In January, I participated in the Chicago Booth Private Equity and Venture Capital Lab, where I had the opportunity to work with the great team at Second Century Ventures, a consumer and SMB tech focused VC based in Chicago, for 6 months. Having spent a considerable amount of time talking to entrepreneurs, sourcing deals, conducting due diligence, and developing investment theses, I thought I would share my learnings with all those interested in Venture Capital as a career path.
Below are my thoughts on what working in Venture Capital is about, what is expected from the investing team, and what it takes to succeed in the industry.
ABS — Always Be Selling
One of the most important aspects of Venture Capital is deal sourcing. VCs have one goal — and that is to get in on the best deals. While partners at VC firms rely mostly on their networks to get deals, there is always an opportunity to expand a firm’s network and reach. A less conventional approach is applying the Rothenberg Ventures strategy, throwing crazy lavish parties and becoming best friends with entrepreneurs (more on this here). The more typical approach is to attend startup events; however, this is less effective given the large number of investors you are competing with at these events. If you plan on doing that, I recommend researching the companies that will be at the event ahead of time and creating a hit-list of the top 10 companies that you would like to talk to. The most practical approach for me was plowing through my own network and mentioning that I work at a VC around acquaintances — that almost always lead to referrals to people working on their startups. Deal sourcing is an art, and I believe that you should experiment with different approaches, until you figure out what works best for you. You need to always be in selling mode, as you never know where the next great lead will come from.
Know Your Pitch
In addition to always having the sourcing hat on, it is critical to know what is unique about your firm. The Venture Capital world is full of VCs claiming entrepreneurial/operational expertise and access to networks of potential customers and experts. Given the large number of venture capitalists that entrepreneurs talk to, they need to clearly understand what sets your VC apart from the rest. For this reason, it is critical to understand how your firm can actually help a startup (whether it is through a network of customers and experts, deep functional expertise in a certain industry, or entrepreneur-friendly terms) — Entrepreneurs expect more from their investors and strategic partners, and only those who are able to show a real value-add can get in on the good deals.
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Research Your Leads
Once a company has entered your deal pipeline, you will have an initial introductory call with them. These calls are generally informational and exploratory; however, they are still very important. It is critical to spend a good amount of time thinking about the businesses/markets/industries that these startups are in. Make sure you understand the general trends of that industry and that you have a perspective/point of view on it. When talking about your firm and its value proposition to the entrepreneur, they might decide to ask “what are your thoughts on our industry?” — and you will need to be ready for that if you want to leave a good impression and follow up on your call.
Size the Market
Everyone has seen this — a startup presentation sizing the market at Billions of dollars, with the startup targeting a small percentage of that market. What that is supposed to show is the total number of customers willing to purchase that product, what they are willing to pay, and how much total revenue that sums up to. While a product with traction in a market of 1 Mn users is attractive to investors, investors prefer a product that targets 40 or 50 Mn potential users. Hyde Park Angels does a great job explaining how the the size of the addressable market is calculated here, so I won’t dwell on that. I would just like to note that granularity is very important when coming up with market sizes, and understanding the assumptions behind these estimates is crucial — especially when presented in an Investment Committee setting.
Identify Real Traction
One major component in the decision making process for VCs is traction (revenue and/or customers). However, it is important to be able to identify the source of the traction: paying customers, referrals, acquired customers, friends and family, beta-testers, etc. Doing diligence on the overall sales cycle and the sales pipeline is probably the most important part of diligence, as it will enable you to uncover the source of the traction. While there is no “bad” traction, this diligence is imperative to assessing the company’s prospects and evaluating the overall cash need of the business over the next 16–24 months.
It is very easy for VCs to invest in a repeat entrepreneur who has had a successful $50M+ exit. True venture capitalists are those who are able to identify a first-time entrepreneur with potential. While there isn’t a scientific methodology to identify potential, there are several tactics that are indicative of entrepreneurial potential. Detailed conversations about target markets, customer acquisition, and scaling are considered to be one signal. Another signal is spending a day or two in the company’s offices, understanding how the entrepreneur is spending his/her time, and observing team dynamics. Spotting potential is not accomplished through a formal process; rather, it is the culmination of all interactions with the management team — from introduction, all the way to diligence and negotiation. VCs want to invest in entrepreneurs who know the ins-and-outs of their industry and are able to present a realistic yet ambitious plan for their business. If an entrepreneur does not exhibit passion for the business, does not realize what his company’s weaknesses are, and does not know how to address them; then maybe it is not wise to invest in them.
7. Build Your Network
There is nothing more important than a network in Venture Capital. Whether you leverage your network to source a deal or to conduct diligence on a company, your network is your number one asset. As this article states, make sure that you start networking before you need it, have a plan for how to grow and use it, and never dismiss someone as unimportant. Being someone who people remember, as well as someone who is resourceful and has access to professionals from different backgrounds is a key component to differentiating yourself in the VC world. (Networking is also critical for recruiting — but that is another beast)
Negotiate Term Sheets
While security type, liquidation preference, and valuation are the key components of any term sheet, there are many intricacies (read: legal wizardry) in term sheets that require time and experience to be fully learned — which is why involving legal counsel in the deconstruction/construction and negotiation of a term sheet is critical. Moreover, no two term sheets look alike, and even if they do — different parties perceive terms differently . While one entrepreneur might be concerned about liquidation preference, another could be concerned about the impact that a certain deal has on his cap table and early stage investors. Term sheets are negotiated heavily and hearing that terms are being discussed amongst lawyers is nothing to fret about — closing deals take time, and both parties need to be happy about the terms if the relationship is ever going to be successful.
Understand Firm/Fund Dynamics
The same way that tech companies such as Apple, Google, and Facebook are different from one another — so are Venture Capital firms. Venture Capital firms range from small funds trying to establish their brands, to large funds with billions of dollars in assets. This has significant impact on the type of work you do — a smaller fund might give you the opportunity to take on significant responsibility in making deals happen, while a larger fund might have you focus on conducting diligence and researching investment theses. Moreover, firms vary greatly based on where they stand in their fund life cycle — a firm raising a new fund will be very busy contacting LPs and analyzing previous returns, while a firm 1 or 2 years in its fund is focused on deploying the cash. All that is to say that firm dynamics vary greatly, and that each of those offers a different value proposition from an experience perspective — making sure that your short to medium term goals are aligned with the firm’s goals will increase utility for all parties.
As you consider a career in Venture Capital, be aware that VC is an industry that requires a broad range of skills. To succeed, you have to be willing to wear as many hats as possible. You have be a a marketing/product/SEO/technology expert, a highly-skilled networker, an expert problem solver, a fearless salesperson, a wonderful negotiator, and most importantly — a risk-taker.