We’re more than halfway through recapping the ten lessons we’ve learned since the beginning of our venture capital journey four years ago. I hope you’re enjoying the series as much as we’re enjoying writing it.
Last post, we discussed the importance of Entry Valuations, and why funds like ours chase companies that have the potential of achieving 50x returns (for each individual investment).
This week, we discuss “Graduation Rates,” or the probability that any one of our investments will successfully raise their next round.
This math really matters to VCs, and our hope is for this blog post to provide founders with additional insights about how VCs think.
Startups are hard
Being a Founder is hard.
“Great CEOs face the pain. They deal with the sleepless nights, the cold sweats, and what my friend the great Alfred Chuang (legendary cofounder and CEO of BEA Systems) calls “the torture.” Whenever I meet a successful CEO, I ask them how they did it. Mediocre CEOs point to their brilliant strategic moves or their intuitive business sense or a variety of other self-congratulatory explanations. The great CEOs tend to be remarkably consistent in their answers. They all say, “I didn’t quit.” ― Ben Horowitz, The Hard Thing About Hard Things: Building a Business When There Are No Easy Answers
The Bureau of Labor Statistics reports that approximately 24.2% of small businesses do not survive their first year. That number grows the longer businesses are in operation. After five years, 48% have failed, and 65.3% have failed at the 10-year mark.
Harvard Business School reports that historically, only a tiny percentage (fewer than 1%) of U.S. companies ever raise capital from VCs.
Crunchbase reports that for startups that raise seed funding, only 15% eventually exit.
Founding a company is NOT for the faint of heart.
Implications on VCs
As a reminder, Automotive Ventures typically invests initially at the Seed stage, with valuations of <$20m.
When you think about the journey of an early-stage company from initial funding all the way through to exit, VC-backed companies typically raise multiple rounds over a decade or more.
Recent Carta data shows that approximately 50% of startups that raise their Seed round make it through to raise their Series A.
Let’s assume that companies have slightly higher conversion rates as they continue the journey from Series A to subsequent rounds (for sake of simplicity here, we will assume 60% at each subsequent round). If we assume that the average company raises four rounds of funding prior to exit, total survival might look like:
50% (Seed to Series A) x 60% (Series A to Series B) x 60% (Series B to Series C) x 60% (Series C to Series D) x 60% (to exit) = 6.5% of companies make it all the way through to exit.
Only 6.5%!
Now you can start to understand why the Power Law applies (especially in early-stage investing) and why funds like ours need to underwrite to a 50x return for every investment.
We spend a lot of time with our Founders to support their growth to their Series A round (and beyond). Startups need to achieve strong milestones to signal strength to potential Series A investors. Some of he many things we do for our founders include making introductions to potential customers as well as potential investors in their next round of financing. It’s critical for a VC to be a committed partner to help derisk our portfolio companies’ success.
Wrapping Up
Hopefully, these last few posts have helped you to better understand how a VC thinks about structuring their portfolio and why they need to invest in founders that can achieve 50x+ returns.
The better a Founder understands how a VC thinks, the better they’ll be prepared to pitch them and talk their language.
We like to think of an investment as a marriage (or at least a very long-term relationship). The best relationships are built on a foundation of mutual understanding and transparency, and the Founder/VC relationship isn’t any different.
VCs have to understand the key drivers within a business and what support we can provide to accelerate success.
Founders should understand how their VC investors look at their portfolio of companies and their business model in general, to ensure there is 100% alignment. This is the best way to create a healthy, long-term relationship and ensure a true win-win.
Join us on the journey,
Steve Greenfield
