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is your startup a good fit for a vc fund by smok ventures for vestbee blog
23 August 2021·8 min read

Borys Musielak

Founding Partner, SMOK Ventures

Is Your Startup A Good Fit For VC Fund?

You have a bright business idea that only needs a bit of money to kick it off, but all the VCs say that “you are not the right fit at the time”? Read on to see if your startup is actually VC fundable and find out what to change to attract VC money and if it’s actually worth it.

Startup founders complain about venture capital funding as it is hard to get one and the procedures are complicated, and they are often rightfully so. As a group of investors, we’re often too slow, not very transparent, and struggle adding value. However, the majority of founders complain that VCs don’t understand the business and blame them for not getting funded simply due to lack of understanding the economics of VC funds - what kind of companies they look for and what kind of exit horizon they typically have. To catch the whole perspective, let’s go through some of the major misconceptions then.

Where is the fund you are pitching to in its spending lifecycle?

Before you send a startup pitch deck to a VC fund or contact its partner, here are some key findings you should know about and verify before trying to get funded.

  • Funds are usually raised every 2–5 years and last for 8 to 12 years before they need to sell all their assets. When was the fund you’re pitching set up and how many years they have till the planned exit?
  • Funds usually invest around 50% of their money in new startups and the other half into follow-ons in their portfolio. First 2–3 years they usually focus on new companies and for the rest of their lifecycle they follow on. How much of their initial investment money has been already spent?
  • A portfolio of a typical fund consists of 10–30 companies. How many companies has the fund already invested in? How many more they plan to fund?

It makes the most sense to pitch a VC fund that is at an early phase of its spending cycle, hasn’t invested in many companies from the current fund, and still has a long way to go before the exits. The later stage of a VC fund you reach, the more likely it will be focused on supporting the portfolio companies more than looking for new ones to invest in. And even if they still have room to invest in more startups, your chances of being that one picked company are significantly lower than at the beginning of the fund setting-up. The later the fund invests, the more mature the company needs to be as well as the maximal number of years till exit goes down each year.

Do you fit the economics of the VC fund that you’re pitching?

VC funds want to only invest in startups that can return the whole fund (aka “dragons”). This is the direct result of the economics of venture capital - we want to get our investors at least 2–3x returns from the capital invested. There are multiple strategies to achieve this, but history shows that it’s actually easier to find 2 or 3 companies out of 20 that return the whole fund than manage to invest in 20 companies that each returns 2–3x of invested capital.

What’s the size of the fund you’re pitching? - as the most crucial question

Let’s say you’re pitching a €10M fund and they are looking to invest €500k for 15% of the equity in your pre-seed round. In order for the investment to be viable, the partner at the fund needs to believe that they can get €10M+ from your company alone at the exit. This means that assuming they own around 10% at the time of the exit, you need to sell for at least €100M to be a good investment for the fund. Remember, the bigger the fund, the bigger the return expectations will be - a €100M venture capital firm needs at least a unicorn to be interested in investing. While for a €1B fund even a unicorn won’t do, as they need a decacorn to be satisfied.

So if you’re targeting a €100M market that is not growing very fast, don’t be surprised when no VCs are interested. They need at least a €1B market or a smaller but fast-growing one to even look at your business idea.

Likewise, if your revenue predictions in year 5 are €5M per year, don’t expect the VCs to be impressed. They know those are optimistic numbers anyway, and even assuming that you hit them, this sum won’t generate enough value for them to sell the company at a price that is suitable for a VC. However, if your startup is not fundable for one VC it does not necessarily have to mean that it’s generally not fundable. It might simply tell you that you need to talk to smaller funds with different expectations.

Where do you want to take this company?

This question is often asked not because the VCs think you’re a prophet and want you to tell them the future. They simply want to know how big your ambition is and whether or not there is a match between your vision and theirs. So decide wisely what to say.

The moment a VC fund gets a feeling you’re looking for a lifestyle business that just generates you a sizable dividend each year, it will immediately lose interest. What might be a great outcome for your startup will be a horrible outcome for the VC, as they don’t want you to generate profits, ever. They want you to reinvest all the profit into the company to increase its value as much as possible until their investment cycle is over so that they can sell the shares with the most profit.

Any wrong answer always includes the statement “I don’t want to sell my company”. Well if you don’t want to sell, then don’t even take a VC onboard as the whole point of VC investing is buying into startups early, growing them and selling with profit. The investors usually add the clauses to the investment agreement that enable them to sell the shares or sometimes also yours if a good buyer shows up, so be aware of that while making a deal.

What kind of founders are the VCs looking for?

The VCs are looking for specific types of founders.

  • They want people who’ve done it before, either in another startup or elsewhere in their professional life.
  • They seek entrepreneurs fully dedicated to and focused on this one business idea.
  • They are looking for people who never give up.
  • They want startup founders who can attract talent, customers, and future investors.

If you can prove you have all the qualities mentioned above, your idea is big enough for the fund you’re pitching to and they still have room for making initial investments, your chances of getting funded are higher than average.

However, if your startup team lacks one of the above features or they are hard to prove, (e.g. you’re a first-time founder, or you started a lot of projects but haven’t finished any) you have more than one project under management or you haven’t proven to be a leader, yet, chances that the VCs will ask for more traction before they commit are really low, as their risk is increased with each unchecked checkbox from this list.

What is the VC fund you’re pitching to actually looking for?

Fortunately, each VC fund is different and they might be looking for different things in startups and their founders. Some corporate-led funds might be only interested in investing if it is strategic to their business, some funds only invest at a specific stage or location, while some of them like specific industries and are focused only on software, games, hardware, biotech, impact startups, or other. The good news is that most solid funds don’t hide what they want - check out their websites, social media, articles and FAQs to find out if your business matched their target and if so, how to best pitch them to get funded.

Do you need to be a VC match to succeed?

Remember that only around 1% of companies are actually VC-type businesses. There is nothing wrong about and a lot right with not being VC fundable. If you feel that it’s a good solution that will support achieving your goals - just go for it and try, if not - do your business and look for other funding sources. The former, however unlikely, can make you and everyone involved very rich, but the latter usually means less stress, improved cashflow, and a lot more control over your business. Choose wisely which type of business you want to run.


Related Posts:

7 Steps To Make Your Startup Ready For VC Investment (by Agnieszka Poznańska, Head of Origination, Shape VC)

Where To Find The Right VC Fund For Your Startup? (by Olga Chechłacz, Editor, Vestbee)

How To Spot Best Startup Accelerator? (by Cristobal Alonso, Global CEO, Startup Wise Guys)

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