Raising money. Part 4 - Questions to ask VC's
Photo: Édouard BISSON Question to the Cards 1889
This is a 5 post series to prepare you to raise venture capital:
- Part 1 - How VCs work
- Part 2 - Reaching out to VCs
- Part 3 - Short story about the pitch
- Part 4 (This post) - Questions to ask VCs
- Part 5 - 50 shades of VC No
When it comes to talking with VCs, most of the advice out there is from a VC perspective. This is how you talk, this is what you present, this is what you don't do. But raising capital is not a one-way street. You, as a startup, are about to get into a relationship and there are questions you should ask VCs to learn more about your to-be partner for the next 10 years.
Your goal is not only to understand VC as such but also to figure out how it would be to work with them.
We covered fund math in the first post of this series. Here we will cover how you should read these numbers and why it matters.
How old is the fund?
Fund has its lifecycle - investment period and exit period. Roughly investment period is 5 years and a 5-7 year period looking for the portfolio exit.
Let's say the fund has recently launched. It means that you have a time window of 12 years to get to an exit. If the fund is 5 years old and VC is giving out the last tickets from the fund your time window will be 5-7 years. Upside - they might want to be done with the fund (aka. you could get investment fast) and move on. The downside, you now have less time to build a business and get to an exit.
What is a ticket size?
First of all, it will give clue if this is the fund you are looking for. If you are raising 20m, don't spend time talking with funds that invest up to 1m. The same applies to small tickets. If you are raising 50k, don't spend time talking with VCs, who spend 1m+ per deal. This might sound obvious but I have experienced both cases.
Ticket size gives also an indication of the maturity of businesses VC works with. Pre-seed companies have a different set of challenges than Series-A.
If someone says that they invest from 50k up to 2m, it means that they probably are not very hands-on investors across the spectrum or they have a big team covering different stages.
The size of the fund?
Now that you know how old is the fund and what is typical ticket size, you need one more piece of information - fund size. With all three of these, you can figure out how many investments roughly they have to make per year and where they are on their journey. For example, a 40m fund with an average ticket size of 0,5m in their 3rd year would mean that they should have made around 20 investments out of 40 (remember, a big chunk of capital is reserved for follow-on investments) or 6 investments per year. There is still a room.
There are times when the market is hot and VCs have ran for deals and invested over their yearly quota. They might be pickier about next investment.
Every fund has one. It might be strict, or it might be loose. Usually, strategy is either with geography or industry focus. For example, investing in the Baltics, CEE, or investing in e-commerce, B2B SaaS startups.
"Seed", and "pre-seed" terms are used to describe the stage of companies but the terms themselves have become vague and people have a different understanding of what it means. Sometimes pre-seed might be just an idea, sometimes an MVP and a couple of users. Then again, the seed stage can be pre-revenue. If you hear these terms being thrown around, simply ask to elaborate on what it means for their team.
One more thing. A lot of times strategy will be out of the window if a partner gets very excited about a particular company (hopefully yours). Partners have this magic, secret power of being able to bend reality to fit the strategy. Amazing!
What is the decision-making process?
Even before this question, you should understand who-is-who in a fund. Usually, General partners are in charge of making investment decisions. But that doesn't mean you should just ignore everyone else. There is a reason there are Associates and Principals. And in some VC firms, they might have a say over smaller tickets.
Understanding the decision process helps you to plan your fundraising process. Usually, funds have regular deal-flow meetings where they go through deals. Some funds simply give freedom for partners to make an investment decision. There might be looser rules for smaller tickets which in turn depend on the general ticket range at the fund. For example, if a VC firm invests 50k up to 2m, decision-making might be faster with 100k tickets. But if ticket size is from 500k up to 5m, 500k might be easier.
How do they work with portfolio companies?
Of course, every investor is "value adding" but again, "it would be nice if you could elaborate on that". There are more hands-on VCs and then there are hands-off VCs. Both are Ok if you know what you want from this relationship. Sometimes you are looking for money because you might have your lead investor who also happens to add value (been in your industry before, has a valuable network, has valuable coaching sessions). Sometimes you are looking for someone who is knowledgeable in a particular field and could help you. You have to talk about it and express what kind of relationships you want to build and what you are looking for. Essentially it is expectation management - how you both would work together.
Lead and co-investing
Lead investors are the ones who prepare all the documents and do due diligence. The hard work. Co-investors join the round and add money. Usually, lead investors have a bigger say on deal terms and thus you have to pick them carefully. Co-investors besides bringing money to the table can also be valuable if they have industry experience or network. Some funds just co-invest. That is their investment strategy and they reduce risk by giving smaller tickets to companies that have been discovered by other VCs. Some funds will not co-invest at all and take the whole round. By splitting the round, VCs also split equity and it is simply not worthwhile to put time and energy into a deal where you end up with only a couple of percent of equity.
Check their portfolio companies
Strategy tells you what VC thinks. An actual portfolio shows what they are doing. Are they investing in crazy ideas or are more inclined towards safer bets? Is there a common pattern in companies? For example a lot of fintech companies. Is there a potential conflict of interest?
Prepare questions and ask about existing portfolio companies. Also, reach out to founders and ask about their work with a particular investor.
Ask questions and get to know your potential partners. It also will show investors that you have prepared and done your homework. Every business by the end of the day is people's business. Investors are investing in you as a person. Particularly at the early stage where there isn't much tangible to look at. Being prepared and asking tough questions can go a long way.