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Have you ever read a fundraising announcement on TechCrunch and wondered how that founder secured investment from reputable VC investors for just an idea? Does the venture capital journey seem like a mystery to you? In the world of startups and innovation, securing the right kind of investment is often the key to transforming a great idea into a successful, scalable business. Venture capital (VC) investors play a pivotal role in fueling the growth of high-potential startups, offering not just financial backing but also invaluable expertise and industry connections. If you're an entrepreneur looking to scale your business, understanding the role and nuances of VC investors, as well as distinguishing them from other types of early-stage investors is crucial. Whether you're just starting out or you still haven’t found the next big idea, this guide will help you navigate the complex landscape of venture capital and find the right partners for your journey.
What is a VC investor?
A venture capital investor, colloquially known as a VC, is someone who provides financial support to startup companies with high growth potential. In exchange for their investment, they receive an ownership stake in the company in the form of preferred equity. VC investors are interested in helping these companies grow and succeed because if the companies do well, the value of the ownership stake increases, leading to significant financial returns in the case of an exit, such as a public listing or an M&A with another company. More often than not, VCs offer not just money, but also expertise, advice, and industry connections to help the businesses they invest in succeed, usually through what has become known as “platform services”.
How is an institutional VC investor different than an angel investor or a family office investor?
The term “VC investor” is usually used interchangeably between an institutional VC investor, an angel investor, and a family office investor, even though there are significant differences between them. An institutional investor is part of a venture capital firm that manages a venture capital fund on behalf of limited partners, also known as LPs.
Effectively institutional investors are raising capital from limited partners and then investing that capital into startup companies through their funds in the hope of generating financial returns to the limited partners. The institutional investors are recompensated for their work with annual management fees and carried interest, a percentage of the profits they generate for their LPs.
As a result of their structure, institutional investors have 10 years from the start of a new fund to return the capital back to the LPs which means that they can only invest in companies that can scale and exit in that time period. This raises the bar significantly for any startup looking for funding. On the other hand, angel investors and family office investors are putting their own money to work which means they are not responsible for generating financial returns for other people. This allows them to be more flexible with the types of companies they back and more patient with the exit timeline.
5 types of early-stage VC investors
There are a variety of different early-stage investors out there but they generally fall into one of the following four categories:
1. Accelerators
Even though not technically always a VC investor, an accelerator is a program designed to help startup companies grow quickly. These programs typically last a few months and provide startups with a combination of mentorship, education, networking opportunities, and funding between $50K and $500K. In exchange, the accelerator often takes a small ownership stake in the company. Accelerators aim to fast-track the growth and development of startups by offering intensive support and resources
2. True pre-seed investors
Firms that invest as early as the idea stage, often before a product is even built, are the hardest to find and have the highest selection bar. To convince such a fund to back your startup company, you will need to show a track record of building, scaling, and exiting technology businesses along with a compelling startup idea.
3. Early-stage followers
Firms that do invest in true early-stage companies often before a product is built or revenue generated but do not have the conviction to be the first checks into a startup company. These investors require other investors to participate in an investment round. While they shouldn’t be your top priority, having a number of followers lined up can generate enough momentum to find a true believer to lead the round.
4. Misleading pre-seed investors
Firms that brand themselves as “pre-seed” and “early-stage” investors but need to see a product in the market generating early revenue and other traction signals before committing to investing. These are the firms that you should not waste a second on since they will always delay the process, ask for more “proof” and more often than not, they will pass because you are “too early”. Remember: you can never be “too early” for an early-stage investor.
5. Multi-stage voyagers
Firms that typically invest in growth companies or later-stage startup companies but do, from time to time, invest in the early-stage too. These are easiest to identify since they usually boast about managing over $1B in assets. There are no early-stage funds that large since the usual check for an early-stage fund is $250K to $1M meaning most funds are between $10M and $100M. These firms rarely lead investments are often behave very similarly to Early-Stage Followers, with the difference that they can invest significantly more in the company as it grows.
6 things early-stage VCs need to see before making an investment
1. A VC-backable idea
First, the most important of all is the ability of the business idea to not only reach over $100M in annual revenues in 8 years or less but also have a clear path towards an exit such as a public listing or an M&A by another company. Due to the constraints of institutional VC investors described above, this is a non-negotiable and usually the place where most founders realize that not all business ideas can be backed by VCs.
2. Clear explanations
Second, is the founder’s ability to clearly and succinctly explain their business. I have learned along the way that effective communicators are effective leaders since they optimize for the other person’s understanding in relation to the time spent explaining. There is nothing worse than a pitch meeting during which I have no understanding of what the other person is talking about which is why I always screen for clear explanations, short answers, honesty, and transparency. This way, I know we’ll get to the bottom of each challenge ahead of us.
3. Founder’s ability to dream big
Third, is the founder’s ability to paint a picture of the future in which this company is worth billions of dollars and changed the world in some way. Building a business is already incredibly difficult and jumping on the VC bandwagon makes this much more challenging as it adds the pressure of creating a billion-dollar exit event in the next 8 to 10 years. There’s a very small number of companies that can achieve that and a tiny number of founders crazy enough to attempt it. Founders who can visualize such an outcome and align themselves with the arch of history have the best shot at achieving it.
4. Proven demand
Fourth is proven demand for the product or service. While many founders operate under a “build it and they will come” mentality, successful founders find creative ways to stress test their assumptions and systematically increase their odds of success. While revenue is a great proof of demand, it is not the only way. The best founders I saw initially focus their time on proving that their business will not work and begin working on a product only when they see a clear path to success. They are also the ones navigating investor Q&A the best because they have already challenged their model several times over.
5. Scalable models
Fifth is the ability of the company to scale without needing a disproportionate amount of capital. Startup companies only raise a few rounds of capital before needing to grow which means business models that scale without a lot of investment are preferred over the capital-intensive ones. Since I have never worked at a billion-dollar fund, I do not know how it is to sit on a practically infinite supply of money to back your portfolio. As a result, I have never taken bets in highly capital-intensive industries since the risk of them not securing the right amount of financing is much higher than my ability to provide it. This is why I have almost exclusively invested in software businesses, ideally with a product-led growth (PLG) motion that can scale revenues exponentially without their cost base growing at the same rate.
6. Unique wedge
Sixth is the unique wedge. This is the most complicated one of them all because it requires a founder with domain expertise who clearly understands the market better than anyone else. A founder who was able to find a novel approach to secure distribution, funding, or leverage an existing system to generate more output than their competitors will be the one who can achieve the escape velocity of the early stage the fastest.
Prepare before you raise
Navigating the world of venture capital can be daunting for early-stage startup founders, but understanding the requirements and expectations of institutional VC investors can significantly improve the chances of securing investment. By assessing if your idea is truly VC-backable, focusing on a scalable business model, demonstrating demand in creative ways, and clearly articulating a compelling vision, founders can position their startups for a successful early-stage raise. The most important thing to remember is that thoughtful preparation pays off and if VC is not the right track for you, it’s better to learn that early on and look for other financing options.
Read more from Vlad Cazacu and Mark Bugas
Vlad Cazacu and Mark Bugas, CEO and CRO Co-Founders Flowlie Technologies
Vlad Cazacu is a Co-founder & Chief Executive Officer for Flowlie Technologies. Vlad is an Ex-VC investor and syndicator having led investments in 11 companies, a published author on VC, and a 40x angel investor.
Mark Bugas is a Co-Founder & Chief Revenue Officer of Flowlie Technologies. Mark is a repeat founder, ex-VC investor, and experienced go-to-market and revenue leader.
