CEO Ventures Entrepreneur Resources... How Do Venture Capitalists Select Investments? Full content credits to Catharine Merigold

Expensive! Cheap! Cost of Capital Stage of Company SeedMature Self FF&F Employer SBA, SBIR Banks - PG Banks - AB Strategic Investors Venture Capital & Incubators Venture Lending EarlyLate Private Equity / Mezzanine Sources & Costs of Capital

Venture Makes Sense for Very Few Companies MOST successful companies are NOT funded by venture Venture Capital ONLY makes sense for very few companies My own advice: If there is any way to build a business without venture capital, you should Venture capitalists are not risk-takers, they are risk managers

1st M: Money How a VC “selects” investments is a function of: 1) “Whose” money they are investing; 2) What other rates of returns are available to those who invest in the fund (LPs) from other investment vehicles 3) The stage of company they invest in

Where do VCs Get Their Money? Commitment Sources to US VC Funds

The Entire Fund Has To Return Higher Than Other “Less Risky” Investments Consistently a higher rate of return than other investments An “alternative” asset class Rate of Return Time Horizon Venture Returns by Type, Q1 ‘00

If Fund to Return 30%, Avg. Investment Must Return More Depending on Number of Losers “Typical “ Early-stage Venture Portfolio Returns

The Lesson: An Early-Stage Portfolio Return is Determined by 2-3 Winners Venture Fund Portfolio Model Assume fund = $ 100,000,000 Assume investments =25 Lemons ripen early

How Much Does Venture Capital Cost? Risk – Return Continuum

2nd M: Market “Big” market Ability for rapid growth up to a substantial sales level The opportunity to deploy significant capital –For example, some funds want to invest $10-20 million over the life of a company to create an “impact” investment

Market Part 1: Market Size Market for the product/service should be more than $1B or small & growing rapidly Why? Need for Exit – Remember, VCs get their money from someone else, and have to close out all investments in 10 years A large share of a small market, even with profitability, means: No one will pay a premium in an M&A situation Can’t go public because growth limited

Market Part 2: Rapid Growth Ability for rapid growth up to a substantial sales level –$50M+ in 4 years –Why? Rate of Return Therefore, VCs look for: –A company that solves a significant market “pain” –Sustainable competitive advantage This means many good businesses are not fundable because they either cannot grow quickly enough or are not scalable – e.g.retail, many service-businesses

Market Part 3: Ability to Deploy Capital No matter what the rate of return, VCs will typically NOT invest if a company needs less than $5 million in capital Why? Fund Size and Rate of Return If a Fund has $300 million to invest, it would take 30 “home runs” of 10x return on a $1 million investment just to return the fund

3rd M: Management VC mantra - management, management, management At the end of the day (unless an irrational market lifts all boats), it is management that is responsible for success Depending on the particular VC, they may look for: –“Recycled” entrepreneurs –Domain expertise –“Sticky” entrepreneurs –“Real” entrepreneurs

Value Creation in Business and Product Value Tech/Prod Business alpha Bet a Patent Idea PoC Sr. Team Customers Partners Sticky Bus Plan Rev Ramp Ship

Management risk Market risk Sales risk Technology risk Business strategy risk Financing risk To Maximize Funding Potential and Valuation – Minimize Risk Vectors

Finding the Right VC Choosing the right VC firm as your “partner” is important Look for help beyond capital –Industry expertise in your area –Good track record –Reputation for working well with entrepreneurs Make sure the VC’s expectations on growth strategy, future fundraising, and investment time horizon are the same as yours

How Do VCs Choose Investments? Recap: The 3 M’s –Money –Market –Management Full content credits to Catharine Merigold