Correctly timing the VC fundraising round can be extremely critical. And there are several well-known factors that govern it – product status, revenue traction, business model proof points, team build-out etc. However, there is one more extremely important factor that doesn’t often come up in discussions but plays a critical role behind VC decision-making – presence of ‘positive trending’ and ‘negative spirals’.
Meaning of ‘positive trending’ and ‘negative spirals’
At the VC stage, most deals are extremely risky. Revenue is small, if at all existent; few customers (not necessarily paying) exist; v1.0 of the product is out but still evolving etc. In addition, VCs ideally want to invest in companies that scale fast and will give them 5-6 year returns commensurate with the risk they are taking at an early stage.
For right or wrong reasons, one of the key signs VCs look for in order to judge the scalability and market potential of a venture is ‘positive trending’ – broadly upward trending of key operating metrics, financial indicators and intangibles such as team and brand. Similarly, and again for right or wrong reasons, what causes VCs immense discomfort is ‘negative spirals’ or downward trending of the same key indicators.
An important point to note is that the time period for observing this trending may vary depending on sector and stage of the venture. For early stage software product companies with license based models, it could be quarterly trending over 6 months to 2 years; for Internet and cloud companies, it could be monthly trending over 2-3 quarters.
Key trending indicators
Across all sectors, the key indicator used to observe trending is revenues. In B2B sectors, order books and sales pipelines are also important proxies to judge sales potential. In B2C Internet and mobile sectors, other similar metrics could be number of downloads, number of monthly unique visitors, repeat behavior, conversion rates from ‘page views’ to ‘purchase’ etc.
While most of the above metrics are quantitative, trending in terms of periodic positive developments is also observed in intangibles such as profile of senior management team members added, quality and intensity of media coverage/ visibility etc.
How to present a strong ‘trending’ case
If all metrics are shaping up nicely, trending is a non-issue. But this is rarely the case. In most early stage ventures, several parts of the product or business model are still evolving and the entrepreneur has limited control over revenue trending. However, taking a more holistic view of the business, it’s still possible to build a strong trending case for the business, in front of investors. Here are a few pointers:
- Order books for B2B businesses – most VCs would give almost equal importance to order books, as they would to revenues, while evaluating B2B businesses. For instance, in case of license-based software products, revenues are lumpy and quarterly trending might not be that attractive. In these cases, positive trending in order book/ sales leads/ customers-in-pipeline can be used to demonstrate revenue potential of the business. Another important metric could be increase in distribution network or channel partners.
- Number of downloads/ visitors/ subscribers etc. for pre-revenue Digital Consumer ventures – in caseswhere the venture has built something extremely cool in the Internet/ Mobile space, but consumers are not yet paying for it, operating metrics such as number of monthly downloads, number of visitors, repeat behavior, subscriber base, customer lifetime value, breakeven point per customer, ranking on the app-store etc. will prove to be excellent indicators of future revenue potential.
- Increase in ‘range’ and ‘contribution margins’, especially for e-commerce companies – positive trending in range could be in terms of SKUs stocked, delivery radius, number of brands available, number of product categories available etc. Equally important and attractive would be improvements in contribution margins and path to profitability for the venture.
- New geographies entered – this is considered an extremely important sign to judge international market potential and future scaling. Even if they are pilot deployments, this aspect should be definitely played up.
- Intellectual property creation – especially for hi-tech ventures, number of patents granted/ filed/ in pipeline is an extremely impactful positive trending.
- Smart use of ‘Intangibles’– the following intangibles can be smartly used to create a positive vibe around the venture’s investor case:
- Team additions – especially at the senior level. In particular, it’s important to highlight pedigreed people joining the ventures from large companies or reputed competitors.
- PR/ Media visibility – it’s important to emphasize the increase in visibility and positive word-of-mouth being received by the venture in media and customer circles.
- Strategic partnerships/ alliances – any collaborative partnerships inked with large companies in the space are an excellent positive validation of the market potential.
A very important point to end with – too often, high potential ventures get into negative spirals because of lack of seed/ angel capital or postponing the Series A round. This jeopardizes future chances of the venture raising quality institutional money. A key role an entrepreneur (especially the CEO) needs to play is judging the need, quantum and timing of capitalization, and avoiding negative spirals due to capital starvation.
The views and opinions expressed in this column are strictly personal, and not those of any organization/institution the author is or has been a part of, nor is made in any official capacity of such organization/institution, unless explicitly stated otherwise. None of the information, views and opinions in the column should be construed as business or legal advice.