Inside a VC Mind
Investors are often keeping things close to their chest, and deciphering their thinking is difficult. Most entrepreneurs come out of VC’s meeting with no or little conviction on their impact.
It should not be that way, as every meeting, positive or not, should contribute to the entrepreneur’s learning curve. It is often clear whom the VC does not want; however, picking the winners is a daunting task. That’s why VCs don’t want to say no, and leaving the door open is critical.
I have lived in Silicon Valley for 17 years; I am a General Partner of a pre-seed fund; I have met with brilliant VCs; it’s time to share some little secrets :-).
I will try to stay focused on the early stages, up to a Series A, given that after the Series A, decisions are more data-driven thus easier to grasp. When I say that, picture yourself wanting to invest in Boeing. Your decision will be purely data-driven, show me the numbers, and I’ll see if I want to invest. From Series B and on, data plays a major role.
Also, think of investment stages as a way to derisk. It is a way for the co-founders to derisk their assumptions starting with the riskiest, and it is a way for investors to validate the derisking to jump to the next investment stage. It is to be noted that startups that raised large amounts early on and attempted to jump multiple stages rarely succeeded. Take Magic Leap, which raised $600M early on, and is now at more than $3B total. They have little to show for (at least I do not see it) and should have been better off raising less, focusing on the first step, then the second one, and so on. You can disagree, but being constrained and focus is what creates success, not an insane influx of money early on.
Time to read minds….
Pre-Seed
Pre-Seed is when you raise up to $1M, the average was $500k in the US in 2019.
At the Pre-Seed stage, you have an idea, assembled a co-founding team, and started to execute on your vision. You probably do not have a product yet, at best, a prototype. The only thing you can sell is the dream.
2 things investors look for to trigger a Pre-Seed
How exciting your startup is
Your capacity to execute
Excitement
Excitement will come from 3 elements, the team, the purpose, and the market, in that order.
Indeed the first filter is the team. You have heard countless times that the team is the essence; it is. If the team does not convince the VC, nothing else matters. There are different criteria to evaluate the quality of a team, but briefly, it relates to the individual attributes and skills (smart, driven, competent, decisive, unusual, sales, …). Every VC has a mental image of what they seek in a founding team.
The second filter is the purpose. VCs are looking for startups tackling big problems with a high level of ambition. They also pay a significant level of attention to evaluating the founders’ fit. In other words, the key question is, why do you do that? Why is this team the one that will crack the code?
The third element is the market. VCs invest money to get high returns. They are ok to change the world as long as they make a lot of money along the way. It is really hard/impossible to create a significant business in a niche market. Sizing a market is super hard; both VCs and entrepreneurs are often wrong. However, conveying the current size and the growth potential is critical. In addition to sizing, the market timing comes into scrutiny. Why now is the right time is crucial to investors.
Capacity to execute
The capacity to execute will come from the product state. But not only.
An investor is looking for a startup that is moving forward. Movement is what matters. Entrepreneurs need to showcase movement, whether it is a technical breakthrough, a milestone, significant hiring, whatever moves is good.
Pre-Seed is investing in future potential, an exceptional team with a high level of ambition on a promising market.
Pre-seed money helps create a product and acquire first users.
Seed
Seed is when you raise between $2M and $6M.
Coming out of a Pre-Seed investment, you now have a first product and some usage. You won’t yet sell data; we are still more heavily lining towards building the dream still. But the dream is starting to materialize.
2 things investors look for to trigger a Seed
Ensure the first users/customers start to validate the market vision
Monitor customer engagement
First market validation
At the seed stage, you must convey that you are aiming at Product-Market Fit. Having a few users/customers in love with your solution will go a long way. Most investors are not looking for a high volume of users/customers but rather a low volume of real passionate users. Paul Graham said, “It’s better to have 100 people that love you than a million people that just sort of like you.”
First Engagement & Retention
The quality of the users/customers should lead to a first understanding of the quality of the customer experience. VCs will want to understand engagement and retention.
Engagement is the frequency of usage, the length of the sessions, and how customers can become ambassadors and spread the word. Show signs of love, emails, posts, reviews, you name it.
Retention is proof that customers love your product. It’s also the first step into showing that scale can happen. If you can retain clients, you can grow. If they come and go, growth is much more challenging.
Essentially you need to demonstrate a product fit, meaning your capacity to have loving clients.
Seed money helps transform product fit to product-market fit.
Series A
Series A is when you raise between $6M and $20M.
Coming out of a seed stage, you must move from Product fit to Product-Market fit. Product-Market fit is not having a few fantastic customers. It’s when everything starts to break because the demand is picking up, and the startup cannot address it. Sales are overwhelmed, customer service is underwater, development is on edge.
Moving from Seed to Series A is the most difficult. Only 15% of the startups achieve that. This is where you are moving from selling a dream to selling real data, no hiding anymore.
Investment is a way to help the startup handle the current pick of activity and prepare for a significant scale (Series B).
2 things investors look for to trigger a Series A
Actual sales/product activity/market opportunity
An opportunity to scale big.
Clear PMF, Revenue, Large Market
In 2018, 82% of startups raising a Series A had revenue. Without revenue, you are trying to climb Mount Everest. In addition to income, you must demonstrate high retention and high growth.
You need a clear MVP, much momentum, and signs that this could be big. We are no longer dreaming; we are becoming data-driven. You need to have in place a metric strategy to measure your business. You have to have a feedback loop with customers to keep the pulse of the market.
Capacity to Scale
You need to build a growth engine that can be measured and fine-tuned. As a Series A investor, you always think about what the startup needs to become a fit for a Series B model. Series B is about scaling. So Series A investors will invest to help the startup build a growth engine that Series B money can leverage. So be ready to answer growth questions.
Series A money helps creates and fine-tuned a growth engine.
Here is a visual summary of what to emphasize based upon the different investment stages.
That’s it, folks, I hope this short review was helpful. Cheers.