Hey there! You’ve got a stellar product that’s turning heads and a business plan that seems bulletproof. Now, all you need is that crucial funding to catapult your product into the market. You start pitching to angel investors and VCs but, surprisingly, no one is biting. What’s going on?
Here’s a little insider knowledge: it’s all about venture math.
Imagine this scenario: your business plan projects $20M in revenue in 7 years, with a current funding ask of $2M at a $10M valuation. You’re expecting $5M a year in profits—sounds like a dream, right? Well, not so fast. While regular accounting might give this a thumbs up, venture math tells a different story.
Why Regular Success Metrics Don’t Always Impress VCs
Venture capitalists aren’t just looking for a good, profitable business; they’re on the hunt for the unicorn that could be the standout investment in their portfolio, potentially returning 100x their initial stake.
Here’s a quick breakdown of venture math fundamentals:
- Investment Liquidity: Startup investments aren’t liquid like stocks or real estate; they’re locked in until the startup is either acquired or goes public.
- Fund Lifespan: Most venture funds operate on a 10-year cycle. This means any startup they invest in needs to be ready for exit within 5–7 years.
- High Failure Rate: About 90% of seed-stage investments don’t pan out. So, for VCs, the few that succeed need to succeed spectacularly to make up for the losses.
- The Need for High Returns: With safer bets like index funds available, VCs are looking for significantly higher returns to justify the higher risk.
- Competition Among Funds: To attract investment, venture funds need to outperform their peers, not just the market.
Understanding the High Stakes
To make a venture-worthy 20% annual return over 7 years, a $10M investment needs to exit at about $36M. However, if we consider that only 1 out of 10 startups succeed, this successful one must exit at around $360M to cover the failures.
Moreover, each funding round typically dilutes the initial investment. If a startup goes through multiple rounds, the required exit value could skyrocket to 80 times the initial valuation!
The Realities of Startup Exits
High-value exits usually require significant revenue thresholds. For example, acquisitions might not even be considered unless a startup is pulling in upwards of $50M. For a $10M valued company aiming for a modest $20M revenue in 7 years, reaching a venture-worthy exit can seem like a Herculean task.
So, What Can You Do?
If your business model shows $5M in profits annually but doesn’t fit the exponential growth model VCs crave, you might need to rethink your funding strategy. Venture capital might not be the way to go if your growth trajectory doesn’t meet these high-risk, high-reward standards.
For those determined to pursue venture funding, it’s about reshaping your narrative. Show how your startup can not only reach but exceed $100M in revenue in less than 5 years and become a prime acquisition target. It’s all about painting a picture where your startup is the next big thing that industry giants simply must have.
In conclusion, understanding venture math isn’t just about crunching numbers—it’s about aligning your startup’s growth story with the high stakes and high expectations of venture capitalists. If you can master that, you’ll be in a much stronger position to capture that elusive venture capital you’re after.