Looking for Startup Fundings in 2022? Learn How VCs Make Their Decisions

Is there a better way to celebrate the new year than making the first step to turning your dreams into realization? Dreams are just like seeds, full of potential. But they will remain as potentials if you do not actually act on them. Your ideas hold no value if others could not see them manifesting in the world. Regardless of the industry, starting your own business is no piece of cake. If you have what it takes to run a successful project but money is your main concern, what if we tell you that there are people whose jobs are literally giving out money so people can materialize their ideas?

Enter, the venture capitalist (or VC for short). 

How venture capitalists work

A venture capitalist is a private equity investor that provides capital to companies with high growth potential in exchange for an equity stake. A venture capitalist usually collects their money from limited partners (LPs), usually traditional investors such as banks, institutions, or pension funds, who entrusted them with their money to invest.

Why do VCs exist?

Investing money comes in many shapes and forms. One way to do it is by investing through the stock market or real estate, which are lower cost, liquid, and could “safely” return 7-8 percent per year. But what if you can afford a higher risk and want to get a higher return? The answer is to invest in new, radical business models that can change people’s lives, one of which may as well be the one idea you have secretly thought of for years.

Venture capitalists are actively looking to invest in promising business models that otherwise would be deemed “too risky” by traditional investors. VCs are playing in a high-risk, high-return environment because 90% of startups fail and will not be able to return their investments. That is why VCs invest in many startups at once. By “sharing” the funds (instead of pouring all the money in one pot), they increase the probability of investing in at least one outlier, the top 10% overachiever, which will not only make up for the loss by the 90% but also generate a return for LPs.

So, how do you convince them that your idea is in the top 10%?

The answer is you cannot. Brian Ma, the founder and managing partner of Iterative Capital, conclusively summarized in a tweet thread that as a founder, the best course of action to get funded by the best VCs is still focusing on a great product and making customers happy. But if you have to know, these are some of the metrics used by VCs to determine investment.

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First, a venture capitalist’s portfolio construction

Put yourself in their shoes for a moment, investing in multiple companies at once meaning you must see through the bigger picture. Portfolio construction is doing exactly that job. It is a set of metrics that lays out how many companies a VC should invest in, proportional to the total fund they have to generate the expected return. 

The metrics lists in detail how many companies in which series, how much to follow-on on each stage, how much to recycle, etc. In short, it is complicated math that goes beyond your one idea and proposal. So, the next time you get rejected, be at ease because perhaps it is not because your idea is without value, maybe they simply have no quota left for a company of your caliber.

A good tip from Ma is that you can ask VCs the following questions to give you some indication of how aggressive they might be at making a term sheet and how much you can depend on them for future rounds:

  1. How many companies do you do every year at our stage?
  2. How much have you reserved for follow ons?
  3. How far are you into this fund?

Second, show a good accounting

Susan Liu, the Vice President of Scale Venture Partners, confirms that these are the top 3 metrics that VCs are looking for in each proposal they received. First, a growing accounts receivable (AR). Second, good sales efficiency. And third, make it to the gross margins of the overall industry. If your proposal passes the three checkmarks, most likely you will get a call or further discussion with VCs. You can watch the full, more in-depth interview with Susan Liu here.

And that’s a wrap! Finally, one or two rejections are not indicative of how valuable your idea is. As a matter of fact, it can serve as your stepping stone, be it to improve your proposal or presentation skill. Anyhow, there is no success without failure, so keep pushing through until you get that funding!

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