The 3 Big Things VCs Look For When Funding Startups
Most startups fail before they reach Series A. Nevertheless, those that reach Series B are more likely to go on to build large, successful businesses. Much is written about milestones to successfully fundraise at Series A and B — the number of active users, monthly recurring revenue (MRR), strong cost-per-acquisition ratios (CAC) or customer lifetime value (CLTV). But in Cloudant founder (now VC) Mike Miller’s experience, most VC explanations are post hoc, investments are made for a finite number of reasons and decisions are sometimes less quantitative than a founder would hope.
So, what strategies can you employ to maximize your chances of surviving this critical period of growth? Miller says you need to understand why VCs do deals. Here are three big reasons he points to:
Coverage and fear of missing out (FOMO)
No investor wants to miss funding a category breakout. If you’ve ever raised, you’ll notice that your first term-sheets often produce a domino effect in which a number of additional offers arise. Even great venture firms like Bessemer have passed on deals they now wish they’d done, although few are confident enough to admit it. For startup founders, if you’ve got meetings with top tier firms and you can make others fear they’re missing out, then you’ll not only be able to raise, but you’ll do so on founder-friendly terms.
A strong team and market
If your team is experienced running a cash cow product in a well-known product suite, or better yet, you’ve already successfully sold a company in the market you’re entering, you often appear a safer bet to investors. At the very least, you’re unlikely to make rookie mistakes that tank your business before you build a revenue engine and expand into a larger enterprise offering or ecosystem play.
The metrics and money align
It’s not enough to simply hit revenue and growth targets towards a Series A or B, you want to look like you’re on track to be at least a $100-million-dollar exit. The reality is that investors report to their own investors (“Limited Partners” or LPs) and are also financially responsible for returns — generally about three times the initial investment. In Miller’s survey of other investors, a meaningful exit typically returns one-third of the initial fund, whereas a “home run” returns all of it. For SaaS companies, that means tripling revenue in the first two years (or showing 10 percent month-over-month growth) and continuing to double it (6 percent month-over-month growth) for the subsequent three to five years. This shouldn’t shock you. Investors or fund managers are measured by the money returns they generate — and so are their LPs! This means they often work to grow substantial ownership in your business and will not make offers or re-up on teams that fail to earn high multiples on initial investments. These are some of the main reasons why founders cease to raise a next round and why investors fail to raise a next fund.
If you need to fundraise soon, above all else, something about your company (marquee customers, month-over-month growth and/or rising contract values, etc.) should present the opportunity of a meaningful exit for yourself and others.
For more on how VCs view investments, check out these resources from Greylock’s Jerry Chen on Units of Value and pricing for returns, Samuel Gil’s breakdown of Meaningful Exits and Redpoint Ventures’ Tomasz Tunguz on 11 Risks VC’s Evaluate. (Full disclosure: Redpoint Ventures is an investor in my company, Heavybit.)