Greetings! We hope you had a great week and are sliding into a wonderful weekend!
💭 Thought Bubble: VC Math vs. Founder Math
When interest rates were low and capital was cheap, raising venture capital seemed like a goal in and of itself, with little thought to whether it was the best way to capitalize a business. Founders who raised vast sums were glorified, but what got lost in these heroic fundraising tales was whether venture capital was the right financing option for a company and/or a founder. To even ask the question seemed like surrendering ambitions to build a great, successful company.
Venture capital is not a financing Swiss army knife. Despite what Twitter (X) might have you believe, it is really only suitable for a teeny-tiny fraction of companies founded every year. The best stat I could find was that 0.5% of companies formed were funded by venture capital. That figure is over a decade old, and I imagine it has increased, but the point is venture capital is the exception not the norm for funding companies. Yet, over the past several years, we sort of forgot this.
Venture capital is built on outliers. Investors rely on a few companies within a fund’s portfolio to generate the overwhelming majority of returns. It’s why investors want to see a bottoms-up market analysis that is >$1B+, depending on the round dynamics, margins, public market comps, etc…, before they begin to seriously explore an investment opportunity. VCs get a lot of flack for wanting to see these types of swing-for-the-fences outcomes, but venture capital returns are governed by the power law, meaning returns are drastically skewed. They aren’t linear.
This is VC math, and it is sometimes at odds with founder math. Greg Head had a phenomenal LinkedIn post that discussed this at length. He asked investors, “What percentage of pitches do you see that will be great businesses but aren’t a fit for your fund?” The answer was around 30%. The reasons investors passed were because market sizes were too small and/or growth rates were likely going to be too slow given the typical VC exit time horizon. The catch, though, is that while these might not be a fit for venture capital, the investors believed these companies still had the potential to be great businesses and generate meaningful wealth for the founders.
Just like the investors Greg talked to, this topic comes up frequently at SpringTime. We often talk with founders who are going to build a solid business; it’s just not one that we believe has the potential to return the fund based on market size or other factors, and that’s okay! Raising venture capital doesn’t guarantee you success and vice versa.
Venture capital is just one way to grow a business. It’s right for some businesses and founders but not all. Before you decide to step on that VC treadmill (episode 16), think through what venture scale means for your business. Sometimes the founder math is greater than the VC math.
🍳 Deconstructing Pitch Decks
Justin Gray published an article in Fast Company that covers some of the dos and don’ts of crafting a pitch deck. Three don’ts he highlights are don’t be the same, don’t use the wrong numbers, and don’t spend too much time or slide space focused on team members whose track records may not directly apply. The three dos include showing revenue traction, understanding the market, and identifying the goal for your business, both medium and long term.
STV Take: I can’t emphasize the second don’t—don’t use wrong numbers—enough. One of the biggest red flags for many investors is when entrepreneurs don’t have or know updated revenue figures. If it’s the middle of the month and you still can’t tell me what last month’s revenue numbers were, that’s a problem. Time and speed are some of the key advantages a startup has, and being on top of your revenue and user count is critical to assessing when experiments you’re running may or may not be working.
📘 Pitchbook | NVCA Venture Monitor Q3 ‘23 Report
Pitchbook & NVCA released their quarterly report discussing the state of the VC market. A few interesting stats:
The median Pre-seed deal size was $500K and the median valuation was $5.7M pre-money, not too far from 2022’s median of $6M pre-money.
Across all stages, roughly half of the deals done in Q3 were in either the Bay Area, NY, LA, or Boston. The other half of the deals were done outside these areas.
The number of US-based VC funds is on track to be the lowest in nine years.
STV Take: If you’ve been following the venture market at all this year, none of this is surprising. While the pace of deal making has slowed across all stages, including the Pre-seed and Seed, the most promising companies with the most promising teams are still raising on favorable terms. While early-stage (think Series A or B) pre-money valuations fell relative to 2022, median valuations increased at Seed. It’s unclear whether the early-stage market is bottoming out or will continue to revert back to the historical median pre-money range of $25-30M. If early-stage valuations continue to decrease, the spread between the median Seed and early-stage will also decrease, and the path towards securing early-stage financing will continue to get longer and harder.
🗺️ State of Startups in the Southeast
BIP Ventures, an Atlanta-based VC firm, released their annual report on the venture market in the Southeast US. Similar to other parts of the country, fewer but higher value deals are getting done. For example, the size of a Seed deal increased from $500K in 2018 to $1M in H1 2023. The dominant industries for startup funding in the SE are B2B SaaS, healthcare, and fintech.
STV Take: I’m not surprised to see startups within these industries receiving the most funding in the SE. Atlanta is often referred to as Payments Alley, given the sheer volume of payments that pass through the city, while Charlotte, NC, has a robust banking presence. Nashville is a legendary healthcare town with some of the biggest hospitals and health systems based there. We believe industry expertise and knowledge amongst founders will be a key competitive edge as AI makes technical creation easier, which is why the Southeast seem particularly well positioned to create the next wave of startups.
😴 Decompression Zone
It seems like most of the US is finally in the midst of crisp (but not too cold) fall weather, which is why this week I’m not adding another article to this list and am instead encouraging you to get outside, if only briefly. Being in nature, even if it’s an urban park, is beneficial to both our mental and physical health. Take care of yourself, please.
👋 Have a great weekend!