This is the last part of my series dedicated to startups, from the project stage to the final step that I will talk about now – financing via venture capital funds (VC money) and taking the business to the next level.
Partly due to the success of many businesses (Slack, Uber, Airbnb) and partly because of the massive amount of funds available, venture capital has been crucial for the ecosystem of startup companies in recent years. But is this the right way to go about your business? Has your company grown enough for a move in this direction?
In the following lines, I want to shed new light on venture capital funds and when it is appropriate for your business to resort to such a solution. I will analyze the venture capital industry and how this type of players handles their day-to-day activities.
Seed money vs VC money or Angel Investors vs Venture capital funds
I will start by introducing you to the main elements that differentiate angel investors from venture capital funds.
An angel investor is anyone willing to devote time and money to a business. These investors can come from any background and are often former entrepreneurs, motivated by the potential for low profitability and the ability to give something back to the entrepreneurial community.
Having an angel investor with you can be a game-changer, as his access and knowledge of the industry could offer additional benefits to both your team and company.
A viable way to find an angel investor can be through your network, via the entrepreneurial scene or with the help of financial advisors. There are also investment networks and profile sites where you can try your luck.
Venture capital funds
Venture capital funds are similar to angel investors but have a more complex structure. Instead of dealing with one person, you will now be dealing with an investment firm specialized in startups.
Venture capital funds often rely on external investors, which increases their competitiveness, making them more disciplined and demanding.
Venture capital funds tend to focus more on the business than on the entrepreneur. If angel investors rely heavily on a pitch and the entrepreneur, venture capital funds usually have access to a complete business plan and history.
Usually, venture capital funds provide more money in exchange for more control. As the amounts increase, so do the stakes, and venture capital funds will work harder to track their investments and intervene whenever is needed.
There is also an increased emphasis on return on investment. Angel investors are not non-profit organizations. However, venture capital funds are usually based on external financing and are much more focused on making large profits, making them more involved and aggressive than an angel investor.
In short, the angel investor bets on an idea, hoping he can capitalize on it. Venture capital funds invest in a business and hope to become huge, bringing them an equally high return on investment.
When is the best time to turn to venture capital funds for VC money?
Now that you’ve learned how venture capital funds work, I’ll talk about some of the common behaviors I’ve seen in the VC industry over time. These will eventually answer your question of when you can apply for venture capital funding and when it would be better to wait or refocus yourself on other sources.
Great ideas for great markets
As venture capital funds look for the next unicorn, they will always choose companies with high revenue potential (> $100 million – $300 million).
To have the comfort that your startup will reach this income in the established time frame, it is important to have a huge market to operate (+10 billion USD). Then, you have a chance to reach the desired result even with lower initial traction.
Aim as high as possible
Venture capital funds are very selective, and it is not uncommon for them to invest in just a few companies a year. The reason? They need to get the most out of these investments.
This means that they must be willing to risk a good offer or deal now in exchange for a potentially higher future profit.
The winning mentality
Venture funds and venture capitalists know that most of their bets are bad investments. They know how important it is to get the most out of companies with enormous potential. It’s difficult to predict when investing, but as soon as the business starts to show signs of weaknesses, a venture fund may suddenly decide that it is no longer worth putting time and resources into it.
This is certainly not the case with all venture capital funds. The founders of a poorly performing company could be the ones to lay the foundation for the next big boom in the market. However, there is certainly a clear tendency to pay more attention to winners than to losers, even though Peter Thiel, co-founder of PayPal and Palantir, has criticized the VC industry in the past, arguing that most funds spend 80 % of their time on “losers” and not on “winners”.
When should growth be stopped?
The return on investment must come as quickly as possible. To achieve bold business goals in a short time, you need to have constant growth. This can force investors into making certain sacrifices, pushing companies to look for growth at the wrong time. It can also lead to side effects, such as:
• Excessive spending with a low focus on profitability
• Lack of time for solving small problems, resulting in bigger problems
• Short-term growth, at the expense of huge losses, without any indication that the startup will be capable to recover
Businesses with massive growth have recently successfully raised large sums of capital, as the investment world is starving for rapid development and short-term results. As many of these fast-growing companies mature, questions begin to arise about their future potential in terms of profitability. Not everyone can follow in Amazon’s footsteps and continue to focus on growth for far, for too long. At some point, profit is required, and some changes and adjustments need to be made to get it.
Don’t be shy in accepting as many funds as possible.
Discovering new offers is difficult, so once a business shows signs of success, it’s in the best interest of venture capital firms to allocate as much capital to the company. But for every extra dollar invested, the expected value at the time of exit must be significant. This can lead to excessive dilution of funds or to an excessive amount of pressure on companies, forced to obtain an inflated valuation necessary for a high enough return.
The Investment thesis – essential factors for successful financing via venture capital funds
An entrepreneur has the right to ask for transparency when it comes to financing from venture capital funds, both in the decision-making and executive processes. Many businesspeople have noticed how weak VC processes are compared to the startups they support. Here are some things that could improve them for the VC processes:
• More consistent and effective feedback during the decision-making processes; some venture capital funds are perceived as monopolies, with many entrepreneurs describing the process of working with them as tormenting
• Faster and more clear decision-making from the people in charge
• Establishing financial objectives from the pre-financing stage, and analyzing possible scenarios, depending on how events unfold.
• Standardized terms and conditions for offers
• Standardized due diligence procedures
Let’s look at the issue from an investor perspective – examples of successful VC fundings
Before concluding, here are some of the largest rounds of venture capital funding in history:
Facebook’s $ 22 billion acquisition of WhatsApp in 2014 was the largest private transaction by a venture capital-backed company. It was also a big gain for Sequoia Capital, the company’s only venture capitalist, which turned its $60 million investment into $3 billion.
The $16 billion Facebook IPO catapulted the social media giant to a market valuation of $104 billion and was also a huge success for Accel Partners and Breyer Capital. The venture capital firms ran a $12.7 million funding round on Facebook in 2005, and their cut of the deal was negotiated at 15% of what was then “Thefacebook.” At that moment in time, the company was valued at $100 million.
When Snap Inc. went public in March 2017 at a valuation of $25 billion, it was the second-highest valuation for a social media company.
At the time, the stake held by venture capital firm Benchmark Capital Partners was worth $3.2 billion. The IPO also capped a highly productive series of transactions for Lightspeed Venture Partners, whose $8 million investment turned into $2 billion.
In 2014, Alibaba sold $22 billion worth of shares after the most successful stock listing ever. Fourteen years earlier, in 2000, the Japanese telecommunications giant SoftBank had spent $20 million for 34% of Alibaba. While its IPO was initially valued at $ 167.6 billion, its public market debut gave Alibaba a market capitalization of $231 billion and valued SoftBank’s stake in the company at over $60 billion.
The global startup market is growing in efficiency and profitability. Successful companies are now spreading around the globe. From my experience of over ten years as an investor, venture capital funding can prove to be the decisive factor for your business to reach the next level, but only if you bet on a really good idea implemented on the right market at the right time.