What Venture Capitalists Want in Startups: What to Communicate in Sharing Your Company’s Story
By Stephen Dupont, vice president, Pocket Hercules
If you’re among the millions who dream of starting a business, or if you’re a small business owner who needs capital to take your business to the next level, what you’ll need more than anything else in the world is a clear vision of the challenge you’re trying to solve for a customer, and a succinct, easy-to-understand story to express that vision.
To grab your share of the billions in venture capital that’s available to startup companies worldwide, you’ll need to do more than create a disruptive technology. The key, say several experts, is to clearly articulate how your company is meeting a massive market opportunity, how you’ll easily scale up your business with the infusion of venture capital, and how you’ve brought together the right people, at the right time, to successfully implement your business plan.
According to a recent report by CB Insights and KPMG (source: Sara Ashley O’Brien for CNNMoney.com), during 2015 the majority of venture capital funding went to mid- and late-stage companies, such as Uber, Palantier, GitHub, and Vox. While fewer VC funds went to seed- and early-stage companies, funding can still be achieved by entrepreneurs who can clearly demonstrate their ability to maximize the return on the investments made in their company.
Telling Your Company’s Story
Regardless of what stage your startup may be at this moment, the opportunity to attract capital — whether through venture capital firms or through the public markets — hinges largely on your company’s ability to succinctly communicate a compelling opportunity for growth to the right group of investors, says David Dalvey principal of Minneapolis-based Brightstone Venture Capital Fund. Dalvey says the three most basic questions to address in telling your story are:
- What is the fundamental problem that your business solves?
- How large is that market?
- How will your business capture and defend a large share of this market?
The answer to these three questions will quickly communicate whether your startup business is compelling to an outside investor, Dalvey says. A startup must address not just a critical market need, but also the ultimate size of that need and exactly what your company plans to do to build a meaningful business.
“A lot of companies can be screened out quickly with this fundamental test,” says Dalvey, who has invested more than $50 million into more than 15 companies over the past ten years including Definity Health, AppTec Labs, August Tech, BiteSquad and Gravie. “Having the ability to deliver a 60-second elevator speech to help a potential investor quickly understand exactly what you plan to do and why your product or service really matters to a large market will greatly facilitate the process of raising new growth capital.”
Pressure Test Your Idea
As founder and president of Nelsen Biomedical, a leading consulting firm that connects entrepreneurs and startup companies in the life sciences with corporate VCs, venture capital firms, private foundations, and other investors, Barbara Nelsen, says even the brightest scientists in the world can have difficulty in boiling their story down to attract investment capital.
“The best solution is to pressure-test your idea,” says Nelsen, whose firm vets fundamentals of startups, such as technology, finances, and key management.
“Go find real people who will use your product or service,” she says, “and find out what they think about it. That feedback alone can prove invaluable in expressing why your product matters to potential investors.”
Starting up a company and seeking venture capital is somewhat like jumping out of an airplane, says David Stengle, CMO of Prescription Advisory Systems & Technology (P.A.S.T.), a technology company that helps doctors prescribe controlled substance medications safely and confidently. “You can prepare for the jump, but you often need to build your parachute on the way down.”
Based on Stengle’s experiences on the startup side as well as a private equity investor, the real test to attracting serious money to enable your company to grow is simply, “sell your product.” This means that your business must be well beyond the napkin stage — it must have a minimally viable product and attract early adopters who will be able to share how your company’s product or service solved a challenging problem or created new opportunities.
“The best validation of a startup is sales. Raising money from friends and family or Kickstarter is what we do when we need more money before we prove our selling model works,” Stengle says. “Venture capitalists are in the business of helping a startup scale up an idea that has huge potential to generate a massive return on their investment. A-round (Series A preferred stock) investors expect startups to have revenues and show market validation of their sales model.”
The People Behind the Idea
The next test in attracting venture capital is your startup’s most valuable asset — the talent of your core team.
Out of the more than 3,000 investment opportunities that Brightstone Venture Capital received over the past several years, the fund professionals at Brightstone have seriously considered approximately 300 deals but, in the past three years, invested in just ten companies.
“One of the most important factors that drives our decision to invest in a company is its leader and the people who make up a company’s core management team,” says Dalvey. “We strive to back highly capable entrepreneurial visionaries with a track record of successful execution – and help them achieve their vision for extraordinary growth with our investment capital, industry connections and financial counsel.”
As part of its due diligence efforts, Brightstone does a thorough review of everyone involved with a startup, including the board of directors, consultants and outside advisors.
“We look at everything – from how people represent themselves online to their social media posts on Facebook, Twitter and LinkedIn,” Dalvey adds. “We usually enlist a formal reference check service, and we also use online data sources such as CrunchBase.com to learn about the individual team members, former employment and emerging competition to the startups, too.”
Chris Naylor, a certified EOS implementer based in Minneapolis, helps startup companies structure their organizations for healthy growth with the Entrepreneurial Operating System (EOS), a holistic business management system and practical tools designed to improve company performance and boost leadership team effectiveness — ultimately attracting future rounds of venture capital.
“Even if you have a great product or service, many organizations fail to live up to their potential because their leadership team has lost sight of its vision,” she says. “They’re unable to clearly communicate why they’re in business and what challenges they’re trying to solve for their customers.”
Nelsen, who primarily works with life scientists, adds: “You can have solid science behind a new product, but without the right people, it may never go anywhere.”
What happens, based on Naylor’s consulting experience, is that as a company grows and expands, competing strategies emerge, which complicates a company’s narrative. Also, leaders of fast growing companies often don’t have an effective framework to hold themselves or their employees accountable.
“People are the only true competitive advantage,” says Naylor, who consults with a range of companies, from seed-stage companies to larger, more established companies with sales of $5 million to $50 million. “Often times, we have to strip companies back down — back to their core focus to determine their core values, and realign the leadership and talent pool to put the right people in the right seats to maximize a company’s potential for future growth.”
It’s about execution, Stengle says. When a management team is aligned with a clear vision and a product that offers demonstrated value, executing on the startup’s marketing and sales plan becomes the next factor a VC will weigh in terms of whether to provide additional funding to a startup.
Stengle, who leads Startup Grind Princeton, notes the vast majority of all venture capital went to teams with previous start-up experience.
“The investors I’ve worked with are expecting a startup’s management team to identify the holes in their strategy, and fill those gaps,” says Stengle. “They want to see that you’re doing everything in your power to succeed — that you’re leaving nothing on the field. Ultimately, what matters is the tenacity of your management team in gaining traction and building momentum.”
“VCs are swinging for homeruns, not singles,” Stengle adds. “They expect strikeouts. But they’re never going to invest in a company that smells like a strikeout from the moment they walk in the door.”
The Clock is Ticking
Some entrepreneurs may interpret the question of a startup’s “time horizon” as the date they may take their company public. Instead, the more accurate way to look at this question is “how soon can the startup generate an extraordinary return on an investor’s investment,” says Dalvey. That return on investment may come through massive profits generated organically through sales, the licensing of technology to other companies, or the sale of the startup to another company. Most venture capital firms, like Brightstone, are in the business of generating at least a 50 percent annualized IRR return on the investments of the investors with whom they partner.
“A quick rule of thumb,” Dalvey says, “is that venture stage investors are typically expecting a return of at least 10 times their investment within five years. Looking to the expected exit value of a business in five years and the current proposed entry valuation should yield an approximate 10 times appreciation to be competitive to the other investment opportunities in front of early stage investors.”
In building your company’s narrative, it’s critical to speak to how efficient your business will use its capital. This also means knowing your cost of doing business, according Marcus Lemonis, the CEO of Camping World, in a recent Inc. magazine article. Knowing your costs will help your organization more clearly explain how it optimizes its venture capital.
“Years ago, selling the idea or concept behind a new startup was kind of cool and sexy,” Nelsen adds. “But today, you must explain not only how and when an investor is going to make their money back, but how you’re going to use every penny of the investor’s investment. Investors are looking for frugal investors who are determined to meet specific milestones and outcomes.”
More Tips to Raising Venture Capital
Here are five additional tips to help your business make a more powerful case as to why a venture capitalist should invest in your firm:
1. Focus the Concept. You don’t need a 60-page Powerpoint deck to explain what your business does, who your customers are, and the extraordinary value it will deliver. Keep it to no more than 20 well-designed, crystal clear slides (fewer is even better!). Along these lines, you should be able to explain the potential of your business concept in 60 seconds or less, which may be all the time an investor may give you.
2. Beware the Hype Machine. Don’t go overboard in pumping the potential number of customers for your product or service. Because of the volume of deals that VC firms see, it’s likely that they already know the size of the potential market for your product or service innovation. However, be aware of current trends in venture capital funding, such as the current trend to invest in companies that are re-imagining the service industry (for example, Uber), startups focused on the Internet of Things (IoT) such as Nook thermostats, or crowdsourcing apps.
3. Know Your Competition. The competition for your new product or service may not be a similar product or service. You may not even be competing against a well-known, household brand. Instead, your main competition may be long-held habits and processes. In an article for Forbes, Geri Stengal, president of Ventureneer, a digital media and market research company, noted: “Even if you have a disruptive new product, you’re competing against an entrenched way of doing things.”
4. Look Beyond VC Firms for Funding. Venture capital funding is not limited to just venture capital firms. In fact, for some sectors, such as the life sciences, Barbara Nelsen says your best bet for obtaining early funding may be through family foundations, family offices, nonprofits and patient advocacy groups. In such organizations, there is a passion for funding the development of new technologies that may offer life-saving cures but may not offer the large market potential required by venture capital firms. For additional thoughts about venture capital for life sciences entrepreneurs, visit “The View Beyond Venture Capital,” an article by Barbara Nelsen and Dennis Ford, CEO of Life Science Nation.
5. Build Assets. Think of your business like a new home that you’re building and planning to sell. Besides cash flow, what other assets make that home tantalizing to potential investors? Here are some examples: strategic partnerships with large industry players; a growing database of customer data that could be leveraged for multiple marketing purposes; and a powerful brand identity are just a few of the must-haves that will increase the valuation of your company.
The Bottom Line: The key to attracting capital at any stage, from the “friends and family” seed round to later-stage rounds, is clearly understanding and expressing the definitive purpose of your startup organization. Clarity inspires confidence and trust, which is exactly what is needed to inspire all investors, especially seasoned investors, to invest in a new venture. Whether your idea is still a drawing on a napkin or your company has achieved $50 million in sales with an eye on a potential IPO, keep re-visiting the fundamental questions:
- Why do you do what you do?
- What fundamental problem or challenge is your business trying to solve? And,
- Why is your team uniquely qualified to solve that problem?
Stephen Dupont, APR, is VP of Public Relations and Branded Content for Pocket Hercules (www.pockethercules.com), a brand marketing firm based in Minneapolis. Contact Stephen Dupont at www.linkedin.com/in/stephendupont or visit stephendupont.co.