If you follow startups and VC deal flow, it’s hard not to read something on money getting tighter, startup layoffs, etc. That doesn’t mean that there isn’t funding available, but it does mean that there will be greater scrutiny as to what VC firms choose to invest in. So how do founders navigate raising capital in a tight market?

First, it’s important to remember how VC firms are funded, how they make their money, and the return they look for…

  • VC funds are funded by investors referred to as Limited Partners (LP). LPs can be individuals (typically with liquid assets of $1M+), family offices, other types of funds (pension funds, endowments, and sovereign wealth funds), or companies.
  • The average fund will consist of 30-80 startups with an investment of ~$135M.
  • The firm makes its money by charging a management fee of ~20% of the initial fund total spread out over a specified period (2% per year over 10 years = 20%)
  • VC firms invest with a near-term exit in mind. That can be via outright sale or IPO, and that window is typically around 7-10 years. Of course, that can vary according to what the multiplier of the return looks like.
  • VCs must beat the return that investing straight into the S&P 500 and other funds would have given the LP. Due to the high failure rate of venture-backed startups (~75% fail), they need at least 11-12x+ ROI.

As TechCrunch pointed out in May, venture capital dollar volume peaked in November and has been steadily declining. So what will separate your pitch from others? Here are some resources to help begin to answer that question…

So much of it comes back to the basics of running a business as if you had bootstrapped it yourself, as well as answering key questions such as…

  • Do you have a sound business plan?
  • More than generating revenue, do you have a strong model for generating profit?
  • What are your key metrics (number of users, LTV, CAC, MRR/ARR, growth rate, cap table, etc.)?
  • What is the total available market (TAM), and what share do you need to generate 11x minimum?
  • How will the money be used?
  • Do you have the correct valuation?
  • What separates your founding team (what makes your team special)?

It can’t just be a novel idea; you have to show that it will have an ROI.

And if you’re looking for more insights, TechCrunch Disrupt is tackling this subject at this year’s conference in October (link to event registration).

Sources Used:

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