Fund Raising: What a Venture Capitalist is Thinking

This is an excerpt from a recent interview I did with Advisor Garage – , a web community focused on helping entrepreneurs. I hope it gives you insight when you present to us, or any venture firm, to understand just what in the heck we are thinking as you’re presenting.

Venture Capitalist Gives Entrepreneurs Advice

Top Ten Questions:
1. Tell us about your Venture Capital Company.
InterWest Partners was established in 1979 and is a leading diversified venture capital firm currently investing InterWest IX, a $600 million fund. With more than $2B in capital under management, we take a long-term, collaborative approach to venture funding, providing early-stage and ongoing capital, management development and access to a broad network of resources.

InterWest is the lead investor in more than 70% of the investments we make, reflecting our ability to marshal resources and organize financings on behalf of our portfolio companies. We maintain relationships with our portfolio companies for an average of 5 years and in some cases for 10 years or more. An InterWest general partner serves as a director for 85% of the companies in our portfolio, often continuing to serve even after the partnership’s investment in the company has been returned.

2. What is its focus?
Our partnership invests in Life Sciences and Information Technology companies. Within the Life Sciences market, we invest in pharmaceuticals, biotechnology and medical devices. Within the Information Technology market, we invest in multiple sectors such as: semiconductors, telecommunications, consumer and enterprise software, infrastructure and wireless/mobile.

3. What is your minimum and maximum investment?
We invest in companies at all stages depending upon the circumstances. Where we have a strong relationship with the management team and/or know the market very well, we have made early stage seed round investments of $500K or less. InterWest, though, typically expects to invest an average of about $7 – 15 million over the span of our involvement with each company in our portfolio. We invest in companies through the full range of venture investment stages, and investments may be staged over several rounds of financing. Although we generally begin our involvement in the early stages of a company’s development, we pursue attractive opportunities based on their individual merits rather than their investment stage.

4. What do you typically look for when assessing a Business Plan?
At the macro level, we look at the following key criteria.
– Total Addressable Market — is the market large and growing and if so, can it be reached in a capital-efficient way?
– Technology — does the company have unique and defensible intellectual property?
– Management Team — has the management team worked and won together previously?
– Distribution — does the company have a powerful and compelling strategy for rising above the competition to become the recognized global market leader?

5. What do you typically look for when assessing a team?
– Is each member of the management team an expert in their functional area?
– Is the CEO credible and in command of the facts of her/his business?
– Do you have a credible financial model that shows you’ve really thought about the revenues/expenses of the business beyond plug and crank formulas?

6. How long does it typically take to go through the investment assessment process?
If we are very knowledgeable about the market and have a prior relationship with the management team, the process can take as little as two weeks. If we need to do a deep dive on the technology, the market and the team, it can take up to 60 days. Many times, we may elect to pass on the current opportunity to invest but stay involved and help the team for a year or more while they make progress against their plans only to invest once some of the more critical milestones have been achieved

7. How does your VC firm support its portfolio companies and founders?
The answer to this question depends upon the specific partner in our firm and her/his particular investment strategy and/or background. Many of us are former CEOs and/or senior operating executives and therefore are available to help our portfolio companies identify and hire key executives, compose strategic product and marketing plans, attract key board members, structure future financing rounds, etc. In all cases, we work as a team across our entire portfolio and can solicit advice and advisors in areas outside any one of our individual core competencies.

8. What is the best way to get your attention and stand out from the crowd?
Deliver a presentation that answers the questions I proposed in Answer 4 above and a demo (if applicable) in less than 1 hour. Read Guy Kawasaki’s blog titled “10, 20, 30”. He does a masterful job telling you how to pitch a potential investor.

9. Any advice for entrepreneurs relating to getting VC funding and support?
What follows is a long answer, and may be repetitive to some, but I hope it provides you with better insight into what drives the venture community. As an operating executive for the previous 27 years, it wasn’t until I joined a venture firm and had the opportunity to learn the business model that I fully understood what motivates most venture firms and partners.

First, when you meet with a venture capital firm, you need to remember it is nothing more — or less — than a high level sales call. Only in this case, the product you are selling is yourselves. As a result, just as you would prepare for an important prospect visit, it is equally important for you to do research on the firm you are presenting to: each firm is different and you need to understand their history, track record, the partners in general and the specific partners you are meeting with so you can adjust your presentation accordingly.

Unlike one of your typical prospect sales calls, however, where there is always someone who is “the decision maker”, partnerships are different. With few, but notable exceptions, there is no one “in charge” or who is the decision maker. In almost all cases, all the partners are equal in status — although informally some partners are more equal than others due to the fact they have been around longer and may have a longer list of successful investments. As a result, while one of the partners may decide she wants to invest in your company, she must convince the rest of her partners to vote favorably before the investment can be made. To do that, she needs to do due diligence and in many firms involve one or more of her partners in the process so that they are sympathetic and supportive of the investment. Each partner has a financial interest in the overall profits of the fund — called “carry” — that motivates them to be interested in any and all investments each partner makes. Therefore, each partner evaluates every investment opportunity brought into the firm and must weigh that opportunity against others the firm might make before voting positively to make the investment. Again, there are exceptions to this structure but by and large this is how it works. You should attempt to discover the firm’s investment/decision making process in your first meeting or as early as possible.

The one thing that is universally true among virtually all venture firms is that that they must answer to their Limited Partners. Limited Partners provide venture firms with the capital to invest, pay management fees, and run the firm. Limited Partners include entities such as large pension funds, family trusts, banks and other financial institutions and wealthy individuals. Limited Partners consider venture capital one of many asset classes they can invest in and, unsurprisingly, are seeking only the firms with the best investment records; while venture firms seldom share information about their results beyond their Limited Partners, Limited Partners have no qualms about sharing the results of their venture firm fund investments and generally make these available to the financial community at large. A venture capital firm’s track record against other investment asset classes and against other venture capital firms will dictate whether or not it can raise its next fund and survive. Most Limited Partners seek to invest in venture capital firms that are in the upper quartile of returns against all other venture capital firms — as measured by multiples of capital invested and Internal Rate of Return (IRR). Generally, Limited Partners want to invest in venture capital firms that have a sustained and successful investment track record with partners who they have met and known for many years. Partner turnover is a negative. Partners without a long, successful investment record is another negative and works against the firm’s ability to raise its next fund.

Partners are measured by their peers inside the firm and by the fund’s Limited Partners for the quality of investments they’ve made. Unfortunately, it usually takes at least 5 years before a new partner’s deals will mature to a point where the firm will know whether or not those investments are successful. As a result of this and the fact that partner turnover is viewed negatively, firms are very conservative about who they hire, who they fire and when.

Against this backdrop and at the very macro level, here is what the partner who is sitting across the table from you is considering. First, she knows that for the majority of successful venture capitalists, 8 out 10 of their investments will fail — are you 1 of those 8? She also knows that 1 out of 10 will just return capital — is that your company? She also knows for her firm to successfully raise its next fund, the overall fund must return at least a 2-3X multiple ($500M fund must generate $1B-$1.5B) and at least a 15% IRR (this is a rate of interest over time so the faster you return capital, the better your IRR — great companies that take many years to liquidate [e.g. IPO or merger] may have a great multiple but compromise IRR).

If each company, over time, requires an average of $10M of invested capital and 8 of them fail and 1 just returns capital here is how the model breaks out: $80M in 8 companies that are complete losses = net loss of $80M, $10M invested and $10M returned from 1 company = $0, and $10M in the 1 remaining investment. To that, the fund must also cover her yearly management fee (e.g. salary), overhead and expenses. So, assuming $10M for the remaining investment, this one investment must return the $90M+ to cover all previous investments/expenses/management fees and then generate approximately another $90M+ just to produce her share of a fund that returns 2X capital. By the way, a 2x fund depending upon the year it was started may not be in the upper quartile. And, all of this has to happen within 7-10 years of the original investment to generate a good IRR.

So, if the 1 remaining investment you own is 20% of a company that IPO’s with a market cap of $1B within 5-7 years, you will generate an overall 2x multiple of your 10 company investment portfolio with a nice IRR. Although it’s finally getting better in 2007, the problem with the IT market for the past 6 years is that only a handful of companies met this criteria (e.g. Google,, Riverbed, Skype and a few others). Most failed outright and those that managed to hang on had no IPO opportunity to liquidate and few M&A opportunities to capitalize upon. Ouch. With few exceptions, only those venture firms that were diversified outside IT have managed to do well with their 1999-2002 vintage year funds.

This is why most top tier venture capital firms won’t/can’t invest in just any company/idea — even if it’s a reasonably good one. Our business model compels us to invest only in those companies we truly believe can be large (e.g. at least a $500M market capitalization) and/or where we can have significant ownership. For example, a company that becomes $500M in value but where we only own 5% doesn’t really help the fund/firm. This is why many firms won’t invest if they can’t have at least 20% ownership or if the company can’t achieve at least $250M in market capitalization — even if it’s a great idea, in a great market, with a great management team.

And, sometimes, even if you’ve got a great idea, team, market, it may just not be an area that is interesting to the specific partner you’re presenting to. If they pass, ask for an honest answer as to why (if they just didn’t like you/team, you will seldom get an honest answer), and move on.

So, now that you have a better appreciation of the business model and characteristics of how partnerships work, take a long look at your presentation/business plan and see if you’re covering off the issues that the partner you’re meeting with is facing.

10. Any advice for entrepreneurs with their startups or early stage companies?
1. Focus on executing against one thing. Get the entire company behind that one thing.
2. If you are a technology company, spend a significant amount of time thinking about your marketing and distribution strategy — nearly all technology companies can build a product that works but most don’t have a clue how to create a marketing and distribution strategy that compels companies to buy from them — ask yourself, “how will we rise above the rest of the industry to become the acknowledged global market leader.” Clue: the answer isn’t Google adwords.
3. If you feel you need venture capital, only seek out firms and partners that align with your business/management philosophy. If you fail to attract any firms that meet your criteria to invest, re-read my Answers 4 and 9 above and modify your presentation and try again. Don’t just move down to a lower tier of firms — you may get the money but you will more than likely fail because you didn’t really get the formula right.

  • Pingback: Jack()

  • Some great comments here and only reinforces a lot of the strategies I have heard many Saas companies take. I am curious as to what first year Saas companies SPEND to get to that 1 to 1 ratio?