Are You Ticking All The Right VC Funding Boxes?
Jeff Epstein, VC at Bessemer Venture Partners, explains what VC investors are looking for in a startup.
Jeff Epstein started out on Wall Street working at Credit Suisse and became the CFO of several different companies, ending with Oracle. He is currently a VC at Bessemer Venture Partners, which has $1.6 billion in capital and is one of the biggest venture capital firms in the world.
During a Speaker Series event at Founders Floor, Jeff covered some of the most important areas that all startups should focus on if they’re looking for a VC investor to sit up and pay attention.
The more proof points the better
VC investors aren’t fans of risk but as an early stage company there are a lot of unknowns so how do you move past this and still appeal to the VC you’re presenting to?
Jeff suggests having as many proof points as possible. This means that you’ll need to take the time to gather data, data on your product, customers, and distribution. The more proof points you have, the less risk there is for the investor, which means your valuation goes up.
Here are the steps you can follow to gather the right data and reduce your risk in the eyes of investors:
- Building a prototype. Show your market what your solution looks like and what the key features are so that you can get their feedback.
- Build the product. Create an actual product and put it in the hands of potential customers to see whether people are buying it or if you need to rethink your approach. This could be everything from the product offering to your marketing. This stage will provide you with a lot of valuable data.
- Proven product market fit. The data that you collect in this stage needs to demonstrate that people are using your product and that they like it.
Prove that you have a go-to market model
The metric that you will need to use here is customer acquisition cost compared to gross profit payback.
Jeff stated that if a startup can show that they can pay back all their customer acquisition costs on a gross profit basis within 2 years or less, they’ll be a lot more attractive to potential investors.
Know your customer renewal rate
Many businesses live on repeat purchases while others don’t. This could be a service that people are renewing every year or a product that people are buying time and time again.
If you will be relying on repeat business, VC investors ideally want to see that you have a net renewal rate that’s over 100%.
As you grow, you need to pay attention to whether you’re also becoming more profitable.
If you start out with a business that’s generating $1 million in profit and you grow to $2 million and then $8 million in revenue, is your profit margin growing?
If you have a gross margin of more than 75%, that means that you have the potential to double or quadruple your revenue and not increase your costs. If you have a low margin business, if you double your revenue, you’ll double your costs too.
It’s important to have a gross profit margin of at least 75% or more if you want to attract potential investors.
Prove that you’re capital efficient
Here you want to look at annual gross profit versus capital spend. If your capital spend is far greater than your annual profit, it shows investors that you might not be spending very wisely.
For example, if you have a business with $5 million in gross profit and you invested $5 million in capital, that would be an index of 100. You want to be better than 100 if you want to get investors to notice your startup.
Emphasize market demand
While you might be a successful small business, you need to prove that you have the potential to be a successful big business too.
Different VC firms have different thresholds but typically, investors want to see a recurring annual revenue of $5 million or more. Jeff shared that ideally, he would invest in a business that had an annual revenue of $5 million or more with the potential to grow to $100 million and go public.
Have the best possible leadership team
Your leadership team would consist of everyone from your co-founders and head of technology to the head of finance and sales.
By the time a VC wants to invest, they want to know that your entire leadership team is in place. When your team is missing key people, you’re creating risk for the investor and this will immediately turn them off.
Prove your market size
For many investors, this can be one of the most important factors when evaluating a startup. They want to know that you’re going after a large market.
Jeff suggests that to measure your potential market size, look at what your 5th-year potential. How many customers do you expect to have and what is the revenue potential of those customers?
Investors would ideally invest in a company that could get to a $100 million in revenue in five to six years.
How diversified are you when it comes to customers, partners, and suppliers?
For example, one customer shouldn’t be giving you one-third of your business. This is not to say that having big customers is a bad thing but too few customers tend to decrease your valuation and increase your risk.
Is the timing right?
You need to ask yourself why the world needs your product now and didn’t need it last year or the year before that. If you aren’t able to answer this question, you might not really understand the problem you’re trying to solve.
For example, Uber wouldn’t have worked a few years ago because not everyone had a smartphone.
By being able to answer this question in a compelling way, you’ll have a better chance of generating the funding you need from VC investors.
Research and preparation are crucial steps when preparing to pitch to a panel of investors but if you approach everything with the goal of lowering risk for your potential investor, you automatically stand a much better chance of securing the funding you need.
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