In Part I of this series I outlined why your seed stage company may not be investable (and some alternatives if it’s not). In Part II, I’ll look at why venture capital firms may not find your company backable.
Pattern Recognition – Investability
Again, we start with pattern recognition. That is, VC firms look for similarities in your business that they have seen before. Venture Capital firms are sophisticated investors that can “model” a new business based on their experience with a similar business in the past. So, if you are building a biopharma company with a target for an unmet need in an orphan disease category, almost every venture fund can model the time and money it will take you to proceed through clinical trials/regulatory pathway and a likely exit scenario. Doesn’t mean they will invest, but it’s a fairly straight forward financial risk/reward calculation.
For a professional venture capital firm, the financial model is a key piece of the firm’s “investment thesis” Most funds will list information on its website reflecting its investment thesis. Some funds (like “RA Capital” ) take a very scientific approach, while others are more holistic like Founders Fund (“we invest in smart people solving difficult problems, often difficult scientific or engineering problems”). But most firms will almost always list categories of companies they invest in and many times the stage of the company and the size of the check they prefer to write.
They make this information public because evaluating a new opportunity that fits squarely within those parameters is “middle of the fairway” as far as the fund’s investment model. Keep in mind the fund has modeled the performance of the entire fund (all portfolio companies in each of its funds). They then pitched & sold to its limited partners that they will deploy capital based on that model, with the appropriate returns at the exit, and as a result, they will achieve the expected returns. In other words, no venture funds returns are ever certain. The fund has sold its customers that they have a rigorous selection process that when followed will yield the expected results.
Researching and analyzing what categories of venture funds invest in is fairly strategy forward. However, I see too many entrepreneurs not consider the stage of the company and check-size of the firms. This is a key component of the firm’s investment thesis. And while there is always an exception to every rule, this is one rule many established funds simply cannot get around.
For example, you may think the fund would be a great partner and they clearly understand your space, and you “only need $2 Million” but the funds stated minimum investment is $5 Million. The fund is unlikely to be able to invest in your company. Furthermore, you need to demonstrate you can grow the business quickly and to the right valuation size at exit. Some funds need to underwrite to a 50% IRR due to the number of failures they know are likely to occur. In other words, for the fund to realize the expected return, they need to deploy the right size checks in the right type of company at the right time in the company’s evolution. You may be building a great company but your capital needs just don’t fit their model.
Working Towards Becoming an Investable Company
So, what can you do?
First of all, do your homework and build a good target list (at least 50) of qualified funds that fit your parameters and your company fits theirs. A study in California a few years ago shows on average it takes 30 in-person presentations to raise a Series A. Targeting those funds and qualifying them is a part of the capital raise process.
Secondly, allocate your time. Raising capital is a sales process. Unless you have had 2 or 3 successful exits under your belt its likely to take time (3 months at a minimum) to raise from a venture fund. You’ll need time to target and research funds, to activate your network to get warm introductions to those funds that fit your profile and to build, rehearse, revise and repeat your pitch. If you are the CEO as well as the primary business development person, one of those two activities are likely to slip, so allocate your time, staff and resources accordingly.
Thirdly, recognize when your company may not be fundable by a venture capital firm. Venture funds are just one type of capital. If you aren’t fit for any fund, stop wasting your time. You may be better off maxing non-dilutive sources, or debt or angel or growing revenues or a combination thereof.
For more information see CED’s Connect to Capital resources.