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More in the 50 Questions Series50 questions: What’s the difference between Seed, Series A and Series B | How does a VC value a business? | 50 Questions: How should an entrepreneur approach negotiation of the key terms? |
50 questions: What does a VC care about?
Together with Nic Brisbourne of The Equity Kicker / DFJ Esprit, I am writing a series of 50 questions you should ask when raising venture capital. We expect the series to run for a year, after which we will collate the answers into a book. We view this as a collaboration, so please comment to help make this series even more useful.
This is the twenty-third post in the series.
Entrepreneurs raising money can often get very confused about what an investor actually cares about.
Before we get much deeper into this topic, you might want to read the first post in the series “What exactly is an investor”. There is no such thing as an investor, because all are different. They have different risk profiles depending on the stage of their fund, the objectives of their limited partners, their personal preferences and their sense of market conditions.
So I can’t tell you what each investor cares about. But I can tell you how to start working it out.
Are they worried about downside risk?
Some venture capitalists are really swinging for the fences. These investors are trying to back the next Facebook, the next Twitter, the next Groupon. For them, the win is about the handful of deals that really do well, not the rump of the portfolio that either does so-so or goes belly up. This typifies West Coast venture capitalists, and there are fewer of this style of investor in Europe.
Other investors want some kind of certainty. They like to see a order book of enterprise sales before they invest (or else they will encourage you to build one of these after you launch). They want evidence that you are working towards a reliable revenue stream, not taking the Twitter approach of “we’ll build a massive audience and worry about the revenues later.” Most European investors seem to err towards the “certainty” model.
The good news, as an entrepreneur, is that the “certainty” approach means that your business is less likely to go bust. As you are 100% invested in this business, unlike the VC who spreads his risk across a portfolio, this can be good news for new.
The bad news is that VCs searching for revenues are harder to persuade to support a radical pivot to a new business model. They can require you to focus on building a business to deliver against a model that you are not sure is proven. And they can be unforgiving if you fail to meet targets, even withholding tranches of promised investment in extreme cases.
Are they obsessed with the exit route?
Some investors, particularly those with a mergers and acquisitions background, obsess about who might buy your company.
At one level, this is farcical. The technology industry is growing so fast that if an investor has a 5-7 year investment horizon, the likely acquirors may not have been born yet. In my world of games, Zynga is only four years old, but has made 14 acquisitions in the last 12 months.
Furthermore, there are now more ways for early stage investors to get their money out then ever before. Browser gaming business Bigpoint recently “raised” $350 million from TA Associates and Summit Partners. In reality, it was a secondary deal, in which Bigpoint raised no new money, but existing shareholders Comcast Capital and GMT sold down their stakes. Secondary market deals at companies like Facebook, Jagex, Groupon and (I suspect) Rovio have been as much about founders and early stage investors cashing out as about raising new capital.
That’s not to mention the public markets, now that LinkedIn has opened the door to a tech-led IPO frenzy again.
It’s important to have an exit route in mind, because it helps investors how you perceive the strategic landscape. But by understanding the investor’s focus, you can start to work out if they are already thinking of a quick flip, or if they are in it for the long haul.
Which is more important: market, product or team?
Different VCs are different. Mark Suster says he is unashamedly a product guy, although I suspect that market will always win out for him, as it does for my co-author Nic Brisbourne and for Marc Andreessen.
The truth that all three matter. Different VCs will put a different emphasis on each one. If you have to pick, go for market every time. Although just having a product that is *slightly* better than your rival isn’t necessarily a winning strategy. Just ask Betamax.
What does a VC really want?
A VC wants to look smart in front of his peers. He wants to make lots of money for him and his limited partners. He wants to follow the herd enough that he won’t get fired if the deal wasn’t work out, but wants to be different enough to have a chance of backing a gamechanger. He wants to get excited by the passion, enthusiasm and vision of the founding team.
He wants every possible risk removed from the incredibly difficult job of backing startups.
So work out what is unique about this investor, and help remove the perception of risk from your business. Your valuation will go up and you’ll more likely to close the deal.