I worked at a VC firm this summer: here’s what I learned
Venture capital is one of the top 3 buzzwords at Stanford. It’s thrown around all the time in conversation, classes, guest lectures, and the occasional joke between friends.
The thing is, most students start Stanford with 0 idea of what VC is, but at the end of first year, students often leave filled with startup passions and venture capital ambitions. Like many others, I was exposed to Venture Capital through this emulatory environment at Stanford. I know what the word Venture Capital meant, but I didn’t know how to think like a VC and truly evaluate companies.
This summer, I worked at a fintech venture capital firm called Impression Ventures based in Toronto. I certainly learned a lot, not just about VC but also about how to survive in a work setting. This article summarizes my biggest lessons about “how to think like a VC” that I’ve learnt over the past three months. There’s no one answer to this, and I’m still constantly learning new tricks but this is a good start to anyone interested in the pure foundations of VC.
If a deal seems too good to be true, that’s because it probably is….
You enter a pitch call, and the founder says: we’re the only one doing this; no one has even touched this market! At first glance, that sounds incredible. A potential investment has access to, let’s say, a ten billion untapped market. Interesting. But 305 million startups are created every year — of course, only a few become profitable — but the process of creating a product to fulfill a new market or problem is repeated over and over. So if a founder comes to you with an idea to fill an entirely new market, the first thought should be, why aren’t there any other players in this space instead of immediately falling in love with the prospect of dominating a new market.
How to ask the right questions.
The first pitch I ever heard was confusing. At first, the startup seemed great; they presented the problem and then the solution and even better, the solution sounded like it completely solved the problem. Perfect investment, right?
Wrong.
Immediately after I had that thought, the analyst on the call with me started to ask questions about customer acquisition costs, go-to-market strategies, the team’s overall experience, whether the tech was built in-house, etc. Little by little, he started uncovering red flags I would have run through.
Ultimately, venture capital comes down to pattern recognition. It’s these patterns that allow for good questions to be asked. I certainly can’t say that after three months, I’ve learned about every single major pattern, but here are a few that I picked up:
- Inexperienced founders or lack of industry knowledge.
Previous founders have a 4x higher success rate than inexperienced ones, ultimately due to understanding how to drive a startup forward effectively. So much is learned from that first company, whether that’s about managing a team, allocating costs effectively, understanding how to raise money, etc. Now, this isn’t always the case, and new founders have found a lot of success in building successful startups, so inexperience is certainly not always a dealbreaker. Inexperience can also be offset by deep industry knowledge. Now, I worked in fintech VC, which, in particular, compared to consumer or social media investment, is an industry that, to be disrupted, requires extensive experience and knowledge. This often exclusively comes from someone who’s worked for many years in that industry and is hard to learn simply through research. Again, not always a deal breaker, but it is certainly something to consider in the diligence part of an investment.
2. Unable to explain their business model:
If the founder can’t explain to potential inventors what the problem is, how their company fixes it, their customer acquisition strategy, go-to-market, and revenue model properly, that’s a problem. It could be because the problem their startup is solving is hard to communicate and is quite convoluted. But after several meetings, if you’re still confused after asking the same questions repeatedly with no clear answer, that could indicate that the founders themselves don’t really understand their business model or their thoughts are all over their place and thus might not be best suited for investment.
3. The cap table is broken:
The cap table is essentially a spreadsheet showing the percentage ownership each investor, advisor, founder and employee has. If the founder/CEO has too low of an ownership share after investment (say they got diluted from 45% to 35% after investment), they could lose the incentive to continuously work on building their company because they’re not receiving all the benefits of the company’s growth. When you enter a potential deal and look through their cap table, the founder should own a significant portion of the business (ideally around 50%) after a series A investment.
4. Do not rush the diligence process:
So much can be uncovered while diving deep into a market and a potential investment’s competitors. You may discover that an established industry player is investing millions of dollars into doing precisely what this startup is doing, and because of their ubiquitous presence in the market, they’ll squash the startup quickly. You may discover a piece of legislation that renders the solution the startup built ineffective or even useless, or you may even find that the way the founders talked about their financial statements was misleading. Not all this is evident from the beginning, and it’s worth taking the time to break down every part of the business before issuing a term sheet.
5. Not all businesses are VC-able.
Sometimes, a startup may only improve an industry 3x by making it slightly more efficient. I’ve learned that if there’s no substantial ROI in the industry, there may not be a significant ROI for the venture firm. When evaluating opportunities, it’s essential to look if it’s truly disrupting the industry or just adjusting it.
There’s still so much to learn about venture capital; it’s impossible to know everything in 3 months, but these lessons learnt are a fantastic foundation for not only venture capital but also other verticals of investment.
If you enjoyed this article, connect with me on linkedin: https://www.linkedin.com/feed/
