Sent on August 11th, 20212
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The VC business model isn’t something that most founders know well enough. I believe that is one of the reasons that many founders have bad experiences from interactions with VCs.
I recently watched the video interview with Finnish VC investor Jyri Engeström, whose YesVC venture firm has invested in companies like Dapper Labs, Oura, Boom Supersonic, and many others.
Here’s the video:
After watching this video, I decided to write up my thoughts on items that don’t often get covered. VCs don’t explain everything that well. In this piece, I’ll explain a few things that make the most sense to explore and understand.
1. Feedback from VCs is invaluable
Many people see VCs as “banks”; they believe VCs are people who either give you cash or they don’t. And it’s not transparent why some companies get a Yes, and others get a No.
I’ve extensively covered why VCs say Yes or No in previous posts. But here, I want to emphasize what you can get from a VC, for free, without much effort. It’s something that, in many cases, can be even more valuable than cash. It’s the information that VCs hold.
VCs spend countless hours every week going through companies pitching to them. They are developing a sixth sense of analyzing companies by looking at the companies raising and being hands-on helpers in the companies they’ve invested in. They are seeing what works in those companies and what doesn’t work.
In March 2020, I had Callum Brighting, co-founder and CEO of Netspeak Games, on my podcast. Callum had the most creative approach to learning how to fundraise.
I asked him how he has approached fundraising and how he learned that craft.
I was fortunate enough to know someone who was married to a VC who doesn’t make games investments. They do medical tech, FinTech, and a bunch of other industries. We went for lunch and sat down. And I asked him: if I were going to do [a fundraise], what were the questions you’d ask me? It just snowballed from there.
That guy introduced me to some of his limited partners, the people that invest in the funds, so I could understand their sensibilities. Like, why and how would I pick a fund to invest in? Can I use that information to leverage it by understanding that part of the process? Does that give me some leverage trying to get money out of the fund? Almost certainly, yes is the answer, by the way. It was a case of leveraging my network and talking to people. That was the idea.— Callum Brighting
Founders who’ve talked to many VCs and finally landed a term sheet should celebrate. But, they should also realize why other VCs passed. The knowledge behind a “no” will help them evaluate what needs to change in the next 12 months by asking in detail why the other VCs didn’t believe in them and that they could achieve what they promised.
2. Fund needs to be returned
VCs are very different from angel investors. 5x return on a single investment isn’t great. 150x is great. Here’s why.
VCs raise funds from LPs (limited partners). A $100 million fund has to first return the money that the LPs have invested before they can start seeing profits. For example, the fund invests $1m for 20% in a company. Later, the company does an exit for $50m, happy days! Not specifically happy for the VC.
Wait. Isn’t 20% of 50 million, meaning 10 million, for a 1 million investment a lot?
No, is the answer. Out of the $100 million that needs to be returned to the LPs, they are only getting to return $10 million, so 90% of the fund still needs to be returned to the limited partners before they can start to see profits.
The fund math and model are why the ambition for founders going on the venture-backed path needs to align with the VC model. Before raising $1M from a $100M venture fund, look in the mirror and ask: Do I see myself building a $1B+ business? Because that’s what you’re signing up for.
3. It needs to be worth their time
Startups fail. VCs aren’t oracles who can predict with certainty if the companies they invest in will become highly successful companies that will return their investment by 100X, returning the fund.
VCs want to provide help to the companies they’ve invested in. There are a few reasons why that matters to VCs.
They genuinely want to help in creating success. VCs are often very experienced from seeing so many companies succeed and fail that they can provide valuable advice in all the stages of a venture-backed company.
Being an attractive VC. VCs want to show that they will give out more than just the money they invest. They want to be known as the VC firm that does a lot of work for the companies to make them succeed.
But here’s the problem: If a VC has invested in fifteen, twenty, or thirty companies, they start to be in a position where they might be spread too thin. Two partners can handle ten to fifteen companies each, but going beyond fifteen per partner will show how much time they can spend with the companies.
One of the key reasons why people have been attracted to my angel syndicate has been that they get the upside of investing but keeping their time spent at a minimum. Most members work in gaming companies, are founders, and are busy. But, they get to participate in funding some of the best companies out there. You put $5k into a fellow founder’s gaming company, and if it becomes the next big gaming exit, you could get a 100X ($500K!) return.
4. Losing the investor’s money
My first startup failed. I remember the dread of telling my investors that I had lost their money and would have to close down the company. None of them were upset because I had lost their money.
This VC I had as an investor in my first company was investing from a $30m fund. They had invested $250K, so it wasn’t that much, less than 1% of their fund. The general rule is that most of the companies in a VC fund will fail, and if all goes well, they’ll have a few ones who return 100X their original investment.
It’s the same with angel investing. A recent study indicated that “about 10% of exits account for 90% of angel profits.”
It’s precisely the ones that are growing and raising bigger rounds; those are the ones that VCs are worried about. As companies go through new stages of growth, they raise bigger and bigger rounds. In these new rounds, the VC will reinvest, doubling down on the companies that look like they could become big. But they are not winners yet, so worry persists. They will spend more time on the big ones to grow them and ensure that they don’t lose millions, often tens of millions invested.
I’ve previously written a lot about VC. I’ve also done webinars on the topic in the past. Here are a few of the most important ones to check out.
- Getting meetings with investors
- 20 Reasons Why Investors Say NO
- 9 lessons on understanding gaming investors
- Inside the gaming VCs brain (webinar recording)
- How to Create a Game Studio Pitch Deck (webinar recording)
- Success in fundraising
- The perfect teaser deck
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