Throughout the following post, we will be outlining the key points you should consider when preparing your startup for VC funding.
The post is broken up into the following sections:
For the purpose of this guide, we will be focusing on UK/European definitions and making reference to the UK Startup Funding Landscape.
VC stands for Venture Capital, and is a subsection of the more commonly known Private Equity (PE) corner of finance.
VC is generally the practice of purchasing minority shareholdings (~1-25%) in early-stage businesses, with high growth potential. Companies can qualify for VC funding all the way from the idea stage through to pre-IPO depending on the firm's individual strategy.
The money invested is typically raised from 3rd party investors called 'limited partners' (LP's) who entrust the 'General Partners' (GP's) to allocate the capital responsibly.
Given the risky and illiquid nature of early-stage investments, VC's typically seek to build a diversified portfolio of companies, any one of which could potentially 'return the fund' (return the total amount invested across all companies). With this in mind, you will need to demonstrate extraordinarily large ambitions in order to convince VC's to invest.
VC's are typically remunerated via the 2 & 20 model, 2% a year management fee of the fund, and 20% of the 'carried interest' or profits they generate. This helps incentivise the GP's to make good investments, and not just live off the management fees (which in some cases can be very large).
The term [carried interest] originated from the practice of ship owners and ship captains getting a 20 percent commission on the things they carried. If you were going to operate a ship and drive it from, say, the New World back to Europe with some valuable cargo, you and the captain of the ship would keep an interest of 20 percent for whatever you carried. So it’s called the carried interest.
Throughout the course of this post we will outline the key elements you need to consider prior to opening conversations with VC firms and investors.
Before going into any meetings, you will want to have prepared various pieces of documentation, as if the delay is too long to respond VC's may take their attention elsewhere. Generally you should look to have prepared the following:
Your financial model is a key part of your documentation pack and general fundraise. This is your chance to show investors exactly how you will build a valuable business, and what key assumptions you have made in these projections.
Generally, you should build your financial model from scratch and it should be unique to your own business. Everyone knows its a projection and tiny alterations can lead to huge variance in projected revenues or growth.
The key factors investors are looking to understand when reviewing your financial model are:
If you want to use a template, then it may be worth checking out Christoph Janz's blog post titled "SaaS Financial Plan 2.0" where he breaks down the key elements a SaaS financial model should contain.
Before going out to speak to investors, it is generally recommended that you have an investor pitch deck to share. The purpose of this document isn't to secure investment directly, but more to pique the interest of VC firms and secure the face to face (or Zoom) meeting.
It is high-level story telling document that is going to cover the following core components:
Be sure to have a look at our Investor Pitch Deck template.
Once you are happy with the story the pitch deck tells, be sure to practice on some friends, colleagues and other friendly people. Feedback is key. When you're happy with it send it out to VC Firms, Angels and any advisors to circulate.
(the other 2 can be made into their own informative blog posts potentially) Make sure to give a 2-3 line description on each.
A business plan is needed at the very beginning of an entrepreneurs journey, especially in the UK where it's required for Advanced Assurance. A good business plan will lay out exactly what you are building, how you fill a gap in the market/solve for a problem and how much capital you will need to do so.
Investors, both Angel and VC, or lenders want a written business plan before they give you money. A simple description of what the business does is not enough to attract interest from investors. Instead, ensure you have a thorough business and financial plan that demonstrates the likelihood of success and how much you will need for your business to be successful in the long-term.
These are the main headings we suggest including in your business plan:
In this section, conducting a market analysis of what is currently going on and why there is an issue in the market, whether it is a lack of efficient process or a gap in the market you are trying to address, understanding and articulating the problem you are trying to solve is one of the most important things to convey to an investor.
More often than not, entrepreneurs can get too caught up in the solution they are building to service a problem without really digging deep into the problem they're solving. By showing data to back the fact that the solution you are building is needed to service customers and or businesses is how to tackle this first point.
Outline clearly what your solution does and how it addresses the market you are selling to. If there is a lot of technology involved then an outline of how the technology works. Sometimes, keeping a description simple is better than diving into a complicated articulation of the solution/business. But an in-depth description of the solution is expected in the business plan.
A business model is a framework for how a company will create value. It ultimately provides insight into the fundamental questions about the problem you are going to solve, how you will solve it, and the growth opportunity within a given market. Typically, a financial model will accompany a business model in showing the assumptions you believe to be the case given your growth and amount of users/customers.
There are various different business models. Each one varies considerably based on the type of company and products you are offering. For example, a consumer goods company will have a different model to a mobile games studio. Even within a specific industry, business models vary. Here are a few common business models used by technology companies:
Business models over time will develop as the company grows.
Intellectual Property and Structure
Whilst IP is something that will be explained and run throughout your business plan, it warrants its own section as investors will want to see an in depth explanation of the IP built and want to know how you intend to capture future IP and your overall strategy for managing IP. Investors will expect a company to have the correct processes in place to manage IP amongst employees, contractors and clients.
Competitors and Market Size
This section of the business plan is key to show investors how your company differentiates and how big the opportunity you are tackling can be. Understanding what the total addressable market for the company is important as it will give investors the reassurance that you not only understand the market you are operating in but can also identify who the ideal customers are to your business. Expect this to potentially be challenged by investors so make sure this is researched well. An in depth competition analysis will show investors you understand who operates where in the market and highlights the differentiation in your company.
**Risk to Capital [SWOT Analysis]**
This section is particularly prevalent for applying for (S)EIS advanced assurance as it requires you to highlight in a SWOT analysis format all the risks to investing in the business. The best way to approach this is to be honest about what potential risks exists, this will also help you identify to investors how to approach these risks and assist in mapping out what the main challenges the business currently faces.
The Team Profile
This is one of the most important sections to investors. Investors need to understand that the team they are backing has the relevant experience and capabilities to execute on the vision. It is key to highlight any notable experience or accolades that may help you stand out compared to others. In technology businesses, typical the make up of a founding team has one to three people with a CEO, CTO and COO type individuals as founding members, different individuals may wear different hats as the company evolves over time, or may find themselves wearing all three hats at the begging.
History and Progress
Whilst your business might just be starting out with no particular history or progress, it is always useful to explain the journey the company has been on in order to better convey where it is going and how you as a founder have tested your assumptions that it will be able to get to where it needs to go.
If you find there is not much history to show for your business currently, highlighting the history of the industry you have operated in and where you solution sits in the future of this industry is a good place to start. This will help investors visualise where the company sits in terms of trends of the industry.
If there is historic data to present, then be sure to present it open and honestly as investors will conduct diligence and reference checks throughout the investment process. But at the same time, be sure to sell yourself and the company as best as possible.
A roadmap should detail where you expect the business to be in the next 12 months to 3 years. It can be a higher level overview of how you anticipate a timeline of events will happen in which the executive team can execute on. Being to particular on this is difficult and investors understand, particularly at the early stage, that the business will go through iterations in its offering to customers in order to get to where it needs to be.
A financial model is key in your business plan to give insight to the assumptions you have based given the money you wish to spend. Detailing important company expenditure such as hiring costs, cost of goods, sales and marketing costs and any other relevant costs specific to your business is key for investors to understand and challenge your thinking in terms of how you expect to get to the next stage of your business.
Be sure to include historic data in your financial models, as well as a statement of cash flows with scenario planning for worst, moderate and best case scenarios. At the pre-seed stage, financial models can be tricky, particularly if there is not much data to go off in terms of predicting future revenues. Building the framework for a good model and the correct steps such as being fully aware of expenses and revenues will help when ready to going out to fundraise.
In this section of the business plan, this is where you should outline the amount of money you are seeking to raise, what the funds will be used for and how much runway this amount will last you until. An indication of what milestone you are looking to hit after your round, e.g. $1m ARR is also helpful for investors to understand.
For most startups and early-stage investors, Product-Market Fit is the holy grail. Many will claim to have it or be near, but in reality, it can't even really be expressed by a metric or qualitative measurement. In essence, you will be able to know when you have PMF once you no longer have to proactively push your product on the market, and instead, the market actively pulls your product to it.
The number one problem I’ve seen for startups, is they don’t actually have product/market fit, when they think they do. Alex Schultz, Facebook CMO.
What is product/market fit?
This quote from Marc Andreessen, who also famously coined the phrase, sums it up quite nicely:
You can always feel when product/market fit isn’t happening. The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of “blah”, the sales cycle takes too long, and lots of deals never close.
And you can always feel product/market fit when it’s happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can. Reporters are calling because they’ve heard about your hot new thing and they want to talk to you about it.
Sounds pretty great doesn't it? But like most things, it's extraordinarily difficult to achieve in practice and most people would put the process down to serendipity and chance over strategic planning & execution.
The first step in evaluating product/market fit (PMF) can be a difficult proposition for start-ups, especially at the early stages. At the idea stage, the dichotomy of whether to build vs discover is a tough one - if you build without validation, you run the risk and opportunity cost of building something few people want, whereas if you take too long in your discovery of what to build, you may fall behind other competitors in the space.
Various schools of thought will say different things on what product-market-fit looks like... on that basis assessing whether or not you have found it is tricky. In this article, we take a look at how to assess whether or not you have product/market fit and lean on various founders experiences as to what the best practices are to go about achieving product/market fit.
Where to begin finding Product-Market Fit?
The competitive landscape is one of the most important aspects to consider when starting a company or thinking of approaching an investor. Demonstrating that you fully understand your market is a strong signal to investors, and there is no better way to articulate this than giving an in depth overview of the market and where you sit within it.
At the end of the day and as we discussed in the Product-Market Fit section, the winner of any given market is not the first to market, but the first to Product-Market Fit. You need to suitably demonstrate why your offering is sufficiently differentiated and why it is the best option for consumers/customers/users.
There are three main types of market:
Startup Grind put together a great overview here:
Winner Takes All
A market in which the top one or two companies capture the majority of revenues or market share. Generally thought of as a Big fish in a small pond, plenty of food (revenue) if they don't have much competition.
The causal factors that lead to this market structure mean that the dominant player(s) have very deep moats — making competition incredibly challenging. They are very deeply rooted within the market and almost impossible to displace. If you are to overcome them, you most likely will have to become much larger in an adjacent space and siphon their market share. It will be near impossible to beat them from within the same category (think Netflix displacing Blockbuster, they weren't a beter 'video store' they were a completely new category/format).
Omar Ismail, Supernode Global:
Most WTA markets are dominated by behemoths (eg YouTube in UGC video, Google in Web search, and Amazon in horizontal e-commerce). However, there are examples of smaller and more niche WTA markets (eg Cameo with celebrity messaging). Global network effects are the key contributor to these niche WTA markets (discussed below).
WTA markets require a Total Addressable Market (TAM) size >$200m to achieve venture scale (assuming the top 2 players capture >80% market share) which is generally smaller than most other markets VC's would look at.
Winner Takes Most
A WTM market is one in which the top 10 players capture the lions share (>80%) of the market's revenues. This is lots of large fish in a very large pond.
Companies are able to win market share mainly through product differentiation or strategic positioning, competing on features and experience over just price.
For startups looking to raise venture capital, this is the best market structure to address. To achieve venture scale, startups should seek a Total Addressable Market (TAM) >$10bn.
Examples of WTM markets include mobility (ie Uber, Lyft, Didi Chuxing, Gett, Addison Lee, Grab, Bolt), travel search engines (ie Booking.com, TripAdvisor, Expedia, Skyscanner) and online fashion (ie ASOS, Boohoo, Zalando, Farfetch, Depop).
A market structure that is defined as fragmented is one in which no single player captures >20% of revenues. Instead, there is a long-tail of companies, all competing for the same customers.
Most businesses operating in fragmented markets will not grow to venture scale as they generally can only grow to a size that is too small to justify the risks associated with venture investment. Lots of medium-sized fish in a small pond.
That's not to say it's impossible to achieve venture scale, however, it is much more challenging to do so. To de-risk investments, investors should look for a TAM >$100bn.
These markets are best suited to founders looking to build lifestyle businesses or private equity firms looking to adopt a ‘roll-up’ strategy.
Examples include CRM tools, HR tools and D2C brands.
This is arguably the most important component of your pitch. Markets evolve, consumers are fickle and businesses models change (see Slack's early pivot) but one thing almost always stays the same - the founding team.
When VC's and Investors assess an early-stage business, the main thing they will focus on is the Founding Teams composition. Having three world-class CEO's will be less useful than having an experienced CEO, CTO and CMO for example, as complementary skill sets and comprehensive coverage of distinct functions will lay the foundations for great organisational structure.
Before you head into a VC meeting, have a think about the following questions Investors may ask:
Each fund will vary on its own criteria and many will look for different elements and traits within their portfolio founders (e.g. Product focus, storytelling, domain expertise, academic rigour).
When you are raising funding for your startup, creating a list of Investors is really important to the fundraising process. Around 1% of the startups that apply for funding actually receive it, so you should probably open as many conversations as possible by that logic. (If you are in the UK, have a read of our guide to the UK Startup Funding Ecosystem where we've outlined some London VC Investors). If possible aim for 20+ VC/Investor conversations minimum.
The first step will be working out who you should target speaking with, so some Market Research should take place here. As you are looking at each VC Firms website or profile, you should ask yourself the following questions:
Once you have your list ready, it's time to get those meetings booked in. Warm introductions are always the most effective way to get in front of investors, but a well researched and thought out cold email should also do the trick. Again, market research on UK VC Funds is key, as a B2B Software fund will never back a Video Game Startup.
Some VC firms will be a better/more natural fit for your startup than others. You should aim to pitch them in the middle of your fundraising process as your pitch will inevitably need refining. Once you start to get meetings booked, try and keep all the investors on similar timelines so that the process doesn't drag on.
Tips: Get creative where you can. Cold emails in inboxes that are generally overwhelmed are most likely going to be less effective than trying to reach a VC via a less busy channel such as Twitter.
Now that you have an Investor Pitch Deck and hopefully begun pitching to investors, you are now going to have to convince them to invest in your business. This is where the hard work starts. No matter how great your deck is or how many warm introductions you have secured, if your business isn't of interest to VC Firms and other investors, you will not raise funding.
Broadly, VC Firms are all looking for experienced, ambitious teams who are building businesses in large, rapidly growing markets. They will want you to show you understand your market and have a route to achieving Product-Market Fit.
You should hopefully have done some in-depth market research and have a real understanding of your customer persona. From here you need to practice, practice and practice.
One useful tip is to build a Notion document or Google Doc with common Investor FAQ's. In here you can answer common questions in good detail and pre-empt the tougher ones. It is also worth trying to schedule your higher priority investors for the middle of the schedule as you will have had more time to refine your pitch and iron out any mistakes.
In anticipation of any negative responses, have a read of our post on the 5 main reasons VC's reject startups.
If you've had the chance to think through all of the above criteria then you are probably ready to speak to some investors - and we'd love to hear from you!
RLC Ventures is a pre-seed VC firm investing in UK-based companies at the earliest stages, and you can apply for funding on our Investment Criteria page.