Raising money from the big VCs — a winning formula

A founder of a young startup recently asked me if there is a formula to raising Series-A money from big-name VC firms — the top 15-20 venture capital firms in Silicon Valley, the ones who typically have billions of dollars under management, and who regularly show up in Forbes Midas list and the like.

When I raised Series-A capital for AppDynamics as a 20-something-year-old engineer turned first-time startup founder, I pitched to about 20 VC firms and got many rejections before I started to get success with some of them. Eventually, during AppDynamics journey, I was able to raise money from many of the top Silicon Valley VC firms — Greylock, Lightspeed, Kleiner Perkins, Battery, IVP and such.

Here is the formula I learned during that process — if you can thoroughly and convincingly answer these three fundamental questions, you will likely get funding from these top VC firms for your startup. I was surprised to learn that everything always came down to answering just these three questions.

#1: Can this be a billion dollar company?

To understand why this is important, you have to start with understanding the business model of big venture capital firms: high risk and high reward (go big or go home!). They invest in 10 companies with the hope that one or two will become those billion dollar unicorns. They understand that many things will go wrong on the journey of a company, so they need to be convinced that if everything does go right, can this be a billion dollar company or not?

BTW, if you’re not in Silicon Valley or you’re dealing with different kind of VC firms, it may not need to be a billion dollar idea. They may have a different meaning of “big.” You need to know what it is, and adjust accordingly.

Now next step is to understand how companies in your space are typically valued at scale — multiples of revenues, multiples of earnings, etc., and make a logical case of how your company will reach that billion dollar value accordingly. For most b2b software startups, that typically means your business has the potential to reach to $150-200M of annual revenue in the next 6-8 years, still growing at high pace. To make your case, think all approaches: bottom-up market sizing, top-down market sizing, budgets spent with incumbents, data from industry analysts on future trends, competitive landscape, market timing — whatever you can. Most prominent VC firms are not going to invest in your idea until they believe that it could be a billion-dollar business.

However, if you cannot make a convincing case yet for why this can be a billion-dollar company, don’t get discouraged. Not every good business idea has to be a billion-dollar idea; it is just that it does not fit the business model of these big VC firms. So you better spend your energy finding alternate sources of capital for the initial round.

#2: Is there strong external validation for your idea?

You have convinced VCs that you have a potential billion dollar idea. The second thing they want is the validation of your idea, the problem you are solving and the solution you are planning to offer. Success or failure will depend upon multiple, credible points of validation. Do not go to big VCs with your billion dollar idea until you can show external validation for it.

Now, validation can come in many forms. The best validation, of course, is paying customers or users of your product. If you have those, validation becomes easiest. However, in many cases, like what I was doing at AppDynamics which is a complex b2b product, you need investment before you can build the product to have paying customers. In that case, you should try to show validation through potential customer reactions and feedback that you have gathered through initial conversations. Validation could also be from industry experts and thought leaders, but the more you can get from potential customers, the better it will be.

If you hear from VCs “you are not ready yet,” this is probably the main reason. After many early rejections, I realized I was missing external customer validations. Once I started adding those to my story, things became much easier.

# 3: Why you? Do you have a unique advantage to be the winning execution on this idea?

Now that you have convinced VCs that you have a billion-dollar idea and have provided compelling external validation, the next question you have to answer is, “Why you?” If you have a good idea with good validation, chances are other smart entrepreneurs are realizing the same thing and starting competing startups. Sooner or later you will be competing with them. So why should a VC invest in you instead of someone else to execute on this idea? Good VCs know that execution is much harder than coming up with the initial idea, so they need to feel confident your team is capable of winning on execution.

This unique advantage can come in many forms – but mostly it will come down to either a unique strength in your domain experience, or in the technical expertise, or in the business temperament/track-record you have. If you have gaps, you better add a co-founder to fill those gaps. A simplistic example: imagine you have the world’s greatest idea for a new fashion app, but no one on your team has credibility in the world of fashion. You are not getting funded!

Another key aspect of “Why you?” is how committed you are. VCs will judge you on that in every interaction. The startup journey is hard and full of challenges. Are you going to pack up and go home when you run into major hurdles or are you going to fight through them? Are you prepared for crazy hours and work/life balance compromises for the success of your startup?

I remember a VC asked me “If you believe in this so much, why haven’t you quit your job to work on it?” I did not have a good answer then, but that prompted me to quit my job the next morning and start working on AppDynamics idea full-time.

I hope sharing the lessons I’ve learned along the way help you in your entrepreneurial journey. Don’t be disheartened if you get rejections initially. Perhaps that means you need to go back to the key questions and keep working on them until you are ready. Or maybe it means your startup simply doesn’t fit into their model and it’s time to investigate other funding models that are better suited to help you realize your dream. Best of luck!

This post first appeared on LinkedIn and has been reproduced with permission. 

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