Choosing from the Dark Side — Part II

Last week I covered how a startup should choose its VC. On a related note, I want to cover how startups should know which VC is likely to choose them in turn. VCs call it “fund-fit” and it is very important to understand. I see too many founders in Asia pitching to an entirely wrong set of investors than what they should be targeting. It is very simple to create a good first filter based on a few key criteria, which I’ll discuss below.

Starting off with the fund portfolio. You should definitely look at a VC’s current portfolio before shortlisting/going into the meeting. Not only do you get to see strategic value that the investor can provide, but you also get a hint of what kind of deals does the fund usually like. Are there any early stage SaaS companies targeting global markets in the fund, similar to yours? Is the fund heavily investing in the same sector as yours? If the answer is yes, you are highly likely to pique the initial interest from the investor. You are however also likely to face some tougher questions, so be prepared.

Another thing to consider is your potential investors’ strengths. If there are specific portfolio companies that you find strategic value with, you should enquire about the investment professional in the team that spends the maximum amount with the company. Pitching to this person is probably your best shot at making it into the portfolio yourself. There is a high risk that if you pitch to the wrong team member within a fund you’ll not convey your pitch properly and might end up missing a realistic fundraising opportunity. This especially applies to the partners within the fund, and you should read up their backgrounds to see alignment with your own vision. In the end, a fund’s partner or investment committee (usually composed of the partners) is the one making the final decision on your case and hence you should be sure that your company will align with most of them.

Coming last to what I feel is the most important point, the fund size. To start off, as a founder, you should have a very realistic idea about what scale your company can achieve. Let’s say things go as you want them to go and you’re able to find product market fit, scale the company, and continue growing for the next 5–7 years. Would you then be a $50M company or a $100M company or a $1B company? There is no shame in building a $50M company, or even a $10M company. 99.99% of the people you’ll ever meet won’t be able to claim the same. But what your value is likely going to be has a profound impact on which fund should you be targeting. To explain this we need to go into a primer on fund economics.

Karthik Reddy from Blume Ventures gave a very nice interview to The Ken where he talked about fund economics and I suggest reading the whole thing if you’re interested in the Indian startup ecosystem. Essentially, a typical VC fund in Asia creates a portfolio of around 30 companies and is usually aiming for a 3x return. The VC will normally split this into 3 parts, 1x return from a massive winner (IPO/mega-M&A), 1x return from 3–5 decent winners (smaller M&A), 1x return from recovery exits (usually acquihires). While making each investment decision the VC is judging whether or not she can put you in the first bucket. At the very least you need to be in the second bucket. Assuming that the fund holds 20% of equity in your company, sees 5 decent winners, and you are one of them, your company needs to exit at at-least 1x of the fund size for it to be worth the fund’s effort. And from this simple mathematics comes the golden rule:

Make sure you’re pitching to funds that are not bigger in size than your own long-term expected value

If you feel you’re building a company that is going to be worth $50M five years from now, do not go about trying to pitch to $200M funds. This golden rule has seen an interesting impact play out on the startup ecosystem in India and I’ll try to cover this in a future post.

While there are many more things to consider when choosing your long-term partner, hopefully these two posts will give you a good idea of how to start on this journey. As always, reach out to me in case you have feedback/comments/questions.

Note: I am very thankful for all your well wishes and encouraging words, it really keeps me going!