Startup Scripts 4: Is my idea VC backable?
Startup Scripts 4: Is my idea VC backable?
How to identify if your idea is VC-backable.
TL;DR:
What makes a startup VC-backable, providing a clear checklist for founders.
Explains Venture Capital basics and the crucial role of Limited Partners (LPs) in the high-risk, high-reward VC landscape.
Highlights key factors for attracting VC investment( Market Potential, Rapid Growth, Efficient capital usage)
Howdy folks! Today I want to talk about a question I noticed popping up quite a bit in the last few weeks. The question is:
When is an idea VC backable?
I think most of us have an idea of what a VC-backable idea looks like, but I feel there is still a bit of confusion around it. So I want to give you a quick checklist to figure out if your Idea is VC-backable.
A good starting point is to look at what Venture capital is and what motivations and shareholders they have.
At its core, Venture Capital represents a subset of private equity, a specialized financing form where investors, support startups and small businesses with the potential for huge exponential growth. Contrary to common belief, VCs seek beyond innovative ideas; they target companies with the capability to scale rapidly and deliver returns that can potentially exceed a hundredfold of their initial investment.
Who is really in charge?
VCs are only middlemen that invest funds on behalf of their fund investors, also called Limited Partners (LPs). These LPs range from pension funds and university endowments to rich individuals and other investment entities. Their primary goal is usually to achieve an ROI of approximately three times their initial contribution over the VC fund's lifespan, usually spanning 7 to 10 years. Given the high-risk nature of venture capital, where successes are celebrated but failures are more common, this ambitious ROI compensates for the investment risks, distinguishing VC from traditional investment avenues with their modest annual returns.
Criteria for VC Backability
To understand what makes a startup attractive to venture capitalists, consider a VC fund that allocates €100 million from LPs, aiming for a €300 million return by investing €1 million in 100 startups. With a success rate where only a handful thrive, those successful ventures must reach a valuation of at least €1 billion each for the VC to achieve its target ROI.
That is the valuation startups need to achieve or be able to achieve to be considered VC-backable. Now let us look at what factors make such a valuation possible in the first place. You can use the following points as a checklist to see if your idea is VC-backable.
Market Potential:
Startups must aim for a sizable Total Addressable Market (TAM), Serviceable Available Market (SAM), and Serviceable Obtainable Market (SOM). Let us take Uber as an example. The global taxi and limousine market was estimated to be over $100 billion. For a company like Uber, the SAM might have been initially estimated at around $20 billion in urban areas with a high dependency on taxi services. Uber's SOM, the portion of the SAM it aimed to capture within the first few years, could have been projected at $1-2 billion, accounting for market entry challenges and competition. Choosing a big enough market to compete in makes it possible in the first place to reach the necessary valuations to be VC-backable.
Company Growth:
A good example of the kind of growth your idea needs to be able to achieve is Slack. Slack’s growth was fueled by its effective subscription model, expanding from a startup to a valuation of over $20 billion at acquisition. In its early years, Slack reported a daily active user growth of 3-5% weekly, translating to an annual growth rate of well over 100%. Their revenue followed a similar exponential growth path, reaching $400 million in annual recurring revenue (ARR) within 5 years of launch, showcasing rapid scale. So consider the growth potential for your idea. Is it able to double revenue/users every year early on?
Capital Efficiency:
This point is in some cases not as important, but you should still be able to use potential funding efficiently. For example, Zoom only raised $150 million before its IPO. Zoom was not only profitable before its IPO but also demonstrated significant revenue growth, with its revenue increasing 88% year-over-year to $622.7 million in the fiscal year 2020, just before going public. (This is not always the case, but something a startup should strive for.)
Venture Capital investment is not merely a gamble on innovative ideas but a "strategic" bet on startups that demonstrate a potent combination of market potential, rapid growth, capital efficiency, and also visionary leadership to make everything work. Founders seeking VC backing, need to align their ideas with these criteria, showcasing not only the potential for huge returns but also the resilience and strategic foresight to navigate the journey of growth and scaling. In essence, being VC backable is not only about having a groundbreaking idea—it's about embodying the potential to redefine markets, drive exceptional growth, and deliver unparalleled returns to investors.
There you go folks that's it for today. Until next time, folks 🤙