How do VCs value a company?

Sure to fail? Why 99% of all start-ups do not get an investment

Who doesn't know the success stories about start-ups that have secured millions in funding? But that's only the tip of the iceberg, as VC analyst David Stuck reveals: of the up to 1,000 start-ups that apply for a VC investment each year, just 1% are financed. In this guest post you can find out what happens to the remaining 99%, how a founder should deal with rejections and what tips David has for negotiating with VC investors.

A clear word in advance: This is not about the dazzling topics of the colorful start-up world, but about investment rejections and financing rounds that could only be closed at the second or third attempt. Which start-up is willing to admit that? And which VC investor boasts of an investment in a start-up whose development was insufficient for funding at the first attempt or which has already been rejected (several times) by other VCs? And that's no wonder, because the probability of a VC investment is less than 1%.

(Tens) thousands of start-ups fight each year for an investment in the more than 100 German venture capital companies. An (early stage) investor usually makes between 10 to 20 investments per year and rarely sees fewer than 1,000 pitch decks.

In the screening process, 99% of the possible deals are sorted out by the investor. As a founder in fundraising, you always fight against this 99%!

Before applying: check your profile

The investment process is similar for most VC firms. In the first step, the ideas are filtered out that do not fit the profile of the VC society. Investors often have fixed parameters that have to be met, such as certain industries, financing phases (ticket sizes) or regions. Others invest exclusively in B2B or B2C business models, SaaS (Software as a Service), marketplaces, etc. Such a rejection is not a statement about the quality of the start-up (it was not even checked at this point). Therefore, you should continue to confidently “apply” to a (suitable) investor - although the word apply is no longer appropriate, as VC companies also compete for good start-ups these days. As a result, start-ups that have already been canceled end up as a new deal with a second, third or fourth investor, without their quality being necessarily bad.

Tip: It is better to inform yourself in advance about the fixed criteria of an investor and simply avoid this type of rejection. The relevant information can usually be found on the website of the respective investor. Because even if this type of rejection is not substantiated, you should not strain your motivation too much.

If the investor has specific questions about the pitch (deck) or invites you to a telephone appointment, the start-up is one round further. At least now it's about content: business model, strategy, technology, market, traction, team and financing round.

Thanks to years of expertise, an extensive network and a broad market overview, the VC company's investment team can quickly deal with the “crucial points” of a start-up and come to an initial assessment. If this is predominantly positive, the next round begins: a personal meeting between start-up and investor.

Much more often - namely in 85% of the cases - it comes to a rejection at this point!

However, there are various reasons for this.

Clear rejection: no means no

In 90% of the canceled start-ups, one or more points did not fit: investment case too detailed, market too small, business model not suitable, doubts about the team, product not convincing.

Tip: No means no - this also applies to the start-up-VC relationship.

Avoid unnecessary instruction of the VC, because he has thought through his decision for a long time and in detail. The start-up scene in Germany is relatively small and VCs are well networked, so the following applies:

First Impressions Count, but Last Impressions Count More.

If you repeatedly get the same feedback and the same reasons for rejection from several investors, you should (at some point) draw your conclusions. As good entrepreneurs, don't waste time and energy with discussions about criticisms of VCs, but validate your business model!

A second chance for start-ups on the “watchlist”

Much less often - with only 10% of the rejections - the start-up's performance is perceived as "okay". However, the investor decides that the case should not be prioritized for the time being. These start-ups are placed on a “watch list”. With the VC you still have the chance of an investment and receive "homework" that must be done before a more detailed examination of the investor. These differ depending on the business model, also in terms of scope.

Here are a few examples:

  • Market must be reconsidered (e.g. too small) - Vertical / use case changed - Adjust market entry strategy - Create competition analysis
  • Revise / map sales pipeline - bundle leads cost-effectively
  • Identify marketing channels and test them with budgets
  • Obtain qualified letters of intent (LOIs)
  • Finishing the product - showing prototypes - onboarding beta customers
  • Identify and build relevant key performance indicators (KPIs) - validate / adjust pricing
  • Set up metrics: revise CAC, CLV, gross margin financial planning - optimize conversion rate
  • Strengthen the team: find co-founders - add employees - introduce employee participation
  • Bring tech competence into the team
  • Structure / tidy up the cap table - justify the assessment
  • And quite often: build more traction and show a proof-of-concept

In an exchange with the VC, start-ups should be clearly signaled whether it is a clear rejection or parking on the “watch list”. Even if rejections are not fun: VCs always have their reasons and analyze a lot before rejecting a case. Incidentally, professional investors do not cancel the inquiring start-ups only upon request, but rather send their rejections proactively and on an equal footing.

Back to the “watchlist”: a VC investment in a start-up requires mutual trust. The procedure with the “watchlist” serves to build this trust.

The goal of the founder is now to turn the investor into a super fan of his own start-up. The homework should therefore be accompanied by regular personally addressed updates and status reports in order to allow the investor to participate in the company's development and be remembered.

VCs observe the development and estimate the right timing for an investment. As long as founders have not received a clear rejection, they have the chance to convince and take a step towards investment.

The next step is an invitation to a personal meeting. The rule here is: "The stage is yours", because now the partners of the VC company are also getting on board and everyone is intensively concerned with the investment case. Now, if not before, a targeted search for "dramatic" errors, so-called red flags and deal breakers is also being sought. After the first assessment of the “hard facts”, the meeting also deals for the first time with the personality of entrepreneurs - one of the most common reasons for rejection, even if (of course) nobody speaks about it openly and this reason is only communicated indirectly.

If an individual VC doubts that his investment alone will be sufficient until an important milestone is reached or the start-up is profitable and a necessary co-investor for the investment case cannot currently be found easily, this is also often the case a rejection. Start-ups should then collect start-up money through business angels or get several VCs together at one table.

If all open points have been discussed and both parties continue to have a good feeling, term sheet negotiations and due diligence follow. In these phases, too, the VC has to trust the start-up.

Only when the investor is convinced that you are able to build a rapidly growing and sustainably profitable company that performs better than 99% of all other teams will they invest in you!

Quite apart from the fact that the investor naturally strives for an exit and would like to see his investment in your start-up doubled or, better, twenty-fold. The further the investment process advances, the more specific feedback a start-up can expect. Valuable knowledge for the further development of the company!

Don't forget: Only when the ink has dried on the notarial certification of the capital increase will you be one of the 1% of start-ups that have secured VC capital.

Tech-Hero-Slam: Here you can try yourselves

Our digital start-up platform Unternehmerheld is looking for tech heroes. From all applications that are still possible until September 30, 2017, three start-ups will pitch against each other in the final of the 6th “Founding, Promoting, Growing” in front of an audience. You can win prize money of 3,500 euros as well as an interview in our GründerDaily as well as an attractive package of material prizes. You can apply here.

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