Venture Capital: Should You Swipe Right?
Committing to a venture capital deal is very much like entering a long-term relationship. You will be tied to the entity for the most important developmental stages of your company. Some say that picking the right VC fund is more important than any hire you make for your company. But how do you know when to swipe right on those you like, as you would do on a dating app? The decision requires that management have a deep understanding of their company position, needs, and personality.
Venture capital is a private investment made in start-up companies with high potential for upside in exchange for equity. Many start-up companies are not built for venture capital, lacking enough upside for private entities to make investments. For those that are, it may be difficult to decide which is best for your company. The management team’s selection criteria should be based on the company’s growth stage, desired capital, and other needs outside of financial capital.
There are five general types of venture capital funds: Micro, Seed Stage, Early-Stage, Mid-Stage, and Late-Stage. Generally, Micro funds have fund sizes below $15 million, Seed-Stage funds have funds up to $150 million, Early-Stage funds have $100 to $300 million, and Mid-Stage funds hold $200 million to $1 billion. Each fund-size corresponds to a general growth stage of the start-up, with fund sizes increasing as the start-up requires more capital. Micro and Seed-stage funds may participate in the early funding rounds of a start-up, such as pre-seed, seed, and series A. On the other end, Late-Stage funds are generally the last stage of funding before an initial public offering. It is important for the management team to understand where their startup is in relation to the above graph. By measuring revenue and growth, the entrepreneur can pinpoint where their company is and understand which venture capital firms to target. To continue with the Tinder analogy, this step is like adjusting the age and geographic range settings before swiping. This step is paramount in the search for the perfect VC fund because it will narrow the search to relevant and desirable firms.
Once you’ve determined your company’s growth stage and financial needs, the search for the best match begins. There are a variety of qualities a management team may be looking for in a VC fund, but the following are most important when comparing firms. First, comparing firm A to firm B is not as important as comparing partner A to partner B. A VC fund is only as good as the partners making the decisions. The managing director and general partners make all investment decisions in the firm and will be the main point of contact for their investee companies. Their experience, character, and expertise are most important when comparing multiple VC funds. When evaluating a venture capital partner, ask yourself the following questions:
Are they easy-going or tough mentors? Some venture capital firms don’t act as mentors for their start-ups at all. However, the firms frequently offer advice and guide the company, especially if they take a considerable equity in the company. The management team must determine if the partner is tough, meaning “it’s their way or the highway”, or easy-going, meaning their advice is simply that, advice. Sometimes it is worth having a tough mentor, especially if they have industry experience or have previously started their own company. However, it is more difficult to justify having a tough mentor that has no first-hand experience in starting and growing a business.
Do they believe in us and our market offering? Look for partners that truly believe in your efficacy and the desirability of your market offering. With companies that are in high demand, many VC funds will present themselves to you simply because everyone else is. To revert to our Tinder example, ensure you are speaking with someone that wants to be with you because of your profile and not because everyone else is swiping right on you.
Do we have a personality match? This question is more ambiguous than the previous two. A major aspect of this assessment is communication. Evaluate how the partner communicates with you, and think about how they may approach difficult conversations about your company. Are they direct or do they beat around the bush? Are they respectful of your opinion and thoughts when faced with conflict? Can they remain level-headed under stressful and emotional situations?
After assessing the partners on a micro-level, look at the VC fund as a whole. Is there diversity in thought, expertise, gender, and ethnicity? These are important considerations as the partners will shape the culture of your company.
Lastly, when you are on the hunt for a VC fund, ensure you are speaking with individuals that make investment decisions. Don’t waste too much time on Analysts and Associates. Although these individuals scout investments and write memos, they have no pull within the firm. The managing director and general partners are the most important individuals to target when networking.
Before you jump into venture capital, remember that it isn’t always the best option for funding, just like Tinder isn’t always the best way to find love. In fact, if you can avoid the troubles of venture capital you may be saving yourself and your company from a lot of stress. Consider the following funding routes as potential alternatives: Family Friends and Fools, SBA loans, government and private grants, accelerators, crowdfunding, individual or group angels. Regardless of the funding source, be sure you “Super Like” each other when you match, otherwise you are bound to encounter conflict down the road.
George, B. (2016). Preventing dysfunctional conflict: Examining the relationship between
different types of managerial conflict in venture capital-backed firms. An International Journal of Entrepreneurial Finance, 18(4), 279-296.