One of the more perplexing aspects of venture building is figuring out how to finance your technology and company. A common mistake is assuming that Venture Capitalists (VCs) have money to invest in your venture when you need them. The reality is that VCs at most times have no money available to invest in any new venture. Intrigued? Then read on.
While many entrepreneurs strive to connect with VCs, it is really somewhat of a waste of time in most cases. That is, unless you understand the inner workings of the ‘VC world’, selectively choose the right VC and have good timing.
All private equity funds, including venture capital funds, are run in a similar pattern. They raise money for their fund, invest in companies, wait a while, and then exit those companies for the purpose of trying to make a bundle of money. Each fund has a portfolio of typically 10 to 15 companies with an investment time horizon of about 10 years. Success is measured on the entire portfolio’s performance.
The fund raising period and the initial few years of investment are quite frenzied. This is when the pipeline is built, term sheets signed, due diligence conducted and expectations are high. Then comes the hard work and the wait. Earliest exits are during years 3 to 5, and these are often winners. Years 5 to 8 are when the majority of invested companies are exited and then the laggards after years 8 through 10 (or longer). Of course some sectors have much longer horizons – like pharmaceuticals; while some investor approaches have exits based on milestones much earlier in the technology commercialization or business development stage.
To use a baseball analogy, the goal for the VC fund portfolio is to hit at least one home run, with the expectation that there will be a handful of singles and doubles. Walks will happen, but most feared are the fouls, or bad bets, that bring down the entire portfolio’s return. The goal for each invested company is 35% or higher ROI – depending on the fund.
So we can see that it is primarily in those first two to three years when a fund has money to invest. During that earlier period, initial investments are made, but also funds are committed or reserved for follow on investment rounds for the same portfolio companies. Thus, as a general rule, from year four onward (or 60-70% of the time), VCs have almost no money left to invest from a particular fund.
The lesson for entrepreneurs is first to be aware of the private equity investment lifecycle. Second, entrepreneurs should try to identify where a particular VC is in their lifecycle. This is not a simple task. One must read the news, ask around in networking circles and perhaps pose the question to the VC. Given the nature of the investment lifecycle the best times for entrepreneurs to connect with VC are when a VC is raising its next fund or else in the first few years of the new fund. Of course always be cordial as VCs are always building their pipelines. Also, remember that the VC community is a small one and you never know when one VC might introduce you to another who is in the sweet spot of their investment lifecycle.
What is your perspective? Please share your thoughts in the comment section below.
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About the Author
Sylvester (Syl) Di Diego, Managing Partner, Strategy Dynamix, LLC is a venture advisor and delivers venture accelerator solutions. He has assisted hundreds of entrepreneurs and investors to successfully navigate the venture growth lifecycle and helped to raise $300 million of capital. Learn more about Syl and connect with him at http://www.strategydynamix.com/aboutus/executives.php.