???????? Hi friends!

I’ve been busy melting in the heat, exploring some of the beautiful spots that Tuscany has to offer whilst keeping an eye on the doom and gloom cycle that a slow news cycle in venture over the summer tends to lend itself to.

In this weeks Off Balance, I’ll be chatting about whether VCs are wasting your time and money, how I suggested one founder think about the current funding environment, breaking down VC funding on a stage by stage basis as well as discussing what it is that VCs tend to look for when funding a business.

All of that will be followed by a look at what else has been happening in the world of tech and venture in this week’s Lowdown.

Also, don’t forget to check out this week’s guest on the pod – Maya Moufarek – who scaled Pharmacy2U by delivering an acquisition rate equivalent to opening a brick and mortar pharmacy every 2.5 days ???????? You can listen to the Primer episode here with the main episode out on Friday 25th August.

Remember, if you have any feedback or if there’s something you’re desperate to see me include, just reply to this mail or ping me online – I’m very open to conversations.

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Now let’s get into it.

Sitting on the Dock of the Bay, Wasting Time

The one article that has been shared more than just a little bit over the last week is this “provocative” take from the Financial Times’ Alphaville section.

It does a magnificent job of both being incredibly accurate whilst also being completely wrong.

It argues that VC requires an investment strategy that relies on moonshots and returns are driven by Power Law (Pareto Principle / 80:20 rule) – i.e. that a small number of successful businesses drive all of the returns.

And that as a result LPs allocating into VC funds are equally at risk of finding themselves being woefully outperformed by the S&P 500 (because obviously investing in stocks that just keep going up is a no brainer right?).

The point is that in over 20 years, many individual stocks have outperformed the median VC fund. The challenge is predicting which ones. Using factors like growth and momentum might enhance the chances of spotting these outperformers, but such methods aren’t easily applied in private markets.

And not only that, if you are chasing “median” in venture, you’re doing it wrong.

At the end of the day, VC is an industry that is predicated on outliers, as with any asset class money can be made, and money can be lost – but ask yourself this, how many advancements

How can did I add value?

I am a member of a number of communities whether for VCs, angels, CFOs or founders (variously – bar one – all hats I have worn) and try to be as supportive as possible.

Recently, a founder in one such community reached out after having spoken to another founder who, despite being this being their third startup, was struggling to get straight yes / no responses from the VCs they had been speaking to, something they were not used to having raised in the “good ol’ days” of the last few years.

The founders question was: “How different is raising capital today versus the previousl 12 or 24 months”.

Whilst I have said it before, I responded with the following (as you know I love me a good list):

LPs are pulling back so VCs are having to too.

Lots of well funded startups yet to come back to market with tails between their legs having ‘frittered’ away lots of cash at high valuations.

I therefore expect some VCs to be preserving cash for special situations / recaps (ie promising businesses with bad cap tables).

Time frames are now 9 months to close a round rather than 6.

Need to show both growth as well as strong unit economics to raise from good funds.

Lots of companies should NOT be raising venture (previously they could though) and so no doubt that is also playing out.

Expect next 6 – 12 months to be painful.

If pre seed experiment quickly and with capital efficiency and get metrics for seed (a 50 person waitlist is not metrics for seed).

If post seed see point 5. SaaS should be growing at 33222 year on year as rule of thumb (more on this below).

Be pragmatic. Find solutions. Don’t wait for funding. Valuations are not “coming back” in fact they have now RETURNED to where they should have been.

Simply put, in the past you could use other people’s money to run your experiments and you could find that money pretty easily. Today, for most of us to raise money, you need to be smart about where you spend your time, focus on what you can do without a tonne of capital behind you and show traction before going after any significant investment.

Off Balance

Last week we covered off a fair amount covering a range of areas within VC including

A Brief History of Venture Capital
Meeting the VC Players
Understanding the GP / LP Relationship
How VCs Make Money

So this week we’re going to tackle two topics that still trip lots of people up:

VC Funding Stage by Stage
What VCs Look For

Now obviously there are always exceptions to the rules so take the below as a guideline that you can then use to sense check your own progress and milestones – but always look for what makes sense given your vertical, your business model, your stage and your traction.

Marketplaces will have a different set of metrics to a B2B SaaS play after all.

Over the next couple of weeks, we’re going to tackle some biggies including term sheets, valuation and due diligence – so strap in, it’s going to get interesting…

VC Funding Stage by Stage

If you’re not a founder or investor and come across one, they may talk about a round they’re currently involved in.

What they are talking about is a funding round, or an investment event into a particular business.

These funding rounds (rounds from here on) are typically aligned to the growth stage of the investee company and tend to follow a general pattern.

It is worth thinking about each round as a level in a computer game and the investment as the energy the player (in this case the founder) needs to reach the next milestone and unlock the next level.

The first and most common round after launching a business is typically called the Friends and Family round (sometimes unkindly the Friends, Family and Fools round).

This is the riskiest stage of the business and it’s potentially nothing more than a deck, an idea and an excited founder (or founding team).

Obviously given the lack of anything concrete to gauge, more formal investors are unlikely to get involved at this very early stage. The only exception to this rule is where you have a repeat founder at the helm who has a proven track record.

With that in mind, the investment from the friends and family round is typically used to test out the hypotheses the founders have and see if there is a viable opportunity ahead.

At this stage it’s likely that there won’t be much built and the business is running on manual processes.

If the team proves that there is something there, then they may move to a pre-seed round.

This is still a pretty risky stage of the business. But there are at least some proof points that there may be something viable ahead.

This round is likely to be several hundred thousand dollars, and as such, is most likely to involve more traditional angels.

Whilst some VCs also invest at pre-seed, there tend to be fewer of these funds and, especially in the UK with tax incentivised investing, angels are keen to get involved so VCs leave them to it.

The cash from this round is likely going to be used to build a Minimum Viable Product (MVP) and securing early revenue.

Next up we have the Seed round. By the time a company is ready to raise its Seed, it has likely shown that it is on its way to achieving $1m in revenue.

This is normally when you’ll see the first “institutional investor” (read VC) get involved. The business is still early but has proven that one or several VCs think it’s worth making an investment, and the investment is likely to be in the low-to-mid 7 figure range.

Cash from this round is most likely going to be used to build out the product and prove out early signs of Product Market Fit (PMF). This is when it’s clear there is demand for the product from (paying) customers and that the business is able to scale.

Assuming the business is able to do that, it’s likely to get to the next round once it is at around $1 – $2m of annual revenue and has clearly got PMF.

This round is called the Series A and at this stage the startup is starting to resemble a more traditional business.

A Series A round is typically in the high 7 to low 8 figure range, and cash from this round will typically be used to scale up quickly.

Where getting to Series A was about proving Product Market Fit, getting to the next round (as one of the VCs I interviewed – Annalise Dragic – would say), is about proving Go To Market Fit.

What this means is the business should have a playbook by the time it is getting ready to raise its Series B round (as the next financing event is called) that they can roll out with new products and new territories. And they should be scaling rapidly.

Hereafter the rounds continue down the alphabet, but post Series B you could almost lump them all together as Growth Rounds. Typically large amounts of capital invested in now well established startups with a view to funding growth be that through organic, acquisition, product or M&A.

And from here on in, an exit is always potentially on the table.

Whether that’s being acquired by a corporate, or by private equity or going through an IPO and listing on a stock exchange.

But there are some nuances…

Firstly whilst previously rounds tended to follow a general pattern in amounts invested in any particular round, that largely went out the window over the last several years.

Additionally, there are a variety of smaller rounds that might take place between the rounds I’ve talked about above. These may “bridge” from one financing to the next, may be top ups to the last event or may be to fund an opportunistic acquisition to name a few reasons.

And finally, I haven’t brought things like secondaries (discussed above) or venture debt into the picture, nor have we talked (yet) about different instruments that might be used like convertible loan notes, warrants or options. These may be used during a financing round, or equally in between rounds as well.

At each fundraising event, the company should have removed some of the risk from the business. They should also be showing decent signs of growth if they’re looking for investment from most players in the VC ecosystem.

What VCs Look For

Everyone assumes that there is some sort of template that will tell you exactly what you need to have proven in order to secure your next round of financing but sadly this is just not possible in most cases.

Why?

Because every startup has a different business and business model, vision and execution ability. So whilst there can be some general guidance, here’s what I know having talked to almost 100 investors on my podcast and numerous investors and founders beyond.

Time and time again, two themes keep arising at the early stages.

How big is the market

How likely is it the team will execute

A couple of weeks ago I quoted Andy Rachleff on the interplay between markets and teams. In case you missed it, here it is again:

If you can get comfortable knowing that there is a huge opportunity, everything else is down to execution.

And by huge opportunity we’re essentially talking about a multi billion dollar market size.

After all, to command the sort of valuation that makes sense for venture investors, you have to capture revenues and value in the 100s of millions and into the billions.

If the market is small(er), you’d have to capture a higher percentage of the market to secure a venture style outcome – and unless you’re a Google which commands over 93% of search as late as May 2023 per Oberlo, monopolies are still pretty hard to create.

Next up comes the founder and team’s ability to execute in the market. Often VCs are looking for signals that the early team has some form of unfair advantage which makes it more likely for them to “win”.

This may be deep expertise in the area they’re tackling, evidence that they have scaled a business (or been part of a team that has) in the past – which is why repeat founders often find it easy to raise funding, even if their previous business has ended up washing out (Adam Neumann anyone?)

At later stages, focus moves on to traction, evidence of being able to build a product, take it to market and scale it.

For example in B2B SaaS, a number of investors look for the 33222 pattern – simply put the company should scale revenue 3x year on year for the first two and 2x thereafter. Assuming starting revenue of $2m, this would result in $144m in revenue by the end of the five years, which on a reasonable SaaS multiple of 7x on revenue would value the business at $1bn.

Obviously at the time the VC is investing they won’t know for sure if the company is going to hit those numbers, so it’s relying on indicators of the same:

‘Can they demonstrate PMF?’

‘Have they been growing at expected pace on a month on month basis?’

‘Have they built a flywheel that drives growth?’

‘Are their gross margins and unit economics healthy and sustainable?’

For example, many VCs will look for LTV:CAC ratios (the relationship between customer lifetime value and the cost to acquire them) or a minimum of 3:1.

Any lower and there is a risk that you will end up destroying value (as customers tend to get more expensive to acquire over time). Whilst higher LTV:CAC is a good thing, at earlier stages, it may suggest you aren’t spending as aggressively as you could on growth.

And that’s really the crux of it: VCs are looking for businesses that will be category winning companies that can scale quickly to a valuation that allows the VCs to exit and return the fund.

Anything your business is able to show that allows a VC to get comfortable with this premise will make them more likely to invest.

Side note – only a tiny percentage of startups are suitable for or receive venture capital funding. They are either businesses with small markets, mediocre teams, poor growth or poor unit economics.

VCs will likely look at something like 3,000 decks before meeting with 50 founders and maybe investing in 10 companies (we’ll talk about portfolio construction in a future edition). That’s 1/3 of a percent that raise from VCs.

So you can imagine how good your proposition needs to be to attract interest…

And, if you can believe it, we’ve still only just started to scratch the surface of just the basics of what you need to know if you’re involved in the VC space. There’s plenty more to come in the future, but I hope you’ve found this valuable in the meantime.

The Lowdown

Let’s check in with what’s been happening in the wider tech and venture ecosystem this week…

If you’ve been paying attention to what’s happening on social media as of late, there is probably one thing that hasn’t escaped your attention.

The hyper masculine peacocking going on between Elon Musk and Mark Zuckerberg that is meant to culminate in a cage fight that, frankly, would be less interesting than the idiocy that has come before it.

I was even more bemused to see this piece in the Times of India slamming the tech bros for this stupidity and find it hilarious that a country (or at least an author from that country), that is known for churning out 1,000 movies a year watched by 3 billion people, is completely disinterested in this spectacle of toxic masculinity.

Even the Italians are disavowing they ever offered up the Colosseum as a venue. If only these two guys could sort their stuff out and maybe make their platforms a bit better for their users, they’d probably get a lot more bang for their buck.

Next up, it turns out that all the buzz around LK-99 – the material that some South Korean scientists had claimed was not only superconductive but was able to be so at both room temperature as well as pressure.

Judging by the number of supercondutivity experts that sprang up on Twitter (X) overnight, this was clearly a big deal.

Except it’s not.

Or at least not the big deal people thought it might be.

There had been a fair amount of scepticism already and scientists have independently tried to recreate the material and its properties unsuccessfully (this is kind of necessary for something to be adopted by the scientific community).

But, it may be that the material has other, magnetic, properties which could be interesting in other applications.

One thing it’s worth saying is that this is the beauty of the scientific process – the ability to challenge findings in positive ways and, for the scientific community collectively to work towards substantiating or disproving a theory. Something that seems to be missing all too often in other areas of our debate.

Finally, I’d previously written about the conservative activist that is suing the Fearless Fund – a fund focussed on investing in women of colour – for discrimination under US civil rights legislation.

I was glad to see that this has garnered the sort of attention that it deserves, and as of writing, over 70 VC firms have signed an open letter denouncing the lawsuit.

It bears repeating that less than 2% of VC investment goes to women and people of colour, and a suit like this does more damage (in my opinion) than good.

It unwinds decades of attempts to improve peoples’ access to things as fundamental as education to less universal rights such as access to capital.

You can read the full Open Letter and show your support here.

????And that’s a wrap for this edition of Off Balance – I’d appreciate your feedback so just reply to this email if you’ve got something you’d like to say.

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That’s it from me so until next time…

Stay liquid 🙂

Aarish