Two out of three VC-backed startups fail, and to increase the chances of success, it is crucial to do a comprehensive due diligence to understand how VC investors think in order to find the most suitable match.
Digital transformation
Venture Capital is more than just money
Some VC funds offer services as part of the “package” that includes e.g. strategic counseling, introductions to other investors and customers as well as support in acquiring board members and new employees. VCs such as Andreessen Horowitz and GV (Google’s Alphabet VC department) also offer their portfolio companies a wide range of services including accounting and marketing support.
A recent study with data from more than 900 VCs has shown that 60 percent of VCs interact with their portfolio companies at least once a week and 28 percent several times a week.
A VC investor/fund buys equity in a startup in the hope of redeeming some, or all of their shares when a merger, acquisition, IPO, or other liquidity event occurs. Meanwhile, the value of the young startup should preferably have grown considerably.
This was the case when the Silicon Valley based VC, Accel Partners, bought a ten percent share of Facebook in 2005 for $12.7 million. When Facebook went public in 2012, Accel made $9 billion on the investment.
Most investors therefore have a natural interest in helping their portfolio companies in the best way possible with the resources available.
The capital offered by a VC investor should be seen as a mean of success and not a measure for success. The greatest value is often found within the expertise, network and resources that the VC brings, which can be difficult for a young startup to get access to.
Find the right investor
However, to find the right VC investor, it is not only interesting to look at the services a VC offers. A thorough screening of relevant VCs can also identify a person and a foundation with the needed professional expertise and network that matches the startup the most.
Some of the questions a startup should initially investigate are:
- What other startups have the VC invested in?
- How much has been invested and under what circumstances?
- Which network does the VC has access to?
- How has the VC helped its portfolio companies?
- If necessary, is the VC willing to "write more checks" to increase the investment?
Unfortunately, few startups focus on those questions when looking for an investor. A VC / startup relation can be seen as a long-term marriage, and it is a shame to realize down the road that you do not meet each other's needs and are not a match for the further process.
How VCs decide who to invest in
Thorough preparation can result in a gross list of relevant, potential VCs - but there is no guarantee of mutual interest.
The battle for money is fierce. Out of 100 startups that catch the interest of a VC investor, only about 30 percent achieve a meeting with the management team, about 10 percent meet the VC partners, about 5 percent continues to a due diligence process, and approximately 1.5-2 percent will be negotiating a contract (term sheet). Overall, only 1 out of 100 startups will obtain funding.
It takes an average of 83 days to close a contract, and VCs spend approximately 118 hours on the due diligence process itself, including calling an average of 10 references.
Therefore, for a young, ambitious startup who wants a slice of the cake it is important to understand how VCs operate and make decisions.
Network-based references
An investor's most important task is to generate "high quality deal flows" – i.e. to get in touch with startups that in the long run bring high returns. The majority of VC investors’ deal flows come from references from colleagues, other investors, or startups in the VCs own portfolio.
Only 10 percent come from "cold inquiries", where a startup contacts a VC directly. In other words, it is very rare for a startup to engage with a VC without the proper introduction. Hence, a basic investor screening and systematic network building around the investor can make the path to money easier.
Jockey vs. horse
But how do VCs then select that one startup they want to invest in?
VCs favor either the "jockey" or the "horse," where the startup team is the jockey, and the company's business model and strategy is the horse.
Both jockey and horse are a necessity, but ultimately the founding team is the most important factor. As many as 95 percent of VCs perceive the founding team as an important factor in an investment decision compared to factors such as the company's business model (74 percent), the market (68 percent), and the industry in which the company operates in (31 percent).
Since the founding team is such an important element in a VCs decision-making process, it is important that you as a startup are prepared and think about how to best present your strengths and team to relevant investors.
This applies not only during pitch sessions and concrete dialogues with investors, it starts with building a digital presence for both the company and the team.
A favorable time for venture capital
Although the road to funding may seem long and hard, the timing for chasing venture capital in The United States is quite favorable at the moment.
Despite a year of global uncertainty due to the COVID-19 pandemic, 2020 was a record year for VC investments with more than $130 billion invested in US startups - a 14 percent increase compared to 2019.
Thus, there has never been as much venture capital as now, and the venture funds are fighting hard for the best startups and deals.
This is also reflected in the first quarter of the year, where US-based VC-backed startups have raised a total of more than $62 billion - an increase of 117 percent compared to the first quarter of 2020 and an increase of 62 percent compared to the fourth quarter last year.
In the first quarter of 2021, there has almost been raised just as much venture capital as in the first half of 2020, which sets the direction for a strong 2021 in the sign of venture capital. Hopefully, Danish startups will benefit from this trend when looking for capital as well.
At ICDK in Silicon Valley, we are also experiencing increased demand, both from Silicon Valley-based investors seeking new leads and Danish startups seeking venture capital in the US. Therefore, our team supports an increasing number of Danish startups with i.a. investor analyzes and screenings. If you would like to know more, please feel free to reach out to us.