During a recent webinar with eMerge Startup Showdown competitors, we fielded questions about how founders can navigate VC relationships as they raise capital for their early-stage companies. In this post, we share highlights from that conversation, including what venture capitalists want to see, what's happening in the marketplace, and how to fundraise, build, and scale successfully.
VC is more than a team with a big fund of capital that they deploy to founders. Venture capitalists have bosses - the investors (you'll see them referred to as "limited partners" or "LPs"). We raise money from LPs and then invest it in exceptional founders in high-growth categories. The decision to bring a company into the portfolio takes massive research, data analysis, and relationship-building.
VCs return the money we've invested in each portfolio company over a period of time – typically seven to 10 years. That is when our investors earn their money back, with interest. The goal and intent are to ensure they earn at least 3.5 to 4 times their money.
Data from over 20,000 deals over ten years shows a 50-65% chance that an investment will not return the money invested. Put differently, there's a 50-65% chance that the startup will fail. That's a lot of risk for founders and investors.
That high risk of failure is why investors talk about outcomes. If approximately half of all companies in a portfolio do not create a return on the money invested in them, then each company with a successful exit has to return 8x. Or if only a third of the companies in a portfolio succeed, the ones that do need to return 12x. The bottom line is that successful venture investing takes strong outcomes. It's why between investment and exit, a good VC will work diligently alongside founders to provide them with support and resources beyond the capital. It helps them succeed and accelerate their progress – which is good for everyone.
Think about how you know that you have a viable business. Like you, investors want to understand the problem you're solving and know that the problem is real. Prove that the market is compelling and ready for what you are offering. Confirm that you understand the problem and solution, as well as possible hurdles and how you'll address them. And show that you have an organization purpose-built to address those issues. You can answer all these questions by showing your traction, data, and team.
Many investors need to be able to invest in an incorporated business. But don't rush into it just to apply for funding. An investor will talk you through the structure that makes the most sense for where to start and if/how you convert over time. Do what is best for your company and team.
Unless you're talking to an investor who does not invest in pre-revenue businesses, there are a lot of proof points you can show without showing revenue. For example, you can share user engagement, time in an app, or customer feedback. Those things tell investors you have a market.
Consider whether your incentives need to be aligned. Are you headed for a $500 Million outcome when the fund that invested in you needs $5 or $10 Billion? Investors have limited time, and they have to allocate it accordingly. Be smart about whom you target as an investor if you can.
In 2021, we heard about 100x and 200X revenue multiples for companies with minimal traction. Now, they're back to five and ten. There are two main points to consider here:
After about ten years of extremely low interest rates, things slowly ticked up. It shocked the economy. COVID exacerbated the situation. The result was valuation craziness. Everything in the market tripled. Companies trading at 4x were suddenly at 10 to 12x due entirely to outside forces.
If you plot company KPIs over the last ten years or so, you see little change in top, median, and bottom quartile results. However, valuation multiples changed meaningfully over the two years since the onset of COVID. With entry valuations increasing 2.5x-5x across the board, revenue performance expectations for the same return to investors also increased 2.5x-5x. These are massive jumps, and they impact the exit value needed by companies. Essentially, more (and more significant) outcomes are necessary for a fund to hit its return goals.
You may have heard conversations about needing Decacorn-type outcomes. A $200 million exit that earned the founders $50 Million becomes a disaster for a Billion-dollar fund because the exit, while sizeable, only returned 1.5 or 2x. That's a significant consideration for private capital investors.
Especially as valuations of private market-funded companies have gone up (similar to those in the public market), investments have slowed. Funds haven't been willing to pay as much. It's created some fear (especially in 2020-2022 fund vintages that may have a greater proportion of investments done at historically high prices), but people are still investing.
Over the past six months, the market has started to normalize. Venture investors are sitting on record amounts of dry powder (capital raised but not deployed). In fact, at the start of 2023, there was $290 Billion in dry powder. That is a lot of money to deploy to high-growth startups. The considerations are that the time between investment and exit might be longer. The valuation might be slightly lower. But capital will be invested.
If you're in the Miami area (or want to travel) on April 20th and 21st, register for eMerge Americas! Let us know if you do. We'll have a whole team there and would love to meet you.
