‘Decoding’ Starting Up with Vani Kola: Chapter 3 – Is Your Business VC Fundable?

“We are unsure about the potential size of the market”; “This is too early for us, show some traction”; “We think that the business you’re building is not highly scalable” – As an entrepreneur looking to raise external funding from VCs, you might have heard these and other such responses, that is, if you weren’t ghosted and received no response at all.

These responses are polite disinterest from the VCs.

Often entrepreneurs get baffled. Why does it seem like other entrepreneurs and businesses raise VC funding easily, but not them? They get disheartened that their pitch is not being comprehended by VCs for the value and opportunity that is ahead.

The other often discussed question that we get is that why do unprofitable companies get funding?

Take the example of Amazon. Amazon remained unprofitable for much of its early years. It reported its first full-year profit in 2003, nearly nine years after its founding in 1994 and that is when they scaled from 0 to $5B in revenue in 2003! Amazon's initial focus was on growth and market share, rather than short-term profitability. This strategy involved reinvesting revenues into expanding its infrastructure, developing new services, and acquiring customers. Even after turning profitable, Amazon's profits were modest for many years because it continued to prioritize investment in areas like cloud computing (AWS), logistics, and new ventures.

Even if for majority the lifetime, a company has been unprofitable but scaling rapidly in terms of revenue and customer base with a clear path to profitability eventually, VCs would be interested to back the company.

In the third edition of ‘Decoding Starting Up’, we talk about how pattern matching inspire decision making for VC’s.

Given the nature of the VC business, in a fund’s portfolio - only a few companies are likely to create significant returns. These are the ones we call as ‘multi-baggers’ or ‘fund returners’. This is the reason why VCs operate differently and are open to moonshot ideas – that can scale massively, even if they are investing at a pre-revenue stage. A single company invested at the right time that may return the entire fund for the VC – becomes a homerun. These are the Airbnb’s’, Ubers’ or Amazons’ of the world – that simply redefine how the society functions.

Venture Capital funds look for specific indicators when deciding what and when to invest in. While the parameters can vary from VCs to VCs and across sectors and businesses, what remains common are a few threads.

Now, for the second part. Once you’ve determined that your business is venture fundable, it’s important to understand the different stages of funding that align with your company’s growth phase. Finding the right fund and a Partner is one of the most important decision that an entrepreneur will make for their business.

It is highly important to understand the right attributes of a VC fund before reaching out and engaging with them for a potential investment.

1. Seed:

This is often the very first external funding your startup will receive, beyond your own personal investment or money from friends and family. Seed funding helps you develop your product or service and get initial market validation.

2. Series A:

Now that there is some traction and proof that your product works, external capital is raised to fuel further growth. Series A funding is where the investors step in to help you scale and refine your business model.

3. Series B and C:

Investors that are willing to take the market expansion risk, not early PMF risk. Once you have PMF and validation of sales model, they tend to help you reach early market validation and not PMF.

4. Growth:

Investors that give you capital to accelerate the company’s growth and enable geographical expansion. Late-stage funds, including private equity firms, look for established companies that have consistent revenue and a clear path to profitability and exit.

If you’re building something scalable, disruptive, and ready for rapid growth, then VCs could be your best partners for the ride. The right partners at the right stage can help you take your business to the next level.

For the last part of this blog, I want to touch upon the topic of exits and how entrepreneurs should build on an exit strategy for their investors since the very first round of external funding that they raise.

VCs invest their LPs money and have a duty to make returns for them in the given period of time. They want to know how and when they’ll make a return on the investment. Does your business have potential to be acquired by a larger company, or could it eventually go public, so the capital invested in the business by VCs can also exponentially grow?

Entrepreneurs should think about investor exits strategically, ensuring alignment between their vision and the expectations of their investors. For every external round of capital an entrepreneur raises, proving that you can create value for the investors help build credibility for the entrepreneur that helps them go a long way and establish trust with their board members and investors.

Throughout my journey as an investor, I have told this to many founders – “venture funding isn’t right for every business”. With external funding, comes more responsibilities – which may not be right for the type of business you were planning on building.