When to venture for venture capital | Commercial awareness on The Gateway

When to venture for venture capital

Completing our series about raising money for your startup David Langer examines venture capital.

A Venture Capital firm's (VC) core aim is to raise large funds of money (typically £100-500 million) from investors such as pension funds and high net worth individuals and to return a lot more money to these investors up to 10 years later. They do this by investing each fund in a portfolio of private companies (typically 10-25) and "exiting" these companies a few years later, usually via trade sales or initial public offerings (IPOs).

As a result of this model, seeking VC investment for your startup is only likely to be a good idea under certain circumstances:

1.You are aiming for a big exit (£100 million+)

VCs expect the majority of their returns to come from one or two companies in their portfolio. Therefore, they generally expect each company they invest in to have the potential to "return the fund". VCs will often try to answer this question by asking you about the size of your addressable market. They are typically looking for a number of at least £1 billion, as smaller markets may make it too difficult to build a large enough company.

2. You need to raise a large amount of money (£500,000+)

VCs have large funds to invest but only a small number of partners (typically 4-8) to manage their portfolio. Therefore they generally don't want to invest less than £500,000 initially as too many small investments would lead to a portfolio that contains too many companies for the partners to manage.

3. You are comfortable with losing some control

Taking on VC investment is accompanied by various conditions. In addition to a seat on your board of directors, a VC is likely to want various protective provisions or veto rights, on matters such as whether you can sell the company, grant stock options or increase your own salary.

In the right circumstances, VC investment can be a significant help in growing your company. Google, Apple, Facebook and many other great technology companies wouldn't be where they are today without their VCs. The main benefits VCs will offer your company (other than money) include:

1. Connections

Your VC will be able to introduce you to potential customers, potential employees, potential partners, other investors and the press.

2. Experience

Many VCs are former entrepreneurs themselves so they can share their experiences of being on your side of the table. They are also likely to have experience of investing in other similar companies to your own and can help you work through common problems companies face as they grow.

3. Credibility

Only a small percentage of startups ever get VC funding so just by doing this you will stand out from the crowd. This can help you with signing new customers, hiring, attracting press attention and raising further investment if you require it.

What do I need to achieve in order to raise VC funding?

Assuming that you're targeting a large enough addressable market, you're comfortable with the loss of control described above, and you haven't already started a successful company in the past (in which case raising investment gets easier), a VC will generally talk about wanting to see enough "traction" before they will invest.

Different VCs will have different interpretations of this, but as a general rule of thumb, you'll need:

  • At least a beta version of your product out in the marketplace

  • A meaningful number of users/customers that you can prove are getting significant value from your product
  • Some revenue (If you are starting an Internet company and have a very large number of free users, this may not be necessary)

  • A scalable distribution strategy (i.e. a way of reaching your large, addressable market) The rules for approaching and pitching to VCs are similar to those which apply when dealing with Angel Investors (see issue 24). You'll need a great deck and/or a strong introduction in order to secure a first meeting and - even more importantly with VCs - you should get a great lawyer to help guide you through the process when the time comes to discussing terms.

If and when you are ready to raise VC money, here are 10 of the top firms in the UK you may wish to consider approaching (in alphabetical order):

  • Accel Partners - www.accel.com

  • Atomico Ventures - www.atomicoventures.com

  • Balderton Capital - www.balderton.com
  • Dawn Capital - www.dawncapital.co.uk

  • Eden Ventures - www.edenventures.co.uk
  • Index Ventures - www.indexventures.com

  • Octopus Ventures - www.octopusventures.com
  • Pond Ventures - www.pondventures.com

  • ProFounders Capital - www.profounderscapital.com
  • Scottish Equity Partners - www.sep.co.uk

    The best firm(s) for your startup will depend on your industry and how much capital you require. Different firms specialize in different industries and will have different "sweet spots" of how much they like to invest.

A few last tips:

  • Think carefully about your choice of partner to approach at the VC firm. They are likely to be harder to divorce than a spouse.
  • Read every article about fundraising on VentureHacks.com - I consider this to be the most useful resource available on the topic.

  • Check out reviews of VCs you pitch on TheFunded.com.
  • Speak independently to one or two of the VC's existing portfolio companies as early as possible in the process to get advice on pitching the VC.

  • Finally, if you want someone to review your pitch and potentially introduce you to investors, get in touch with me on Twitter (@langer) or email me on david@davidlanger.co.uk.

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