Usually, startup companies finding external financing often go to venture capital (VC) firms. These companies offer capital, strategic support, introduction to potential partners, customers, and employees, and miscellaneous services.
Venture capital financing is quite a challenging task. Entrepreneurs are better prepared to achieve venture capital financing if they are familiar with the process, the anticipated deals’ terms and conditions, and the prospective issues that may arise.
The Probability of Being Funded by a Leading Venture Capitalists
The odds of being financed by Andreessen Horowitz are about 0.7%. The founding partner of Venture Capital Company, Andreessen Horowitz, and Marc Andreessen gave an interesting sneak peek of the odds of a startup company receiving funds from their firm in a conversation at Stanford Graduate Business School.
In the interaction, Andreessen described that about four thousand startup companies annually go to raise venture capital financing. Of these 4000 startups, they investigate around 3000 annually, the majority of them coming from inbound interest. The number breaks down to noticing approximately twelve opportunities daily (50 weeks each year, 5 days each week). Of the 3,000 screened, they consider 200 very seriously. Annually they invest in around twenty startup businesses making it only 0.7%.
Furthermore, from an aggregate point of view, the leading venture capitalists fund about 20 startups each year. As there are 4000 companies seeking financing, this equates to odds of 5%. Out of the two hundred companies that are funded by the leading venture capitalists, fifteen of these startups businesses will generate an almost entire economic return. The remaining will either go to nil or struggle along without generating much return. Hence, even the leading venture capitalist companies tank about half their deals. Therefore, they are extra careful and conscious about being wrong.
Factors that affect acquiring Venture Capital Financing
It is critical to understand that venture capital firms usually focus their financial investment activities using one or more of the following factors:
New York, San Francisco/ Silicon Valley, etc.
- Specific Industry Sectors
SaaS, software, semiconductor, digital media, mobile devices, biotech, etc.
- Stage of the Company
Early-stage seed or Series A rounds, or later phase rounds where companies have achieved impactful revenues and traction.
Before contacting a venture capital firm, try to familiarize yourself with whether their focus is compatible with your company and the stage of development.
The other thing to get acquainted with is that venture capital firms get inundated with investment opportunities, several through unsolicited emails. The majority of unsolicited emails are considered spam and are ignored. The best method to get noticed by venture capitalist companies is to exhibit a welcoming and warm introduction through a reliable entrepreneur, colleague, or a lawyer cordial to the venture capitalist himself.
A startup company must also have a great ‘elevator pitch’ and an influential investor pitch deck to appeal to the interest of a venture capitalist. Additionally, startup companies and business owners should also understand the process of venture financing can prove to be extremely time-consuming—for instance, just getting an appointment with a principal of a venture capital company may take up to weeks; followed up with more conversations and meetings; subsequent presentation to all of the partners of the venture capital fund; issuance and negotiation of a term sheet, with continuous diligence; and ultimately the drafting and negotiation by lawyers on both ends of various legal documents to evidence the investment.
Qualities of a Startup That Attract a Venture Capitalist’s Interest
Venture capitalists are specific about the characteristics of a startup they may consider funding for. The three qualities top venture capitalists usually look for in a startup company are as follows:
- Outstanding management team
- Differentiating technology
- Huge Market
These criteria are strategic and logical. If the market is too small, it does not matter how great your product and service are, it just won’t cut it as it will lack the big impact. If the technology is too similar to that of the competitors, then the odds of breaking away from the lot are low. Ultimately, outstanding people are necessary, but neither of the other two criteria matters.
Venture Capitalists Look for Specifics in a Founder
Of the above-mentioned three criteria (people, market, technology) more venture capital companies will say the decision primarily comes down to people, as opinions on technology and market are highly challenging to get right and are not necessarily that relevant.
Concerning the people, the two most important characteristics are:
- Intelligence and Brilliance—ideas, harder to force yourself to do/more intrinsic, way of thinking.
- Courage—not giving up in the face of adversity, determination to succeed; ability to learn from mistakes.
Of the above characteristics, one can be learned through conditioning, while the other is not.
All human beings are born with a specific courage quotient, however, that concentration can be considerably improved through life experience, training, and conditioning.
Intelligence and brilliance, on the contrary, are very difficult to develop. Intelligence can be enhanced through continuous learning, reading, etc., however, it may not improve your chances of success.
However, it does not suggest that intelligence is more important than courage—not at all. Willpower and determination help you to overcome all the obstacles that come your way.
Good Pitch vs. Bad Pitch
A bad pitch primarily lacks the essential characteristics. Precisely a bad pitch may have the following qualities:
- The founder does not maintain their position when challenged on it.
- Small market, basic technology, and ordinary people.
- The idea maze is absurd and not well-explained. It is much convoluted and likely to get lost in the maze.
- A ‘me too’ approach
A good pitch, on the other hand, can walk you through the idea maze effortlessly and seamlessly. It is likely to lead you from the original concept to a commercial idea that can work and generate money. There is only a short winder of time to present to an investment committee, therefore the story has to be logical, succinct, and compelling.
Venture Capital Term Sheet
The term sheet is a critical document as it suggests that the venture capital firm is seriously considering the funding and wants to go further and finalize due diligence and prepare the legal investment documents. Term sheets are still not a guarantee that a deal will be consummated, however in the majority of experiences, a high percentage of term sheets that are finalized and signed resulted in completed financings. Although it is a non-binding document, the term sheets are still the most significant document to negotiate with investors—almost all the important matters are included in the term sheet, leaving only small matters for the financing documents that follow.
Moreover, it is beneficial for both the investors and the founders of the companies to have the long comprehensive term sheets, as it will mitigate future matters in the definitive document drafting phase.
Valuation of the Startup
The valuation put on the company and business is of critical importance for both the investor and the entrepreneur. The key aspects that determine the valuation include the following:
- The past success and experience of the founders.
- Size of the market opportunity.
- The proprietary technology is already established by the company.
- Any initial traction by the company (Partnerships, revenues, favorable publicity, customer satisfaction).
- Progress in the direction of a minimally viable product.
- Recurring revenue opportunity of the business model of the company.
- Capital efficiency of the business model.
- Valuation of comparable firms.
- The economic atmosphere
Each startup and valuation analysis is unique, however, the range of valuation for very early-stage rounds is usually between 1 million to 5 million dollars. The valuation range for companies that have received some traction and are doing a Series A round is generally 5 to 15 million dollars.
Venture capitalists will want to ensure that the founders have incentives to stay and grow the company. If the founders’ stock is not already steered to a vesting schedule, the venture investors will request that the founders’ shares become subject to vesting based on the continuous employment. Standard vesting for employees is monthly vesting over a forty-eight-month period, with the first 12 months of vesting postponed until twelve months of service are completed, however, founders can usually negotiate better-vesting terms.
Venture capital financing can be critical to the success of a startup; however, it can be challenging to land a top venture capitalist. The key factors affecting the chance of getting funding from a venture capital company include the huge market, outstanding people, and exceptional technology. Additionally, venture capitalists also pay close attention to the founders and their personalities. In their view, the genius, and determination of the founders to beat all odds make for exceptional traits in the potential successful company. By familiarizing the key issues in venture financings, entrepreneurs can enhance their likelihood of getting financing from a venture capital firm.