What VCs Look For In A Startup (And How It Makes Them A Fortune)

What VCs Look For In A Startup (And How It Makes Them A Fortune)

How do you become a venture capitalist?

There is no straight line to becoming a VC. Going to college and studying finance or business won’t guarantee you a chance to succeed as a startup investor.

A common thread among VCs nationwide — both newly appointed partners and those with decades of experience — is that most have operational experience as a founder or working within a start-up.

Square Peg Capital’s Paul Bassat is credited with co-founding Seek, Blackbird’s Rick Baker started two software companies before getting into investing (Right Party Connect and IDC Global), and AirTree partner Craig Blair founded Travelselect before selling it to Lastminute.com in the early 2000s.

Folklore’s Alister Coleman is an outlier among the country’s longest-serving venture fund partners, having started his career investing as a senior analyst for a family office before moving to Fairfax Media and overseeing its M&A strategy. But he, too, gained operator experience before moving into VC, co-founding ShippingEasy in 2011.

A new member of the local VC scene, Jackie Vullinghs, was promoted to partner at AirTree in mid-2021. She was never a founder, but worked for a start-up before joining the fund.

“I studied history at university and then sold equity derivatives on the trading floor of Merrill Lynch and Citi in London for six years,” she says.

“Throughout my journey in banking, I wanted to start my own business, but I didn’t have the confidence to jump right in, so I joined Lystable, a B2B start-up Seed-stage SaaS in London, as Head of People When I decided to move to Sydney in 2017, I thought I would experiment by mixing my interest in investing and my love of start-ups by trying venture capital.

Vullinghs and Coleman agreed that for anyone wanting to enter the industry, your ability to get a job in VC has more to do with your mindset than your experience.

“You want people who think independently, who are incredibly curious, who are good at deductive reasoning and taking in information but don’t ground themselves in it all, and people who accept that there is a lot of uncertainty in the world and who aren’t embarrassed by it,” Coleman said.

How do venture capitalists make money?

Venture capital fund partners receive a salary and also receive a carry in the funds. Carry is a form of profit sharing, and they only earn that part if they provide strong returns to investors in the fund. Barriers to carry mean that if a certain agreed rate of return is not achieved, partners cannot participate in any of the profits.

For most venture capital funds, the total carry distributed to partners tends to be between 15% and 30%, with 20% being the average.

Carry is how VCs make a lot of money, but, with many funds having 10-year lifespans and returns often not starting to flow until six or seven years into the fund’s life, it pays to be patient.

What does a venture capitalist look for in a start-up?

How you evaluate a startup depends on its maturity. An investor who buys a company when it has already raised a few rounds will be able to look at metrics such as revenue growth, average revenue per user, customer acquisition costs, its cash burn rate and its path to profitability – something that is increasingly being scrutinized. amid this year’s tech market correction.

But, when a business is still in its infancy, there is hardly any financial data to review and this is where curiosity and intuition come into play.

Factors considered by VCs include the experience of the founders and their team (some funds prefer founders who have firsthand experience of the problem they are trying to solve), their ambition, the size of the potential market, and their personality. .

It’s also common for start-ups to get to know their potential investors for months or even a year before they even raise capital. This gives VCs a chance to learn about the company and see the founders’ ability to bring their vision to life.

“The most critical part of the decision is in your heart – do you love this company? Do you fancy taking a 10-year journey with this founder? It’s more art than science,” says Nick Crocker, partner of Blackbird Ventures.

Vullinghs says AirTree does two to four weeks of legal due diligence on its investments, but the fund values ​​much more than the terms of a deal.

“We seek to understand in detail the experience and motivations of the founding team, the unique vision that led them to start the company, the market opportunity, how the product works and if it engages users, sales and marketing strategy, unit economics and financials, and competitive advantage over time.

Coleman’s fund, Folklore, specializes in seed investing, and he thinks he can “get a feel” for a founder in less than 30 minutes.

“The fastest we’ve ever had for a new investment is five days. The fastest follow-up investment we’ve ever made is 5 p.m.,” he says.

“When that happens, the bonding chemicals are gone from everyone’s mind. [We like founders] who are wildly ambitious, have very clear thinking, they are honest and…understand the catalytic power of the team.

“We also spent six to seven months [assessing an opportunity]. Swoop Aero took seven months because we didn’t understand drones, and we wanted to understand the environment they operate in, and Swoop wasn’t ready to grow at the time.

What red flags does a venture capitalist look for?

Lying. Coleman and Vullinghs say there were times when the founders lied to them during the pitch process and said it was an immediate red flag.

“We also do legal due diligence and background checks to make sure there are no skeletons we need to know about,” Vullinghs says.

Coleman says if a founder is evasive or dismissive, that’s also a warning sign.

“You try to help these people, but they see the questions as something to be thwarted and avoided,” he says.

How does a venture capitalist deal with market hype?

Every once in a while an area goes from hot to scorching. If you are an investor picking the top of the market, this can result in eye-popping gains, but if you miss it, the losses will be plentiful and quick.

There’s no better example than the buy now, pay later sector, in which companies like Sezzle and Zip fell more than 86% last year.

Coleman says Folklore always tries to invest in trends before they’re discovered.

“You want to invest early, before it crystallizes as a thing,” he says.

“You do not want [the trend] never to be discovered, but you must understand if something is real and lasting.

Crocker, however, says Blackbird pays no attention to the hype.

“We could fund a start-up at the peak of the hype cycle – like ascending SaaS (software as a service) in 2021, and we could fund a start-up when everyone thinks the industry is dead – like crypto in 2013.

“A great company will take more than a decade to build. Wherever that company is on the hype cycle when you meet it, it won’t be where it is a year or 10 from now. »

How are start-ups faring this year?

Since interest rates began to rise this year, funding has slowed significantly and venture capitalists are experiencing the toughest investment environment in more than a decade, says AirTree’s Vullinghs.

The higher interest rates rise, the more investors appreciate future income and, as a result, valuations and the number of new transactions have been affected this year.

In 2021, more than $10 billion has been raised by Australian startups, while this year as of October 31, around $6 billion has been invested, according to Cut Through Venture.

(Despite this drop in investment, the amount invested in October of this year – $490 million – still exceeded the total invested in 2016, which was $465 million.)

Founders now face the very real consequences of the mega-towers that were lifted to lofty valuations in 2021, when cash flowed freely and competition to close deals was fierce.

The tech sector saw a pullback with equities (S&P/ASX All Tech Index) down 31.7% so far this year.

Investors are now advising portfolio companies to make their capital last longer, leading to industry-wide layoffs, reduced hiring rates and lower spending in areas such as marketing.

“We encourage companies to continue to develop products and focus on growth, but to focus on effective growth – continuously assessing the effectiveness of spending and closely monitoring forward-looking demand metrics to understand if customer demand slows, then accelerating decisions to extend the runway if necessary,” says Vullinghs.

However, investor optimism remains high, with VCs highlighting the long-term nature of investing in start-ups.

To manage the current uncertainty, Crocker said Blackbird’s approach is to focus on the progress of its portfolio companies, not “the emotions of economists.”

“We’ll never be good at predicting the future, but we can get good at predicting which founders will make progress on their vision, no matter what comes their way.”

#VCs #Startup #Fortune

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