For this article on venture capital, I have the privilege of Michael Garbe as a contributor.
Michael was the founder of Accelerated Connections, a data, voice, and networking company he founded, grew, and eventually sold in 2018 to GTT Communications.
Michael and I have been friends for many years. I first met him in the 2005 time frame, at a point where we were both growing our voice and data businesses. I have learned a tremendous amount from Michael over the years, especially in the last few years, when we were both actively growing revenues and getting the business ready for an eventual sale.
Before I met Michael, I was always debt-averse. I eventually understood I was viewing debt from the wrong perspective.
Michael taught me how to strategically apply debt to a business and use that debt to grow the revenues, either through strategic acquisition or through accelerated internal growth.
I’ve been writing The Kickass Entrepreneur since June 2018. I’ve now written over 120 articles, and unfortunately, none have been on raising funds. It just isn’t a personal area of expertise. It certainly is Michael’s.
Michael started Ripple Ventures shortly after he sold Accelerated to GTT, and in under two years, Ripple has funded over eight companies, all at different stages of development. He’s the perfect guest to have author an article on many business topics, especially venture capital.
5 Big Mistakes Founders Make When Pitching for Venture Capital for Their Seed Round
Each week, several companies approach Ripple Ventures for seed round funding. Invariably, they all make key mistakes.
I’ve written this article in the hopes that you don’t make the same mistakes if you’re pitching for venture capital.
Let’s assume the company pitching matches our investing criteria, which in Ripple’s case, is B2B software (no cannabis and no crypto). Once they pass the first conversation, they come in for a meeting with our firm. Some of the mistakes I see businesses make in their seed round pitch are:
1. Founders Put Very Little Thought into Potential Commercialization
We see this a lot from technical founders looking for venture capital funding.
They come up with a great technical solution to a problem, however, they really haven’t given any thought as to how the product will be sold.
Most founders fall in love with their products, and so they should. However, if they are going through life with blinders on, they forget that it isn’t the solution they should be in love with, it is the problem.
5 Questions Founders Need to Consider Before Pitching:
- Is there a market for their solution?
- What milestones do they need to get over for product-market fit?
- Is the product priced appropriately?
- Will the champion they find as the potential customer have the authority to place the order?
- Can the product be scaled?
2. Mistakes with Financials
In every first meeting, we ask to see the financials.
It is quite typical for the founders to show themselves as pre-revenue or just a small amount of revenue.
They all show forecasts of going from zero or near zero to a huge amount of revenue within just a few months.
That isn’t going to happen.
Even if they can sign those first few customers, they are going to take months to fully roll out.
Founders often fail to realize they don’t receive payment the moment they invoice the customer, so when their financial forecast includes a revenue component but not a cash-flow projection, we know their estimated runway is wrong.
The lack of a clear understanding of the financials and financial projections is a major problem.
3. Overinflated Valuation
“My advisor told me our company is worth $10 million” is something we’ve heard only too often.
Well then, let your advisor write you the check!
This happens almost every time. Someone, who is not an actual venture capital or angel investor, comes up with a valuation that simply cannot be justified.
As a VC fund, we look at several components that make up valuation.
Some Factors That Contribute to Valuation
- Our ability to bring other investors into the round
- The runway the company will get from this round
- The likely uplift in subsequent rounds
- The market valuation
When founders come in and have an unrealistic valuation in mind, it often leads to a larger amount of dilution than they originally expected, which starts the relationship off on a bad note.
4. Too Many Cofounders All Making Decisions Together
Another recipe for disaster we see too often is multiple cofounders, where every decision is a group decision. We see this all the time.
A group of friends has a great idea and they start a company.
It is a hard decision to make, but one person needs to be the CEO. Not two, not three, but one.
The CEO will ultimately be the one to make the hard decisions.
- Who to hire
- Who to fire (potentially even one of the cofounders)
- Whether the company needs to pivot
- When is the right time to raise additional capital
These, and many other decisions will rest on the shoulders of the CEO, and that can only be one person!
5. Unclear Understanding of How the Investor Will Make a Return on the Capital
The founder comes in to ask for an investment. The questions I ask that always seem to throw them is “How will I make money by investing in your company?” or “How will I at least get my money back?”
When asking someone to invest in them and their company, the founder must know how the story is going to end for the investor.
Critical Financial Questions the Founder Must Know in Regards to the Investment
- Is the company likely to be purchased by private equity down the road?
- How many rounds of funding do they think will be required?
- What will this mean to the investor, and the company, in terms of dilution?
- How long will it take, and what sort of overall return should the investor expect?
If you can’t answer these critical questions, then why should I invest in your company? Would you put your own money into your company if you couldn’t answer these questions?
Seed stage companies are not expected to have all the answers. As VCs, we recognize that companies who come to see us are early stage. However, keeping these top five rookie VC mistakes in mind will help founders have more successful outcomes in your first meeting and, ultimately, in funding.
What is the Difference Between a Venture Capitalist (VC), and an Angel Investor
Below you will find a short video and an explanation of the difference between an angel investor and VC. You should watch this before finishing this article.
A VC investor serves a similar role as an angel investor. Both invest money into a business and in return, they generally take an equity share, and participate in the growth and eventual sale of the business.
The primary difference between the two is generally the dollar amount involved, the risk, the expected return, and the stage the company is at.
A VC investor will generally pool capital from a group of individuals or companies, where an angel investor is an accredited investor with a net worth in excess of $1 million, and they will use their own personal funds to invest a much smaller amount than a VC.
An angel investment is usually an earlier stage investment, but, VCs generally have a higher expected return on their investment. As an example, an angel investor might be looking for a return of between 20% to 25%, while a VC will look for a higher return of between 25% to 35%.
A VC investment is usually a later stage business with a more proven business plan, although that is not always the case, whereas an angel investor might often invest pre-launch,
According to the US Small Business Administration, the average venture capital deal is approximately $11.5 million, while the average angel investment is approximately $325,000.
Whether an investor is acting as an angel, or as a VC, because the risk of loss of capital is so high, most investors rarely make only one investment. The law of averages clearly applies here, where, for every twenty investments, one might return 100x (called a Unicorn), two might return 20x, 5 might return the initial capital, 8 might stagnate for years, and 4 might go out of business within the first few years. Of course, every investor is looking for the Unicorn, they are hard to find. Jason Calacanis has done over 200 angel investments. You can read more about him and his investment on his blog.
You might also find this interview I did with Jeremy Greven, another angel investor, interesting. In this interview, Jeremy reviews is life prior to becoming an angel investor including some of his business challenges. Jeremy has made 17 investments so far. From Missing Payroll to a Successful Exit and Now 17 Time Angel Investor. An Interview With Entrepreneur Jeremy Greven
And here’s another article you might find interesting: How to Become a Decamillionaire, Grow your Net Worth to $10 Million, and Join the 1% Club