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:
- Idea and team
- Minimum Viable Product (and willingness to pay)
- Product Market Fit (and quantify the total addressable market, or TAM)
- Early Growth (and demonstrate more money will increase the company valuation)
- Scale (and TAM expansion)
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.
- Idea and team (friends and family, angel investors or pre-seed)
- MVP (seed)
- PMF (series a/b)
- Early Growth (series b/c)
- Scale (series c/d/e)
- 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.
- Founders waste time on investors who are unlikely to invest
- Startups are pitching investors that don’t align to the current milestones of the business.
- 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.
- Founders have a mismatch of ownership expectations (ie dilution) by stage
- 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.
- Capital duration mismatch
- 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.
- 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.
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)
This is one of the most frustrating chicken and egg situations. If you are not seeing early signs of word of mouth or organic growth, you will need capital to grow. Options that can help increase confidence this will work:
- Small marketing tests that validate profitable unit economics
- A letter of intent from a distribution partner
- A signed contract
This unfortunately is the case for many founders. Fundraising is always hard, and this makes it harder. Closing the Equity Gap is a book that talks just about this very topic. Here is some responses from a SF Tech Week panel on this very topic:
- Look for a fund that has people that look like you and hustle to get a meeting with them.
- Find an early advocate, a seed investor who cares deeply about the solution you are building, and have them be your advocate.
- Lead with a growth slide that shows above market growth or unit economics. VCs are motivated by returns, and growth or profitability are great indicators.
- Hire people or add cofounders that look more like the VCs you aspire to raise from.
- Bring onboard advisors who are well connected to venture capitalists
- Get a degree or MBA from Stanford or Harvard
This is hard, and requires additional hustle. Advice we have seen work from other founders:
- Go to SF and attend as many conferences and meetups. They are usually free or have reduced fees for early founders.
- Build a social presence in VC Twitter.
- Find mutual connections and write personalized emails.
- Find investors who have publicly indicated they are interested in the problem you are solving.
I recommend always being prepared to fundraise, so that when the business is ready, you can spend the least amount of time fundraising as possible.
- Fundraise deck prepared
- Investor CRM ready
- Investor outreach drafted
- Cap table compliant
- Data room prepared
- Financials and projections up to date
The more you can minimize the time from a business inflection point to capital, the more time you can focus on business building and growth.