Are you an entrepreneur? An investor? Or are you interested in creating your own business? If you have answered yes to any of these questions, then you need to know what venture capitalists do.
The ultimate goal of a VC is to invest in a startup they believe in, which will hopefully become a “unicorn” and make billions of dollars—and the VC will receive a percentage of the profit.
Ernestine Fu, an angel investor in Silicon Valley and a professor at Stanford, and Michael Carter, a technologist and founder of the WebSocket protocol for HTML5, spoke about venture capital at Stanford University in May.
The talk began with the process of getting into venture capital and ended with explaining what successful venture capitalists do today.
Fu and Carter started off saying that there is no cut and dry way to get into venture capital. It is all about making connections, whether you do it before pitching your startup or you have established connections from a previous company you were involved in.
“If you’re active in the Valley, you’ll kind of get a lot of chances to start to get involved in VC,” Carter said.
The next segment focused on VC firms negotiating with the companies they invest in. Fu and Carter stressed that the most important characteristic a VC firm needs is a positive attitude. They must appear confident toward the startup, because it could potentially make millions or billions in profit. For this reason, it is extremely important to create relationships with fellow businesspeople in the Valley. You never know when someone’s idea can become a successful business, or if some day you decide to create your own business, and need investors.
“You need to start building your reputation before you’re actually even starting negotiations,” Fu explained.
Also, VCs must value and prioritize every relationship, because the average VC only makes 8-10 deals each year, and the average company only works with 2-3 different VCs each year. In other words, venture capital is an extremely competitive market.
“A lot of these matches just don’t get made,” said Carter, referring to VC/startup matchups.
When choosing a VC, companies should look for the firms that show the most interest and will provide the most long-term benefit. Startups should avoid choosing the VC that looks best on paper, because it will not be the most beneficial.
While companies are selective with their VCs, VCs are also picky when choosing companies to invest in. They might find their deal by attending a demo day or simply by searching the internet.
According to Fu, a VC looks for three aspects when deciding to make an investment, which she calls, “tech, team and product-market fit.” VCs want a product that is technologically advanced, is produced by reputable company, and appeals to the right target market.
When a VC and a company show mutual interest in each other, they meet to discuss the business’ “term sheet,” which is essentially a list of the company’s funding and cash flow.
Fu and Carter discussed the most important terms to know from the term sheet, which include liquidation preference, board of directors, protective provisions, right of first refusal, drag along, and employee option pool. All of these positions determine either who contributes funds, or who chooses how to allocate funds.
The speakers then talked about the importance of a VC’s portfolio. A portfolio should list the type of company they invest in, how much they have invested, and how profitable the company is. The company could be described as a “unicorn,” or a billion-dollar business; a “dragon egg,” a company with potential to make billions; or “the walking dead,” a startup that makes a consistent profit, but is not a unicorn.
Now that you know what a VC is, let’s summarize the key attributes required for the position. In order to be successful, VCs must make connections, do constant market research, negotiate with confidence, manage their portfolio, and raise funds.
Carter defined the position simply, saying, “A VC firm is a group of people that get together and say ‘let’s be partners.’”