Founders often ask me for advice on how to go about raising their next round. “What are the metrics a VC needs to see to be interested in investing?”.
Of course, as with anything in this industry, the answer is that it depends and market conditions can make these thresholds a moving target. Furthermore, every VC is different, has different economics (fund size & structure), and perhaps different incentives (strategic vs financial). So giving an entrepreneur a revenue threshold or minimum number of users or whatever metric can be an indication of stage an investor invests in but not far more.
Instead of naming metrics or defining benchmarks, I try to use a more general framework that helps distill raising a round to three things: engagement, momentum, and storytelling. How does a company show the necessary level of engagement and momentum for the age and stage the company is at, communicated in a manner that compels potential investors into action?
Engagement broadly means that the target customers use or engage with the product at a relevant cadence for that behavior, repeatedly over a meaningful period of time. Put another way, the product creates real intrinsic value for whoever your key stakeholder is, such that over the lifetime of that customer they’re willing to give you more value than you’re willing to spend to acquire them. The three core concepts here are usage, cadence, and value.
I consider Usage to be a customer interacting with the product in a desired and specific way that indicates health in the business. Depending on the company, this could be a log in, a defined action, a pageview, # of integrations, social referrals and much more.
The cadence of activity means a desired action is being taken in your product over a time period that makes sense with regard to the behavior you’re encouraging. A messaging app like WhatsApp likely tracks daily active usage, while perhaps an enterprise SaaS tool like dashboarding considers 1–2 actions per week sufficient enough to imply the user is engaged and healthy.
Value can be considered a currency that a user attributes personal value to and are willing to exchange it in order to use the product. This currency could be money, but it could also be time, personal data or user generated content.
Ideally there is cold hard data to demonstrate these things, however, demonstrable data can mean very different things at different stages.
Seed: A product exists and either a few customers are using it, or you’ve spoken to enough potential customers and have the data to indicate that they’d derive value from your service.
Series A: A subset of customers are using it repeatedly over a relevant period of time. You’ve demonstrated that people are willing to exchange something of value to them in order to use it and have data to indicate that you may have a repeatable sales/customer acquisition process to reach more of those types customers. Unit economics are encouraging but not entirely credible at this stage.
Series B: You have a repeatable customer sales or acquisition process. You’ve ramped many other employees to carry out this process, none of whom are the CEO. You understand the unit economics of your business, and can credibly say that you know how to use the proceeds of this investment to the next milestone you need to hit.
Engagement is really a derivative of product market fit. Companies need to determine for themselves what are the key metrics they’re going to track that determine health in their business? Once you decide, measure and track this relentlessly. Every decision you make in the company should be geared towards improving these metrics, as they indicate the health of your business. Don’t be afraid to change these over time if you figure out the metrics you’re tracking aren’t relevant.
Once you’ve proven that you have meaningful engagement for the age and stage of your company, the next thing is demonstrating that there is momentum in those behaviors.
I think of momentum as growth in the relevant metrics to a business, with data to imply that this growth will continue at an increasing rate in the future.
Venture investors all have different economics based on the characteristics of their fund which implore them to make decisions based on certain thresholds. What is true amongst all of them though, is that they need to believe in the potential growth story for an investment to make sense.
Momentum can be demonstrated in many ways and really depends on the type of business that is being built. If the company is R&D heavy, it could be that you’ve hired a string of incredible talent, or are IP at an incredible rate. For companies where go-to-market matters more, the relevant metrics are growing at an increasing rate, or perhaps the forces that be in that given market have shifted such that your position within it is advantageous and there is now a market pull for your product that you need to capitalize on.
One thing that you can count on in financings is that time kills all deals. Momentum creates urgency in a round of financing and can combat the issue of time. If an entrepreneur can show growth and tell a story around future growth, it can force the issue of VC’s to make a decision. Otherwise their incentive is to wait, because every day that goes by, they have better information with which to make their decision.
The Art of Storytelling
Equally critical to engagement and momentum is the ability to paint a compelling picture of the future. What I outlined above frankly is unimportant if there isn’t a leader in the business who can masterfully tell the story of the company in a succinct way that inspires VC’s into action.
A few questions that every should aim to answer in a discussion with a VC is:
· How big/impactful do I think this can be?
· Can I deploy enough capital into this opportunity/market such that this investment of capital and time is meaningful for the fund?
· Is this business capitalizing on a view of the world that I agree with?
In order to get to a yes to these three questions, founders must be able to tell their story in a compelling way such that the investor not only believes in the opportunity, but has comfort that the founding team is the right one to actually capitalize on that opportunity.
There are a lot of moving pieces here, and I haven’t even mentioned dynamics in the fund that may cause a VC to pass (lack of capacity to dive in, age of fund, extraneous market conditions, and so on and so forth).
If a VC gets past all of this, the final hurdle is valuation. Even if they like the business, the next question they have to answer is ‘can I purchase one unit of the business at a price that satisfies my investment return targets?’ Many VC’s target 10x +, so keep that in mind.
We at Leaders Fund invest in less than 1% of the deals we see, which is typical of many VC’s. Bringing this all together is a difficult task at once is really difficult, but is what it takes to raise capital.