By Louis Lehot, business lawyer and partner at Foley & Lardner LLP in Silicon Valley, and formerly the founder of L2 Counsel, P.C.
As you embark on your first fundraise or a full venture capital round, it’s important to know who are the key players in venture capital, what types of deals they fund and what are the VC firms that fund what kind of deal. This post attempts to set the stage for any entrepreneur or management team on who is who and what is what.
When you talk to someone who says they represent a VC fund, it’s important to know who you are talking to. There are two types of people: investing partners, and everyone else. It used to be that you could identify a person who had the juice to decide whether to fund a deal or not by the title on their business card. Nowadays, VC firms hand out the “partner” title widely in their organizations, even to junior deal professionals who used to be referred to as “principals,” “directors” or “associates.” Other times, particularly in large, multi-stage VC funds, partners can designate senior professionals with non-investment functions, like recruiting, legal, corporate development, accounting or finance. Why do they do this? VC firms don’t want you to know that the person you are dealing with does not have the authority to fund a deal or not. Generally, a “general partner” designates someone who can lead a VC firm’s investment in a deal. “Venture partners” and “operating partners” typically refer to part time executives who can help a GP manage the portfolio or are experts in their field. “Entrepreneurs-in-residence” or “EIRs” typically refer to former CEO’s or entrepreneurs who look at deals and hope to be dropped into a new business venture that the VC firm funds, or to source a deal that the VC will fund. “Principals,” “directors” and “analysts” refer to execution professionals who conduct due diligence, manage dealflow, and generally execute on transactions and manage the portfolio. Other than the “general partner,” none of these other professionals have the power to sponsor an investment for approval by a VC fund’s investment committee, which is typically the group of GPs that vote on whether to fund a deal or not. If in doubt, study the VC’s website, and you will likely get a flavor for who you are talking to and what is their level of authority.
How do venture investors structure their investments?
Most venture capital funds define themselves by the types of investments they do, the sectors that they seek to disrupt, and the stage of investment they like to come in.
In the post-pandemic world, VC firms generally do not fund companies before they have a minimum viable product, demonstrated product-market fit or a full founder team. This is the world of friends, family, business angels and micro-seed funds. For early stage companies, the typical tools of financing are SAFEs (simple agreements for future equity), convertible notes and series seed (any series of preferred stock that does not have a letter in front of it).
Once a company has launched a product in market, achieved revenue, demonstrated some level of product-market fit, and can demonstrate benchmarks of achievement, it can approach early stage VC funds, which generally will lead or follow another lead VC firm in what is generally referred to as a Series A round. Historically, a Series A round would be for $5M of capital or more, would be for 20-30% of a company’s post-money valuation, and come with one seat on a company’s board of directors.
A Series B round would then ensue after benchmarks from the Series A financing was achieved, and would be a round of hyper-scaling capital that would enable growth or hyper growth, and so on. Letters of the alphabet ensue for follow-on rounds to enable more and more growth, product add-ons, acquisitions and international expansion.
Exits typically happen when the rule of 40 has been achieved: $40M of revenue at 40% gross margins with 40% year-on-year growth.
What are the different types of venture capital funds?
Depending on the size of a VC fund, it will have stated investment objectives in terms of industry verticals, stage of growth and check size. Following is a brief survey of the types of VC funds we see in 2020:
- Micro VC funds typically invest very early, in seed rounds, typically after business angels and before early stage VC funds. An MVP is required. Some level of product-market fit Is helpful but not required. Typical check size is $500K to $1M. They typically have a very focused industry vertical strategy. Their total fund size may be anywhere between $2.5-$25M.
- Early stage funds will typically invest in late seed stage or Series A in check sizes of $1M-$5M. They typically have a focused industry vertical strategy, but at a higher level of abstraction than micro VC funds. Early stage funds are typically sized between $50-$150M in capital.
- Mid stage or growth equity investors typically invest in Series B rounds or later, write checks of $15-$35M or more, and are funding expansion or acquisition.
- Late stage funds typically invest in very advanced companies as the last mile before exit or IPO.
- “Full stack” VC funds might invest in all stages, but since the financial crisis of 2009, we have seen more and more venture capital flowing into fewer and fewer funds that must invest larger amounts in later stage companies to achieve the returns required to raise the next fund.
Venture capital firms compete to attract funds from institutional investors and family offices that are looking to deploy a portion of their assets to high risk/high return opportunities. Most VC’s will typically look for the opportunity to achieve a 10X return or more, and will achieve outcomes that more often than not end in failure. If you fail to present your business as a 10X opportunity from the outset, with a market size of $1B or more, it’s hard to attract any venture capital.
When embarking on a fundraise of any kind, particularly in the era of virtual everything, it’s important to know what you are looking for, who can provide it, and who you are talking to:
- Target a VC firm that invests in your industry vertical, in your stage of growth and in your geography
- Target an individual within a VC firm that leads the deals in your space and stage
- Structure a round of capital that is appropriate for your stage of growth
- Cultivate relationships with VC’s for the long-term and always be thinking about the next step and the step that is ten steps away
- Engage with advisors who understand what you need, from who and when, and what you can reasonably expect
Even in the pandemic and the nascent recovery, venture capitalists are responsible for generating opportunities to return 10X the capital committed from their limited partners or investors.