“When an investor passes you by, they won’t tell you the real reason,” said Tom Blomfield, the team’s partner at Y Combinator. “ONEThe first stage, frankly, no one knows what will happen. The future is so uncertain. All they judge is the perceived quality of the founder. When they pass, what they think in their mind is that this person is not impressive enough. Not terrible. Not smart enough. Not hardworking enough. Whatever it is, “I’m not convinced this person is a winner.” And they’ll never tell you that, because you’d be upset. And then you wouldn’t want to do it again.”
Blomfield should know – he was the founder of Monzo Bank, one of the brightest stars in the UK startup sky. For the past three years or so, he has been a partner at Y Combinator. He joined me on stage at TechCrunch Early Stage in Boston on Thursday in a session titled “How to Raise Money and Come Out Alive.” There were no mincing words or pulling fists: just real talk and the occasional F-bomb flowed.
Understanding the Power Law of Investor Returns
At the heart of the venture capital model is the law of the power of returns, a concept every founder must understand to effectively navigate the fundraising landscape. Summarizing: a small number of very successful investments will generate the majority of a VC firm’s returns, offsetting losses from the many investments that fail to take off.
For VCs, this means a relentless focus on identifying and backing those rare startups with the potential for 100x to 1000x returns. As a founder, your challenge is to convince investors that your startup has the potential to be one of those outliers, even if the chance of achieving such massive success seems as low as 1%.
Demonstrating this great potential requires a compelling vision, a deep understanding of your market, and a clear path to rapid growth. Founders need to paint a picture of a future where their startup has captured a significant portion of a large and growing market, with a business model that can scale efficiently and profitably.
“Every VC, when they’re looking at your company, they’re not asking, ‘Oh, this founder asked me to invest $5 million. Will it go to $10 million or $20 million?’ For a VC, that’s as good as failure,” Blomfield said. “Hitting singles is literally the same as zeroes for them. It does not move the needle in any way. The only thing that moves the needle on VC returns is the home runs, it’s the 100x return, the 1,000x return.”
VCs are looking for founders who can back up their claims with data, traction and a deep understanding of their industry. This means clearly understanding your key metrics, such as cost of customer acquisition, lifetime value, and growth rates, and articulating how those metrics will evolve as you scale.
The importance of addressable marketing
A proxy for the power law is addressable market size: It is important to have a clear understanding of your Total Addressable Market (TAM) and be able to articulate it to investors in a compelling way. Your TAM represents the total revenue opportunity available to your startup if you were to capture 100% of your target market. It’s a theoretical cap on your potential growth and is a key metric that VCs use to assess the potential scale of your business.
When presenting your TAM to investors, be realistic and support your estimates with data and research. VCs are highly skilled at evaluating market potential and will quickly pick up on any attempts to inflate or exaggerate the size of your market. Instead, focus on presenting a clear and compelling case for why your market is attractive, how you plan to capture a significant share of it, and what unique advantages your startup brings to the table.
Leverage is the name of the game
Raising venture capital isn’t just about pitching your startup to investors and hoping for the best. It is a strategic process that involves creating leverage and competition among investors to secure the best possible terms for your company.
“YC is very, very good [generating] leverage. We basically collect a bunch of the best companies in the world, put them in a program, and at the end, we have a demo day where the best investors in the world basically run an auction process to try to invest in the companies,” said Blomfield. are summarized. “And whether you do an accelerator or not, trying to create that kind of pressure situation, that kind of highly leveraged situation where you have a lot of investors bidding on your company, is really the only way to get great investment results. YC just builds it for you. It’s very, very useful.”
Even if you’re not in an accelerator program, there are still ways to create competition and leverage among investors. One strategy is to run a rigorous fundraising process, set a clear timeline for when you will make a decision, and communicate this to investors in advance. This creates a sense of urgency and scarcity as investors know they have a limited supply window.
Another tactic is to be strategic about the order in which you meet with investors. Start with investors who are likely to be more skeptical or have a longer decision-making process, then move on to those who are more likely to move quickly. This allows you to build momentum and create a sense of inevitability around your fundraising.
Angels invest with their heart
Blomfield also discussed how angel investors often have different motivations and rubrics for investing than professional investors: they typically invest at a higher rate than VCs, particularly for early-stage deals. This is because angels usually invest their own money and are more likely to be influenced by a compelling founder or vision, even if the business is still in its early stages.
Another key benefit of working with angel investors is that they can often provide introductions to other investors and help you build momentum in your fundraising efforts. Many successful fundraising rounds start with a few key angel investors, which then helps attract the interest of larger VCs.
Blomfield shared the example of a round that came together slowly. over 180 meetings and 4.5 months of hard slog.
“That’s actually the reality of most rounds today: You read about the success round on TechCrunch. You know, “I raised $100 million from Sequoia rounds.” But honestly, TechCrunch doesn’t write that much about “I took it for 4 1/2 months and finally closed after meeting 190 investors,” Blomfield said. “Actually, that’s how most rounds go. And a lot depends on angel investors.”
Investor comments can be misleading
One of the most challenging aspects of the fundraising process for founders is navigating the feedback they receive from investors. While it’s natural to seek out and carefully consider any advice or criticism from potential backers, it’s important to recognize that investor feedback can often be misleading or counterproductive.
Blomfield explains that investors often pass on a deal for reasons they don’t fully disclose to the founder. They may cite concerns about the market, the product or the team, but these are often just superficial excuses for a more fundamental lack of conviction or alignment with their investment thesis.
“The takeaway from that is when an investor gives you a bunch of feedback on the first step of your stage, some founders say, ‘Oh my gosh, they said my market isn’t developed enough. You better go do it.’ But it misleads people, because the reasons are mostly bullshit,” says Blomfield. “You might end up spinning your entire company strategy based on some random feedback an investor gave you, when really they’re thinking, ‘I don’t think the founders are good enough,’ which is a harsh truth that they won’t never tell you.”
Investors are not always right. Just because an investor has passed on your deal doesn’t necessarily mean your startup is flawed or lacks potential. Many of the most successful companies in history have gone through countless investors before finding the right fit.
Beware of your investors
The investors you bring in will not only provide the capital you need to grow, but will also serve as key partners and advisors as you face the challenges of scaling your business. Choosing the wrong investors can lead to misaligned incentives, conflicts, and even failure of your company. Many of these can be avoided by doing thorough due diligence on potential investors before signing any agreements. This means looking beyond their capital size or the names on their portfolio and really looking for their reputation, track record and approach to working with founders.
“80% of investors give you money. The money is the same. And you’re back to running your business. And you have to understand that. I think, unfortunately, there are about 15 percent to 20 percent of investors who are actively destructive,” Blomfield said. “They give you money, and then they try to help, and they screw up. They’re super demanding, or they push you to take the business in a crazy direction, or they push you to spend the money they just gave you to hire faster.”
A key piece of advice from Blomfield is to talk to founders of companies that have underperformed in an investor’s portfolio. While it’s natural for investors to tout their successful investments, you can often learn more by looking at how they behave when things don’t go according to plan.
“Successful founders will say nice things. But the mediums, the monks, and the strikes, the failures, go and talk to these people. And don’t get an introduction from the investor. Go and do your own research. Find those founders and ask how those investors performed when times were tough,” Blomfield advises.
