Investors are like sharks, but not the way you might first think. They have to keep moving to stay alive, raising new funds every few years, and more importantly investing and re-investing in the best growth companies available. COVID poses the question: how do rounds close when travel and proximity are risky? Let’s consider how VCs, and founders, can adapt.
Earlier stage rounds
- For early stage, one model is much smaller checks into many more businesses. VC’s get their ‘portfolio effect’ of diversification by extreme diversification, instead of 20 bets of $5-10m, 50-100 bets of $1-2m. Many incubators and boot camps already take this approach - Y Combinator invests a standard $150k for 7% of a company, an extreme form of this.
- Another is actually going even earlier stage. Counter-intuitive in a recession, but funding a quality known team with a slide deck and little else perversely doesn’t require any on-site diligence. Small comfort for unknown teams, so it narrows the investment market, but opens up more $ for some nascent businesses. A brand-new opportunity might raise $3m not $1m as a result, though the team threshold would be higher.
- A third is the opposite of this: going much later stage and playing ‘follow the leader’ investing, say $3m in a $30m round backed by larger, known investors. This is especially attractive if the money is at least partly for innovation, not just execution. This is where a VC can be particularly helpful, and where his/her mentality has value around the board table.
What this likely means is: if you are an ‘unknown’ founder, assume a fraction of the money you might have expected last year. But then again, great people are more available for less, and resources in general get far easier to source for less $. For ‘known’ founders, it can mean perversely more $ at an even earlier stage.
It’s also important to reflect exactly why ‘physical’ engagement is so important for VC’s. There is ‘getting a feel for founders’ and then there is doing due diligence via on-site visits. To close rounds, let’s separate the two. The former can be done via very focused travel, e.g. founders going to meet VC’s, spending time six feet apart. On-site visits may be able to be avoided, and anyway there won’t be as much to see.
One key for any founder, in any stage: get your unit economics clear, detailed, precise and in good shape to present. An equity story engages, but unit economics sell, even more so in a recession. Investors will look for decreasing CAC (customer acquisition cost) even more than lifetime value or LTV (which is more uncertain now). You need a very precise analysis of your company's 'economic engine.' The less they can see you, the more work unit economics need to do to convert interest.
Larger growth rounds
- It becomes even more important in a recession of enforced distance for an internal ‘strong’ VC committing more $. This gives a ‘remote’ growth investor confidence, that can unlock new money. If there isn’t one ‘strong’ VC, then commitment from every institution around the table becomes even more valuable. It can make the difference between a new $30m check, and an internal round only (where existing investors have to support the company on their own).
- Many growth funds are already thinking about smaller initial check sizes (say $20m vs the $50m they would opt for last year), that may require less (but of course not zero) diligence. Paring back a $70m target to say $40-50m, but still targeting $50m+ investors, can shape the round to what many investors will soon be looking to commit. Anticipating this and getting out ahead of it only increases a company’s credibility looking for new money.
- Reference-ability from a ‘trusted 3rd party’ becomes more valuable. This can be stalwarts like Gartner etc., the presence of someone a growth investor knows or can vet on the board, or a common link between the founders and the incoming investor. This is the time for growth companies to upgrade their board, adding well known industry figures or new chairperson. And these become easier to find in a recession. Think externally here, not just internally.
- In larger rounds there is often competition for quality assets. Only 25% of companies raising Series A go on to raise Series C, and nearly $1 trillion of growth money has been raised the last four years, much of it still looking for deals. Creating real competition becomes essential, at a much earlier stage than a year or two ago. And that inevitably means more precision in targeting and engaging with the first group of investors and reaching out to more of those than a founder might have thought necessary last year. Processes become more targeted and front-loaded, to maximize real competition mid-stream where it counts most.
This is not to say any fund would wire $50m without spending time on the team and asset. But there may well be ways to minimize this, and so maximize the probability of success.
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