“When an investor will convey, they don’t give a real reason,” said Tom Blomfield, group partner at Y Combinator. “ANDHonestly, no one knows what the fuck is going to happen. The future is so uncertain. They only evaluate the perceived quality of the founder. When they take an exam, the thought that comes to their mind is that this person is not impressive enough. Not dangerous. Not smart enough. Not hardworking enough. Whatever it is, “I’m not convinced this person is a winner.” And they will never tell you this because you would get upset. And then you will never want to give them up again.”
Blomfield should know – he was the founding father of Monzo Bank, one of the brightest stars in the British startup sky. He has been a partner at Y Combinator for about three years. He joined me on stage at TechCrunch Early Stage in Boston on Thursday for a session titled “How to Raise Money and Get Out Alive.” There were no spoken words or sharp blows: just real conversation, and every now and then a nuclear bomb was dropped.
Understanding the power law of investor returns
At the heart of the enterprise capital model is the Law of the Power of Returns, a concept that every founder must understand to successfully navigate the fundraising landscape. In summary: a small variety of highly successful investments will generate most of the VC firm’s profits, offsetting the losses from many investments that fail.
For VCs, this implies a relentless focus on identifying and backing those rare startups that may deliver 100- to 1,000-fold returns. As a founder, your challenge is to persuade investors that your startup has the potential to be one of the outliers, even if the probability of achieving such massive success appears to be just one%.
Demonstrating this enormous potential requires a compelling vision, a deep understanding of the market and a clear path to rapid growth. Founders must envision a future in which their startup captures a significant share of a large and growing market with a business model that may scale efficiently and profitably.
“Every VC looks at your company and doesn’t say, ‘Oh, this founder asked me to invest $5 million. Will it grow to $10 million or $20 million? For VCs, this amounts to failure,” Blomfield said. “Batting singles for them is literally the same as zeros. It doesn’t move the needle in any way. The only thing that moves the needle on VC returns is home runs, it’s a 100x return, a 1,000x return.”
VCs look for founders who can back up their claims with data, tradition and a deep understanding of their industry. This means having a clear understanding of key metrics corresponding to customer acquisition costs, lifetime value, and growth rates, and determining how these metrics will evolve as you scale.
The importance of the addressable market
One proxy for energy law is the size of the addressable market: It is very vital to have a good understanding of your total addressable market (TAM) and to give you the chance to present it to investors in a compelling way. Your TAM represents the total revenue opportunity available to your startup if you capture 100% of your goal market. This is a theoretical ceiling for potential growth and a key metric that VCs use to evaluate the potential scale of your business.
When presenting your TAM to investors, be realistic and back up your estimates with data and research. VCs are highly expert at assessing market potential and will quickly see through any try and overstate or exaggerate the size of the market. Instead, focus on making a clear and compelling case for why your market is attractive, how you plan to capture a significant share of it, and what unique advantages your startup brings.
Leverage is the name of the game
Raising enterprise capital is not just about pitching your startup to investors and hoping for the best. It is a strategic process that involves creating leverage and competition among investors to make sure the very best conditions for your company.
“YC is very, very good at [generating] influence. Basically, we put together a group of the best companies in the world, put them through a program, and at the end we have a demo day where the best investors in the world basically do an auction process to try to invest in the companies,” Blomfield summarized. “And whether you run an accelerator or not, trying to create this kind of high-pressure, high-leverage situation where multiple investors are making offers for your company is really the only way to get great investment results. YC just produces it for you. It’s very, very useful.”
Even if you don’t participate in an accelerator program, there are still ways to create competition and leverage among investors. One strategy is to conduct a strict fundraising process, set a clear timeline for making a decision, and communicate this to investors up front. This creates a sense of urgency and scarcity because investors know they have a limited bidding window.
Another tactic is to be strategic about the sequence of meetings with investors. Start with investors who are more likely to be more skeptical or have a longer decision-making process, and then move on to those that are more more likely to make decisions quickly. This helps build momentum and create a sense of inevitability around the fundraiser.
Angels invest with their hearts
Blomfield also discussed that angel investors often have different motivations and criteria for investing than skilled investors: themselves they typically invest at a higher rate of interest than VCs, especially for early-stage deals. This is because angels typically invest their very own money and are more more likely to be swayed by a compelling founder or vision, even if the company is still in its early stages.
Another key advantage of working with angel investors is that they will often introduce you to other investors and help you gain momentum in your fundraising efforts. Many successful fundraising rounds start with a few key angel investors joining in, which helps attract interest from larger VCs.
Blomfield shared an example of a round that was slow; over 180 meetings and 4.5 months of exertions.
“This is the reality of most rounds happening today: You read about a hit round on TechCrunch. You know, “I raised $100 million in Sequoia rounds.” But honestly, TechCrunch doesn’t write much about the fact that “I worked my butt off for 4 1/2 months and finally closed the round after meeting with 190 investors,” Blomfield said. “That’s actually how most rounds end. A lot depends on business angels.”
Investor feedback may be misleading
One of the most difficult points of the fundraising process for founders is hearing the feedback they receive from investors. While it is natural to search out and fastidiously consider any advice or criticism from potential sponsors, it is vital to appreciate that investor opinions can often be misleading or counterproductive.
Blomfield explains that investors often abandon deals for reasons they do not open up to the founder. They may cite concerns about the market, the product or the team, but these are often only superficial justifications for a more fundamental lack of conviction or alignment with their investment thesis.
“The takeaway from this is that the investor gives you a lot of feedback on your seed-stage offering, and some founders say, ‘Oh my God, they said my go-to-market wasn’t developed enough. You higher go and do it. But that leads people astray because the reasons are mostly nonsense,” Blomfield says. “You could end up changing the entire company’s strategy based on random feedback from an investor, when what they really think is, ‘I don’t think the founders are adequate,’ which is a hard truth they may never know. tell you.
Investors are not at all times right. Just because an investor turned down your deal doesn’t necessarily mean your startup has flaws or lacks potential. Many of the most successful firms in history were omitted by countless investors until they found the right fit.
Be especially careful with investors
The investors you bring on board is not going to only provide the capital you must grow, but they may also be key partners and advisors as you navigate the challenges of scaling your business. Choosing the flawed investors can result in misaligned incentives, conflict, and even the collapse of your business. Many of them may be avoided by doing this thorough due diligence of potential investors before signing any transaction. This means going beyond just the size of the fund or name in the portfolio and actually examining their repute, track record and approach to working with founders.
“Eighty-something percent of investors give you money. Money is the same. And you go back to running your business. And you have to figure it out. “I think, unfortunately, about 15-20 percent of investors are disruptive,” Blomfield said. “They give you money and then they struggle to assist and it just fucks up. They are very demanding or they push you to take the company in a crazy direction or they push you to spend the money they simply gave to rent you faster.
One of Blomfield’s key pieces of recommendation is to consult with the founders of firms that have not performed well in an investor’s portfolio. While it’s natural for investors to praise their successful investments, you can often learn more by examining how they behave when things don’t go in response to plan.
“Successful founders will say nice things. But average people, singles, strikes, failures go and talk to these people. And don’t expect an introduction from the investor. Go and do your own research. Find these founders and ask how these investors behaved when times got tough,” Blomfield advised.