Venture Capital Funding is usually the lubrication for startups to develop the growth strategy, product market fit, and execution. In general, startup founders either bootstrap or approach angel investors for seed funding to get their business off the ground. However, as the startup matures, founders seek venture capital investments to accelerate growth with a larger injection of capital and often connections that a venture fund brings to a startup.
Venture capital refers to equity financing that provides startups with the ability to raise funding. The venture capital industry funds startups with disruptive ideas and high-growth potential. In exchange for providing capital, venture capital firms get an equity stake in the startup. Typically a venture capital fund is a vehicle that invests in startups, the fund buys and holds a stake in the company.
A venture capital firm performs a dual role in the fund, serving as both an investor and a fund manager. As an investor, they usually put in 1%-2% of their own money, which demonstrates to other investors that they are committed to the success of the fund. Typically they charge management fees of 2% to run the fund, and the fund life is usually between 7 and 10 years (corporatefinanceinstitute.com)
As the fund manager, they are responsible for identifying investment opportunities in exchange for equity, with innovative technologies and business models, or those with the potential to generate high returns on investment Return on Investment (ROI). General partners at VC firms seek funding opportunities with asymmetrical ROI based on their investment stage thesis. Their ROI projection is based on a defined investment horizon, a performance measure used to evaluate the financial return of an investment or compare the efficiency of different investments for the fund (corporatefinanceinstitute.com).
Before approaching venture capital firms for funding, here are 7 tips from our experts at 7startup that startup companies should follow:
At the top of the venture capital funds list is the feasibility of early stage companies, a viable product, and a detailed business plan. For startups to get VC funding, their idea should be disruptive and clearly identify the unique selling point (USP) ‘how we're different' from the current competition in the market. Consider any successful company they all have a “secret sauce”. The business plan should highlight your USP to secure a venture capital deal from venture investors. Startup differentiation can be grouped into three categories:
Institutional Investors don't fund the idea, they fund the people. Venture capitalists want to be reassured that their investment is going to be managed well by the startup founders and that the team is able to manage the current stage of development through to developing high-growth opportunities. High-growth companies need the right team which consists of industry experts, technical skills, and market knowledge. In addition, the team should have a winning mindset to manage the venture investment and drive growth for the startup. An investable management team is a crucial requirement to get VC funding. As a startup founder, you should identify where you lack expertise and plan to acquire talent to bridge these gaps. Many successful founders have learned this along the way to make their startup a success.
Before investing, venture capitalists undertake an in-depth analysis of the market they’re investing in. Investors providing VC funding look for markets that have high-growth potential, to manage their investment risk. When approaching a VC, startup founders need to use data to prove their market is worth investing in to ensure the investment will result in ever-increasing revenues and cash flow. Startup founders should understand the top-down approach, the bottom-up approach, and megatrends. The top-down approach refers to a rough analysis of the entire market size, which can be obtained from research firms like Gartner, Forrester, etc. The bottom-up approach provides the actual market size for a particular company. This is done by taking into consideration certain facts regarding the number of customers in the market and the average selling price of the product, in addition to certain assumptions. Finally, market megatrends must be considered — this plays a key role directly impacting the growth and development of the startup.
Founders should be aware that VC funding isn’t for everyone. Early stage startups ought to focus on bootstrapping, angel funding or crowdfunding. Venture capitalists invest in startups that can demonstrate some form of traction. Early stage startups usually lack a clear product and market strategy and sales under their belt to show sophisticated investors such as VCs. Startups that have high-growth potential and can show sales traction stand a better chance of acquiring VC funding. The intention isn’t to show profits but to prove to potential investors that your innovative idea and startup plan is viable and has a high probability of success in the market. Considering the high stakes, venture capitalists want to ensure that they are investing their money and resources in a venture that will not sink in the future.
Venture capitalists invest a huge amount of money and resources in startups, in the growth phase, which comes with high risks. VC investors require a detailed financial plan outlining how their money is going to be used. The investment plan should detail — allocation for advertising, expansion, acquisition of more resources, outsourcing non-core functions and more. Investors want to know whether their money and resources are going to be used optimally to receive the maximum ROI. Just providing a financial plan isn’t enough. Startup founders must also show metrics and data within an investor pitch deck to prove the allocation of investors’ money will yield long-term rewards and returns.
At the end of the day, investors only invest in startups where they can be certain that their investment will return a significant ROI in return for the risk. To acquire VC funding, startup founders must show growth projections based on data and metrics. Prospective investors require an in-depth analysis of the startup’s current operations and performance as well as the performance and projections on a Y-O-Y basis. The projections, data, and metrics for a tech startup should include KPIs such as R&D expense growth, price-to-sales ratio, SG&A to revenue, market cap, price-to-sales ratio, net income growth, and free cash flow growth.
Finally, the ongoing partnerships you have with technology partners, vendors, suppliers, and other stakeholders also play a vital role when approaching venture capitalists for funding. By investing their money in your startup, they are investing in all your partners and stakeholders. You should be transparent about all your stakeholders to build trust with investors. Strategic partnerships enable startup founders with the smooth functioning of business operations, which is key criterion investors look at before investing.
Approaching venture capitalists for investment can be a daunting task. Not having all your ducks in a row will vastly reduce the chance of securing investment from VCs. At 7startup, our experts can help you with VC funding, we apply investor psychology to your startup investment strategy. Get in touch today!
"This piece originally appeared on Medium on 02/11/2020."
Amit has 18 years of experience in the industry and an MBA. He supports entrepreneurs with every aspect of their business including concept and product development, investor presentations, and fundraising.
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