A few days back I met a young entrepreneur running a very exciting company. Personally, I thought it was an emerging space; not yet very hot, but getting there. As our discussion progressed, we discussed his thought process, how he would go forward, the team he required to execute his expansion plans etc. By the end of the discussion I was thinking that the niche he was targeting was something which had scope for more players (there were a couple of folks already in this space) and if executed with the right partners, it could become big. There were a lot of ifs, but I found the space and the work the company did exciting. But would it mean that it would be the right investment for the firm I work with to make?
It’d be easy to think that the typical investor-entrepreneur interaction can go something like this famous scene from Jerry Maguire:
The folks at Garage get it right when they say:
What is the investor most interested in? Contrary to popular belief, the venture capitalist sitting at the other end of the table glaring inscrutably at the presenting entrepreneur is not thinking, “Is this company going to make a lot of money?” That is the simple question that most entrepreneurs think they are answering, but they are missing the crux of the venture capital process. What the investor is really thinking is, “Is this company the best next investment for me and my fund?” That is a much more complex question, but that is what the entrepreneur has to answer.
And that’s complex. Why? Here could be some of the reasons:
- Because the investor has to think of the timing.
- Because the investor has to think of potential exit routes.
- Because the investor has to also think of sector wise allocation of capital.
Let me elaborate on each of them.
Timing: Every fund has a life. Every fund also has an investment strategy. Life is normally around 8-10 years. The strategy can vary. For early stage funds, based on the type of fund, one can decide their investment strategy, how much to allocate to follow on rounds etc. So if you come to an early stage fund when it is at the end of its investment period, their reaction might be very different from had you come to them a couple of years earlier when they had more capital to deploy.
Exits: This is the only way the funds make money. Not every company is going to have an IPO. Acquisitions and secondary sales are possibly the most common exit routes for early stage investors. Questions arise as to, who will invest in the next round? And why? And at what valuation? Some startups exactly know the answer to this (I’d reckon Bazee.com knew from the start that if executed, they’d be an attractive acquisition for eBay), others have to figure it out. The investor however, would always like to know how likely an exit is and what are the possible routes. This question becomes more pertinent, when the amount you’re looking for is relatively significant, say in crores.
Sector focus and capital allocation: 99% of all VC firms clearly list out the sectors they are interested in. Some mention this in the affirmative, “We like to invest in X, Y, Z”, some mention it in negative, “We will not invest in this”. Inside the VC firm, the fund manager is thinking of how to allocate capital which somehow goes in tune with the investment thesis. LPs (the fund of funds) don’t take kindly to deviations from the plan. The entrepreneur doesn’t know it, but I think being aware of some of the challenges inside the VC firm would make them more aware of the larger system, which they are choosing to be a part of. Have a look at Naukri’s portfolio of strategic investments. Save one or two, all the companies have something in common. Yes they are all digital, but they are all bound by a common thread of listings or directories. At Aavishkaar, we’re looking at companies which will strengthen rural, semi urban and underserved India’s social infrastructure. True, there exist sector agnostic funds, but even within those funds, there’s a rationale as to how much of the capital they’re willing to allocate to a particular sector and a sub sector.
We often hear comments to the tune of “Only 5 out of 1000 startups get funded”, and the reasons for this phenomenon are cited as, “Because every company isn’t a VC type of business”. Apart from reasons like ability to scale, the above are some of the reasons to keep in mind as well.
So at times, it’s not you, its us.
What can you as an entrepreneur do:
Find out more about the fund:
- What is the fund’s investment philosophy? Almost every fund has this clearly mentioned on their website.
- Learn if they have raised a new fund, the vintage of the existing funds.
- Talk to the portfolio companies and gather data on their experiences whilst interacting with the fund.
- What does the fund like to invest in? For e.g: Cervin Ventures (started by the Co-founder of Akamai) has made it explicit that they will not consider B2C plans.
- What does the current portfolio look like?
Risks the fund is willing to take:
- What kind of risk the fund is willing to take?
- And the risks that the funds are hesitating to take. Execution risk? Technology risk? Political risk?
Disclaimer: 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.