Securing venture capital is considered the holy grail of funding for early stage and scaling startups looking to raise capital.
But what is venture capital? And who are the mysterious ‘venture capitalists’ guarding this precious fountain of abundance?
Let us explain…
Venture capitalists, or “VCs”, are private equity investors that inject capital into companies with extremely high growth potential, in return for equity in the venture. VCs are usually looking to (at a bare minimum) see a 10x return on their investment over a set period of time.
Paul Naphtali, Co-Founder of Rampersand, a leading Australian early-stage tech VC, explains there is a lot of nuance between different VCs. He says “it’s important to know that VCs have their own investors. Some are backed by large super funds, some by big corporates. Rampersand is backed by 120 private individuals and family offices.”
Because every VC’s investor base will differ, so too will the VC’s “mandate.”
What is a mandate, you ask?
Mandates determine the parameters of any given VCs investment portfolio. Mandates can vary on issues of cheque size, areas of investment and/or investment practices. Also, companies within a particular stage, usually by ARR level and companies in particular industries or technology types.
Naphtahli explains “we go to our investors to tell them what we will invest in, what returns we think we will receive and in doing so, this creates a mandate. A mandate is essentially the guardrails on which a VC has made promises to their investors.”
To put it simply, VCs are answering to their own investors, based on promises or indications they have made about how they will invest. They’re not simply handing out cheques randomly, to companies that pique their interest.
It’s often said that investors invest in lines, not dots. This means investors want to see the journey of a startup, not where they are at a specific point in time (usually when they are asking for cash). This requires significant legwork from founders to inform potential investors about their company’s growth journey.
So, what should you showcase to VCs?
Venture capitalists will always look for exceptional founders.
“We’re not algorithm investors. This is fundamentally human and seeing the potential in people before they see it in themselves is often one of the most challenging but rewarding parts of our job” says Napthali.
Peter Huynh is a Partner at Singapore based Qualgro VC which invests in startups at Series A & B across Southeast Asia, Australia and New Zealand, focusing on investments in SaaS, Data and Artificial Intelligence.
“The founder and team aspect is by far and away the most important thing. Eighty percent of the success of the investment is based on these factors. Great teams in great spaces, will find a way” says Huynh
Huynh elaborates by noting that being a great founder is rooted in honesty and self-awareness. He says “if founders are able to be honest with themselves and honest with us, it enables them to level up.”
VCs field pitches from hundreds if not thousands of companies a year, making their bullsh*!t radars pretty robust. Approach conversations with VCs in good faith. Explaining the gaps in your business plan while displaying your tenacity to overcome them given the right funding, will help (not hinder) your pitch.
Demonstrating your startup has a significant, addressable market opportunity is important for grabbing VCs’ attention. To secure that 10x return we mentioned earlier, VCs generally want to make sure their portfolio companies have a problem that many customers need solved.
Any VC worth their weight in capital, will expect a detailed market size analysis. Market sizing should be presented from the "top down" and from the "bottom up." This is never going to be 100% scientific, as your growth plans are likely to shift over time. However, it’s important to show VCs that you’ve given significant thought to the scalability of your startup, which you can back up with data.
Whether your startup sells hardware or software, the product (or plans for the product) need to have a significant competitive edge.
If your startup doesn’t have first-mover advantage, why and how will it be able to secure a significant slice of the addressable market? If it does have first-mover advantage, why doesn’t a satisfactory solution already exist?
These are questions you will need to be able to answer convincingly.
Speak to any founder who has undertaken the arduous journey of raising capital from VCs and they will tell you to brace yourself.
It’s often referred to by founders as a ‘full time job’ - meaning, whatever functions you were fulfilling as a founder, will likely have to be put on hold or alternatively, you’ll lose a lot of sleep performing two jobs every day.
Jason Atikins, CRO and Co-Founder of Cake Equity says “to avoid emotional burnout, it’s important to understand capital raising is a matching process and a big part of a founder’s role is finding investors with a mandate that matches what they are doing and to ask the right questions, early.”
Olympia Yarger, Co-Founder of Goterra, a global startup redefining waste management elaborates on the art of asking about the mandate. Yarger says “the context of asking about a VC’s mandate requires remembering that investors are human too. They may not understand their mandate in the way you need to digest it.”
Hunyh agrees with Yarger, that in order to truly understand a VC’s “mandate” you need to ask: “what is the thesis to your mandate?” This might seem like a lofty concept but it is simply asking the VC to explain the rationale behind their mandate: why do they invest in particular industries? Why do they have a certain cheque size?
If you understand the VCs “whys” you have a better chance of matching your company with a pattern for which the VC is looking.
We hate to be the ones to break it to you but the capital raising process doesn’t begin when you start raising. It should begin in what’s called the ‘qualification stage.’
“You need to do the qualification work before you start raising, which means asking investors ‘when we raise, would you like to participate?’ You should have between 50 to 70 investors canvassed, to ensure you have a healthy level of interest by the time you begin to officially start capital raising” says Atkins.
Yarger has (successfully) been through the gruelling capital raise process multiple times and says “raising is about maintaining the relationship with investors for, after and during the raise- not just during the raise.”
All of this is to say, raising really is a full time job for founders.
Make sure you master the dark art of the term sheet; a document often over-complicated by founders during the capital raising process.
Hunyh recommends founders do a little homework. He says the book to read is Venture Deals by Brad Feld and Jason Mendelson because it gives founders a sense of what’s important and what’s less important when it comes to constructing a term sheet.
“Term sheets need to be clear, straightforward and simple. They need to avoid complexity around terms that could replicate into future rounds or could make it difficult for the team or future investors moving forward,” Hunyh says
In Australia, many VC firms have open source documents available to any founder, to use as templates. Hunyh recommends founders make use of these valuable resources and cites Airtree’s open source database as a starting place.
Finally, make sure you’re thoroughly prepared for due diligence to be undertaken on your company. This means having an up to date cap table that includes any options you’ve given to employees via an ESOP.
Cake Equity can streamline capital raises, ensuring your house is in order and you’re ready to send offers at the click of a button.
Use Cake today for free. We make equity easy.
This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.