02. What is a Venture Backed Startup

What is venture capital?

• Venture capital (VC) is "capital invested in a project in which there is a substantial element of risk, typically a new or expanding business."
• In other words, accredited investors give money to startup companies that have long-term growth potential. This investor is essentially buying stock in the company (often at a fraction of a dollar) with the hopes that the company's stock will eventually be worth multiples more.
• Take a simple example: Let's say that a venture capitalist invests $25,000 into a startup for partial ownership, 100,000 shares ($0.25 a share) in an early round. The company uses the money wisely, continues to grow the business, and several years later goes public at $20 a share. The VC's original $25,000 investment is now worth $2,000,000. (An 80x return!)
• However, this VC also runs the risk that their $25,000 investment in this startup goes to $0 if the company does not make it. That is why VC firms do extensive due diligence and diversify their investments with the hope that their (80x plus) winners will more than cover the cost of their losses.

Why would a startup give ownership in their company to a VC?

• Startups need money to grow. A traditional loan does not make sense because the founders rarely have the needed collateral (if they do why are they raising money?) to warrant such a large loan from a bank. Additionally, with the high risk of the company failing (90% of startups fail), there is little to no guarantee that the founder would ever be able to pay back the loan - let alone interest on the borrowed money.
• Founders can use VC money to develop their product, hire employees, and grow the company without the need to pay investors back. And at the same time leverage their investor’s expertise and experience to scale the company.
• Additionally, VCs typically have a value add to the startup beyond the monetary contribution. Many VCs are former founders and operators themselves and can help a startup in strategic ways (hiring, product, sales, etc.) beyond providing capital. This experience and network are crucial in the early stages of a startup.

Lifestyle Business vs Venture Scale Business - what is the difference?

Lifestyle Business

Venture Scale Business

Funding Rounds: What are they, when are they raised, and what is the goal of each?

Seed Round

• This is the initial funding to start the business
• The startup typically has an MVP
• The goal of this round of fundraising:
• Market research
• Product development
• Hone founding team
• Investors at this stage:
• Founders
• Friends & Family
• Incubators
• Angel Investors
• Venture Capitalists
• Round Size: ~$5K - $5 million
• Total Equity Given Away: 1% - 10%
• Company Valuation: ~$1 million - $6 million
• LAUNCH Insights:
• Look for some traction at this stage ~$5K-10K MRR
• Strong growth ~20% MoM
• This would indicate an opportunity for our accelerator

Series A

• There is an established product in market
• There is an existing customer base and it is growing
• Founders have validated market fit
• The goal of this round of fundraising:
• Growth from seed round
• Product evaluation
• Market awareness
• Competitor assessment
• Investors at this Stage:
• Traditional VC firms
• Angel Investors (less influential than seed)
• Round Size: ~$2 million - $15 million
• Often 2-5x seed round
• Total Equity Given Away: 20% - 50%
• Company Valuation: ~$10 million - $30 million

Series B

• Established customer base
• Viable product in market
• Common stock commonly issued
• The goal of this round of fundraising:
• Grow sales
• Grow marketing
• Grow product
• Investors at this Stage:
• Traditional VC firms
• Late-Stage VC firms
• Round Size: $10 million - $20 million
• Total Equity Given Away: 20% - 50%
• Company Valuation: $50 million +

Series C

• Established company
• Operating at scale
• Chance of being acquired or IPO increasing
• The goal of this round of fundraising:
• Continued product development
• Capture market share
• Acquisitions
• Scale
• Investors at this stage:
• Hedge funds
• Investment banks
• Private equity firms

Why do venture capital funds invest in startups if 90% fail?

• With the volume at which venture capitalists invest in startups, they only have to be right once to make up for multiple losses. Take our example above which returned 80x on a single investment. If the next 79 investments go to 0 the VC still breaks even. But 10% are statistically going to be successful meaning there are another 7 companies in that group that will generate returns. With proper due diligence, these VC firms become increasingly better at selecting winners and thus see larger gains.
• VCs are looking for outsized returns and earlier-stage firms can take more risk with smaller check sizes. VCs are not in it for long-term investments. Most VCs want to see returns in 5-7 years and only invest in high growth potential companies because of it.
• Jason explains exactly why VC firms are not interested in slow/modest growth startups in his blog below:

Action item for founders

Summary