When to Approach Venture Capitalists13 Jan 2016
A lot of founders and first time entrepreneurs are not sure of when to seek venture capital funding instead of other financing avenues for their startup. There are several options available to finance your startup, one of the most common one being venture capital funding. Venture capitalists typically finance a small percentage of private companies. But they also provide tremendous value since, in addition to money; they offer their expertise and networks. Before you approach a Venture capitalist or a venture firm with your startup, you should make sure that you startup is a good fit to the VC’s experience, interest, risk profile and portfolio. In this article, we will tell you the key things you need when you have decided to approach Venture capitalists.
- Ideas versus products
They are many ideas and every aspiring entrepreneur has one or more. The days to seek funding for an idea are long gone. It doesn’t matter what idea you have. What matters is the execution. Venture capitalists want to see if you have measurable traction. If you have a revenue stream your chances of getting funding are higher.
- Your solution addresses a big market
As mentioned above, a great idea is not enough. You must be solving a relevant problem for your customers. Your solution should address an existing huge market. The market should typically be a 1B $ market, or it should be able to result in the emergence of a similar size market. According to Venture Partner Pankaj Jain of 500 startups, if the market you’re targeting is INR 500 Crore (US$ 91 million) and it’s not growing rapidly, then the opportunity isn’t large enough to go for venture funding. Even if your business winds up controlling 80-90% of a 500 Cr market, the market is still too small and wouldn’t yield a large enough return for the Venture Capitalist. For example, after dilution, if the investor winds up holding 10% of your company, in the best case, it would probably not be worth more than INR 100 Crore (US$ 18M).
- A disruptive business model
You should have developed a disruptive business model through which you can monetize your solution. These are the three things that make your business model disruptive:
- Better cost of acquisition of users.
- Higher LTV’s
- Higher engagement and low cost of servicing
- Other funding sources cannot help
You know you need venture capitalist funding when you need the networks and money that others funding sources cannot provide you. You approach a venture capitalist when you might need to raise multiple rounds of funding. Other sources of funding are:
- Bootstrapping: cash flow comes out of your own investment.
- Insider round: asking existing investors for additional capital, at a lower valuation.
- Debt: Debt is cheaper than equity though not apparent.
- Angel investors: Friends, family, high-net worth individuals, professional angels, and folks from the industry may all be viable sources of capital
- Private equity: There are many small-market private equity funds that can work with a slower-growth, yet profitable business
- Soft funds from the government.
- Strategic partners.
- Customers that pay upfront: Relying on up-front payments as a financing mechanism will drastically reduce your need for seeking outside capital.
Different venture capitalists take different levels of risk. VCs who invest in very early stage investing are sometimes willing to take risks and fund a product that may not have traction. VCs that fund later stage companies are willing to take market and management team risk. Finally, when raising venture capital entrepreneurs should always remember to be deliberate and match their company’s area of focus with the venture firm’s focus – and more importantly, the expertise of the individual venture partner they want to work with.