Top things an entrepreneur should know before seeking out venture capital. If your company is ready to move to the next level and consider reaching out to venture capitalists, this article is just for you.
Here are the top things start-up entrepreneurs should know before seeking out venture capital.
“In the 21st century, venture capital investments (in the millions of dollars) are almost exclusively reserved for fuel to grow a start-up’s initial traction. If your start-up doesn’t have a product/market fit, it is unlikely you will raise millions of dollars from a VC. But that’s a good thing. Too much money too soon often results in bloated start-ups’ that die from premature scaling,” Venture capitalist Sean Wise said in an INC column.
When seeking outside investment, you should only ask for enough capital to get you to the next inflexion point (think: prototype, first sale, the first thousand dollars in revenue.) Investors want to map the stage you’re at by looking at the next inflexion point ahead. Then they want to give you the smallest amount of money necessary to get you there. Investors know that additional funds would only lead to comfort, overspending and distractions, he added.
The first round of funding should always be the friends and family round, according to most experts. Since this is usually before the company is fully fledged, it is important to know how much you and your friends can invest.
This early money is usually for setting up the company and work on practical ways to bring your product or service to the market.
“The first $50,000 comes from founders, friends, and family. Until you put up your resources, don’t expect others to. This early money is for setting up the venture and for starting to work on customer discovery,” Venture capitalists said.
The early funding also gives you time to know more about your company and understand your business better, apart from giving you a skeletal picture of which of your ideas may not be easy to implement. According to Sean Wise, the first round can be around $50,000.
The second round of funding is usually where you look outside and are ready to bring investors like venture capitalists, angel investors or accelerators.
“The next $250,000 is the first money you will take from people you may not know. This money will be used to bring on full-time employees and to create the first minimum viable product–the prototype that’s pretty enough that customers will pay for it. Early customer adoption and initial revenue are the milestones investors will look for as a sign you are ready for more money,” According to Sean Wise.
Round three of funding should be customer acquisitions and market fit, experts said.
“The next $500,000 is all about finding product/market fit and is also funded by angel investors, accelerators and seed VCs. At this point, you should be looking for low-cost channels to acquire customers while simultaneously looking to increase the lifetime value that each customer generates. Until you have found this, you are not ready to scale. Recently, the benchmark of three has been established–meaning you should not scale until the lifetime value generated by a new user far exceeds the cost of adding a new customer,” According to venture capitalist Sean Wise.
The fourth round is usually where the company scales up and seeks our money because it knows investors are flocking. It is also when you have proven that you can acquire customers for a small amount while generating large amounts of revenue in the future.
Companies should only approach venture capitalists for a fourth round if they are very confident about customer acquisition and revenue growth.
Venture capitalists are now changing the way they look at companies. Gone are the days when people funded companies based on past products or a personality’s popularity. Now VCs look for companies that have proved themselves and are ready to scale up to the next level.
Knowing the exact position of your start-up and a realistic prediction for the future is essential. The last milestone that you hit and the next one that can increase your company’s value is the main thing a VC will want to know.
Also important is to know what type of investor the company is looking for. Are you in the friends and family around, looking for seed venture capitalists or registering with a business accelerator?
Don’t approach VCs until your company is absolutely ready to scale up to the next stage since you might just be closing some doors that may have remained open later.