Raising money via Venture Capital (VC) firm investment can be a challenge. A VC typically sees 2k potential investments by email per year, takes into consideration for a meeting 1 per business day (250 per yr), and amongst all the next “Uber for umbrellas”, will somehow narrow down to 5 bets (per yr) that they think will emerge as billion dollar companies within the decade.
A VC is looking for signals that qualify you as a founder capable of charting a clear path for your startup to transform into a billion dollar company. Nothing less. Once you, startup founder, signal that your path is unclear, a VC will most likely remove you from investment consideration.
I would like to share with you a 3 question inquiry that I like to advise
founders ask of themselves and their startup in order to better position themselves into the 15% of companies that will receive serious consideration for venture capital investment.
founders ask of themselves and their startup in order to better position themselves into the 15% of companies that will receive serious consideration for venture capital investment.
1. Do I Understand the VC Asset Class and Perspective? Why I Need to Scale.
As a founder you are out here grinding, no doubt, trying to convert investor and customer noes into yeses that - if skilled enough and forces align - will eventually turn into a billion dollar company. VCs are founders too – they had to at one point weather a storm of a thousand noes just like you are enduring now, but in their case from elusive financiers called Limited Partners (LPs). The few LPs that commit with a yes and a check to VCs serve as the financial foundation for their fund to exist.
For their LPs to continue making cash commitments to their fund, VCs must produce resounding results - Limited Partners (LP) expect their VC partners to achieve a 3-5x net return objective per fund - otherwise, you guessed it, the VC fund loses their LPs and the VC fund goes bye bye! 3-5x is hard to come by! 65% of venture deals return less than what was invested – this means that of the aforementioned 5 bets per year example in our opening paragraph, only 1.5 startups return more capital than invested in them.
VC investment portfolios are littered with former billion dollar super founders that lose VCs millions. So how do VCs succeed? Funds that are
successfully producing 3-5x returns closely align with the Pareto Principle
– whereby 80 - 90% of the returns come from less than 20% of their
investments.
successfully producing 3-5x returns closely align with the Pareto Principle
– whereby 80 - 90% of the returns come from less than 20% of their
investments.
A figurative example of a smaller size fund demonstrating 5x success under the Pareto Principle:
ACME:
- Fund I – Over 4 Years
- $20 Million (5 Startups per yr over 4yrs)
- $5M per yr ($1M per startup)
- 1/5 portfolio produces meaningful returns = 4 Startups,
- $4M Investment base
*Removed mgmt. fees, follow-on, and dilution for easier math
To achieve a 5x or $100M return for ACME Fund I we would need four 25x type outcomes or two 50x outcomes.
In the VC asset class returns have binary outcomes, you typically either lose your investment or hit a home run. Anything in between isn’t worth the scratch. As a founder, if you can clearly communicate that you can hit a home run, you will become a serious candidate for investment.
2. Am I Building a Predictable Customer Acquisition Model?
Contrary to popular belief and VC Twitter, VCs do not invest in people, products, or just technology; they invest in predictable businesses that can scale in value that also happen to be supported by people, products, and technology. A predictable business is a business with predictable paying customers. You can determine if you have predictable customers if your customer acquisition model starts to look predictable.
By cleanly describing how you are going to acquire customers in a customer acquisition model, you are describing where the return on a VC’s investments will come from.
A customer acquisition model should answer the following questions:
- What are my customer demographics (age, occupation, geography, etc)?
- How many potential customers can I acquire X over Y time at Z cost?
- What is my customer acquisition cost CAC vs lifetime revenue per customer - LTV?
- What part of my customers day am I purchasing (commute, at work, home, lunch, recreation, etc.)?
- What channels will I use to acquire customers (events, referrals, search/display, affiliate, influencer, email, phone, etc.)?
Once you are able to define what your customers look like, how they act, where they are going to come from, and how much it is going to cost for them to produce revenue for your business, you are beginning to provide a model for where the return on your VC’s investment will come from.
3. Is My Startup Demonstrating the Potential to Scale Towards Becoming a Billion Dollar Company?
Demonstrate the ability to scale by showing that your customer base is growing faster than you can fulfill the orders. Your business shows ability to scale in value when your predictable paying customers grow and generate revenue at a faster rate than the resources required to acquire them. Remember, a VC’s investment is just an additional resource to produce greater returns for your business.
A customer acquisition model begins to demonstrate scale:
- Pre Revenue = Waitlist for your product/service
- 20% MoM growth in revenue and/or customer acquisition - almost at capacity to fulfill orders
- Customer growth is predictably derived within demographic pools (age, occupation, location, etc.)
- Customer Acquisition and Revenues increase comparative to costs
- LTV:CAC ratio begins to approach 3:1
- Your product/service is occupying a specific segment of a customer demographic pool’s day (commute, at work, home, lunch, recreation, etc.)
- Multiple customer channels are producing a growing customer base (events, referrals, search/display, affiliate, influencer, email, phone, etc.)
The more predictable and scalable your customers are, the more predictable scalable returns are for your business and the VC’s investment. The larger the predictable returns your business’ customers will generate, the more investment ready your business will be.
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Of course, demonstrating that you and your startup can answer these 3 questions successfully and hit scalable metrics does not guarantee that you will receive VC investment or continue to sustain scalability to become a billion dollar company. However, this 3 step inquiry into your business
will most certainly provide you with a better opportunity, than the majority of competing startups, to shape a predictable and scalable business that will receive a closer look by VCs.
will most certainly provide you with a better opportunity, than the majority of competing startups, to shape a predictable and scalable business that will receive a closer look by VCs.