There are lots of myths out there about VCs, about how they will take over your company and replace you as CEO or that getting a VC investment paves the way on your path to riches. But Jason Lemkin of SaaStr, the world’s largest community of SaaS executives, founders, and entrepreneurs, has an excellent article on some facts you should know about VCs – forget about those myths!
- Entrepreneurs tend to think about VC firms, but in reality VC firms don’t do investments, individual partners at VC firms are the ones making the investments. Just like medical device makers don’t sell to hospitals, they sell to the individual financial decision makers in departments in hospitals that need those devices. And the hard truth is that partners at VC firms do very few investments per year, typical just one or two. So as a collective firm they may do a significant number but the individual partner who’s a potential fit for your firm only one or two. So you need to have a really compelling fit for that VC and you better know from your research which partner in the firm might invest in your firm. That knowledge should be based on their track record, blog posts, social media presence, and G2 you can gather from their portfolio companies.
- As the Bob Dylan song goes, “Everybody gotta serve somebody” and in the VCs case it is their limited partners, those pension funds, college endowments, and wealthy individuals who invest in venture capital as part of their diversified investment portfolio. So check out the limited partners, for example, when we were talking to Greylock about funding Course Technology it turned out they had six or seven limited parters which were college and university endowments – so they were excited to invest in our educational software and publishing company.
- Partners are diversified, you aren’t. Unless you are Elon Musk or Jack Dorsey, chances are very high that the only company you are fully invested in is your own. Not so for partners in VC firms. In essence they are portfolio managers; your firm is just one amongst several in their portfolio. So they will tell you that their interests are fully aligned with your’s but in fact they are not. Resources – money, connections, and their attention – will go to only those firms in the portfolio that they perceive as the winners.
- VCs don’t just make money on exits, they make money on management fees. And to make a lot of money on management fees – typically 2% of funds invested per year – they need to raise multiple funds. And they raise those funds by getting step ups on the valuations of the companies in their portfolios. Yes these are paper gains but they can show their LPs strong IRR on their current investments. So VCs always have one eye on the next fund and how they will raise it.
- Small VCs Align With You, But Lowball You. Big VCs Don’t Align As Well, But Can Pay More. Big VCs can write big checks and they also can hold funds in reserve, so they can participate in multiple rounds without getting diluted. But small funds will probably have to syndicate their rounds – share the investment and any returns – with other firms. Big VCs can write very big checks, but then they need to have a big return to impact the fund. And partners can only serve effectively on just so many boards – typically no more than seven to nine – so if you only need a small amount of funding they can’t afford the opportunity cost of taking the time and attention to invest in you, let alone serving on your Board.
Entrepreneurs have learned about product/market fit, but investor/venture fit is equally important. The amount you need to raise, the market you are targeting, how you play with the partner’s portfolio, and your need to raise multiple rounds to get to breakeven are all factors you need to take into account before you even start contacting VCs. As Sun TZu wrote in his work The Art of War, “Every battle is won before it’s ever fought.”