How do you find the right investor for your start-up?
If you’re an entrepreneur, you probably have asked yourself this question more than once-in-a-lifetime.
As the over-all tech industry is maturing, capital is more plentiful (but paradoxically competitive), the costs of technologies are constantly dropping, and code is being increasingly commoditized. This leads to more companies being built-up faster and for less. The culmination of all this? A lot less white space, and more serial entrepreneurs competing for seed funding.
With this in mind, what do you, as a founder, need to know to ace your increasingly competitive seed round raise? Here are 6 questions you should ask yourself to prepare:
1. Realistically, are you venture scale?
Even without venture capital, you can build a valuable business. You can bootstrap your way to success. But, if you want to raise money, you better be ready to meet the following criteria:
10x return: To build a venture fundable business, you need to create a value of this scale (or more.)
Velocity: How fast can you grow? There is a tremendous difference between getting to $1M annual revenue in 6 months or 6 years.
This matters for two reasons: 1) Investors will extrapolate your future growth rate from your past performance 2) When you’re raising venture money, you’re building with someone else’s money and there is an often unacknowledged cost to that — namely your ownership and ultimately the funders’ returns.
Product < Business < Asset: VCs are searching for high velocity, high return investments. Startups with clear long-term assets are more valuable, which could be a database of genetic information that’s 20X broader than any competitor, or market share in an industry where there is 15+ year lock-in. At the bare minimum, make sure you are building a business, not a product. (If your go-to-market plan is to leave this to the salespeople you plan to hire at some future point, this ultimately will not work — certainly not for venture scale.)
Bottom line is if you are not venture scale, but you’re raising money — or spending — like you are, you have a problem.
2. How competitive are you?
As a founder, you are laser-focused on solving the challenges directly in front of you. While it’s critical to “stay in your own lane” to some degree, you can’t afford to ignore these three absolutely critical competitive dynamics, if you want to be venture-funded:
Cohort effect: When you start raising money, whether you realize it or not, you automatically become part of a peer group, other companies that have raised as much as you have, or to a lesser extent have comparable metrics (revenue, traction/adoption.) If you are way behind in your peer group, you won’t stand out in a weekly VC partner meeting, all else being equal. You could still come out ahead, but your team, market, and defensibility will have to be that much more impressive.
That’s why I generally advise founders to determine what to call their round based on traction, and use the earliest label which can apply. Be within a cohort where you can compete effectively: it’s the adult version of red-shirting for sports teams.
Winners take all: Assuming that your startup is successful and that you’re tackling a valuable market opportunity, 2–4 direct, formidable competitors will likely arise in your space. Most founders don’t look this far ahead, but by then you’re either at the front of the pack, or not — and in the latter case you will lose out on investor money.
Because of the winner-takes-all effect of technology (where the bulk of value accrues to the market leader), few VCs will rationally put money into the #3 or #4 competitor in a space. And, that’s why we evaluate competitiveness from our first meeting, because who wants to put 4–6 years into a business to run into a brick wall down the road? Neither the founders nor us.
You simply don’t get to be the #1 or #2 in your space without planning and executing on that plan from day Amazon is a fierce competitor, one of the best of our era.
Sector bias: Don’t get discouraged just because you are in a less competitive funding sector. While many funds are generalists, the reality is that they will typically focus on the most profitable sectors, and sectors with structural risks, like health care or education, may be tougher to close investment.
This is also a good reason that sector-focused funds are becoming a lot more common. You should take advantage both of them and of strategic angels in your sector, who can crucially help you navigate hard-to-open sales doors with their industry connections.
3. Are you right-sizing your fundraising based on fund dynamics?
Want to know the truth about VC firms? Simply by looking at the size of the fund, you can tell if your company is the right fit or not. The secret rule of thumb that most VCs have: any single investment needs to be able to return the entire fund. For example, a friend at a $800M fund confesses to me that she won’t take a meeting unless she can see clear sightlines to a $300M business. Given the rule of thumb, she’s actually being permissive.
On the other end of the spectrum, angel investors can have a fantastic outcome with a $50M run rate company, and consequently may be willing to take risks much earlier. Don’t waste your early fundraising cycles if there isn’t a fit, especially not in pursuit of a brand name for your term sheet.
4. Where are you on the seed gradient?
While the metrics at each round change every year, we’ve observed internally that even seed companies fall out in distinct spots along the seed gradient. Know the stages, metrics, and amount of your round, so that you stand the best chance in your cohort — review my 2nd question for you again.
5. Do you have a startup Olympian mindset?
Those who are drawn to founding companies have grit, creativity, and determination. High growth companies require all this — and more. Sometimes liken the process of finding great entrepreneurs to seeking Olympians.
Many people (including me) run an occasional 5K or 10K for fun on the weekend. But envision the difference between the weekend warrior, and the Olympian, who has configured her life to support training, has a team assembled to handle the various aspects of growth, and is ruthless about trying what works and discarding what doesn’t.
If an investor does not move forward, please don’t take it personally, or see it as a fatal blow aimed at the business you’re building. Ask for feedback, learn from it, and look for investors who are excited about your business.
6. Are you willing to optimize for investor fit?
Nothing is more painful than watching startups being ill-served by investors who do not have the best read on their strengths or market dynamics or simply have different values. You may be thinking. Yes, but when you’re spending years of your life on your startup, having the right partners at the table is worth getting right. The worst case scenario is that you build an 8-figure business, only to have one of your investors vetoing a profitable exit that doesn’t align with her/his economic interests.
How do you prevent this? Make sure that you and your investors match up on:
Product principles and prioritization
How involved you want them to be
How they handle it when things don’t go well
Also, speak with other entrepreneurs in their portfolio, which will help you answer the key criteria mentioned. Reference checking is a two-way street! Finally, remember not to ignore your gut. With team members and investors, ask yourself this one question, “Who am I most excited about collaborating with?”
Winning as a startup founder is about building something amazing, but it’s also about building relationships, supporting your team, and having fun on the journey. As you gear up for your seed round, make time to reflect and refocus.