectations change by stage as well. So when you are pitching your investors, think about whether or not your startup will fit into their return hurdle, not just for you, but for their entire fund.

The end result is lots of time, effort and distraction at a time when a startup needs efficiency, focus and execution.

FAQs

When giving this talk, here are some common questions I have gotten. They most revolve around reading Techcrunch and thinking everyone is getting funded except you. No, most companies are not getting funded, and even most of the best companies you know struggled to raise, or at the minimum got lots and lots AND LOTS of nos. (Salesforce, Google, Tesla, Twilio and many more)