Published in · 5 min read · Oct 13, 2016
Stewart Alsop has spent 40 years studying entrepreneurs: first as a journalist and eventual Executive Editor of Inc. Magazine writing about startups and getting to know entrepreneurs, then as a serial investor — and he still can’t pin down an exact pattern for what makes a founder or team “successful.”
What he can do is tell you how he thinks as a venture capitalist (and how to annoy Elon Musk and Steve Jobs), because the most important thing to know is what venture capitalists (and crucially, the specific venture capitalists you are pursuing) actually do before you pitch them.
Unicorns vs. Dragons
Take the word unicorn, for example: you might want to be one, but you need to understand what unicorn means in a venture capital context. It’s a company worth more than $1 billion –
“…which is great if you invest when it’s worth $10 million, and good if you invested when it was worth $500 million, but being $1 billion is a kind of meaningless reference point, just a big number from your point of view,” said Stewart. “Our job is to make money. When we invest in your company, we’re looking at how we’re going to get it back, how fast we’re going to get it back, how much multiples we’re going to get it back in.”
So the real measure of success for a venture capitalist? A dragon. A company that will pay off the fund.
“We have a $140 million dollar fund. We invest in 20 companies, expect 10 to fail and 1 to make it big. Our ownership in one company will pay back at least 140 million dollars. Every single time we invest, we’re trying to pick her out.”
Thus, a VC like Stewart is looking for not only factors that will make a company successful, but also the factor in a company that will allow it to explode — which you can’t predict, and what he refers to at times as “magic fairy dust.”
While Stewart’s VC firm is the type that looks to hit the ball out of the park, it is important to realize that this is not the case for all investors or VC firms.
Angel Investors invest his or her own money into companies, and will often do so for no real rational reason.
Stewart, for example, invests in restaurants partly because it is fun.
“Some angel investors will pretend they’re doing it for other reasons. You have to be really careful with individuals investing money, because they frequently don’t understand why they’re doing it, and if they don’t understand, it it’s going to be very hard for you to have them as a shareholder.”
“That is the critical thing once you take money from somebody — they’re going to own a share in your company and they’re going to have an ownership attitude.”
Venture capitalists, however, are paid to invest.
It is their job, and so if you wish to raise from VC’s, then you need to know how their job works. Stewart gave a brief rundown.
Each fund raised lasts for ten years, and a VC has commitments to a certain amount of money.
“You have to figure out how to make your initial investment commitments while still having enough dollars in the fund to be able to support your companies all the way through the process,” said Stewart.
This is a stressful process, one with little certainty and which involves constant guessing.
“It’s fairly attenuated. The next time you raise a fund, you don’t know how the first one went, so you go through two funds — it’s three years plus three years, that’s six years down the road — and you really don’t know how the first one’s going to go until you’re in your third fund.”
If the fund runs out of money and doesn’t have enough cash to support one of its investments when it needs money, that company can get wiped out. And if there’s no money, then the venture capitalists can’t raise more funds, and can’t be venture capitalists anymore.
Even this can be a different story depending on the firm. For a firm like Sequoia Partners, with an incredibly consistent track record of extraordinary success, raising funds is less of a worry and concern.
It is thus important to understand how VC’s work relative to your own interests. With a large firm like Sequoia, for example, you must distinguish between the different partners in the firm.
“Some of them actually know how to do this, some of them are along for the ride. The guys along for the ride are more dangerous than less successful VC’s, because they think they know what they’re doing.”
Outside of VC’s and angels, there are also strategic investors and private equity firms, who all operate differently with their own expectations.
A PE firm, for example typically expects to make money with little risk.
“Their issue is whether they can make 2 or 3x on an investment, but they’re making 2 or 3x on every investment so it’s a different attitude, much more about getting involved in operations of a company and strategy.”
Similarly, strategic investors are usually not worried as much about the money they intend to make off a company as they are about enabling their business and having a successful business relationship, however:
“They also change their minds. That’s the problem with strategic investors, they are interested in what you’re doing, but maybe two years later, they’re not interested in what you’re doing anymore.”
Thus, for your own self-interest as an entrepreneur, it’s crucial to do your homework in sorting out all your options, so that you can find an investor who best fits your needs.
Originally published at www.sheworx.co. SheWorx is a Global Collective of Ambitious Female Entrepreneurs Redefining Leadership
