“When an investor “You’ll be passed over, they won’t tell you the real reason,” said Tom Blomfield, group partner at Y Combinator.T SEED STAGE To be honest, no one knows what’s going to happen. The future is very uncertain. They are simply evaluating the perceived quality of the founder. When they pass by, they keep thinking in their mind that this person is not impressive enough. Not formidable. Not smart enough. Not hardworking enough. Whatever, ‘I’m not sure this person is a winner.’ And they would never say that to you, because you would get upset. And then you never want to pitch to them 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, he has been a partner at Y Combinator. He joined me on stage at TechCrunch Early Stage in Boston on Thursday in a session called “How to Raise Money and Come Out Alive.” There were no sarcastic words or punches: just a flow of genuine conversation and the occasional F-bomb.
Understand the Power Law of Investor Returns
Venture capital is at the heart of the model power law of returns, a concept every founder must understand to effectively navigate the fundraising landscape. Summary: A small number of highly successful investments will generate most of the VC firm’s returns, offsetting losses from many investments that failed to move forward.
For VCs, this means a continued 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 become one of those outliers, even if the chances of achieving such great success are less than 1%.
Unleashing this huge potential requires a compelling vision, a deep understanding of your market, and a clear path to rapid growth. Founders should present 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, isn’t asking, ‘Oh, this founder asked me to invest $5 million. Will it get to $10 million or $20 million? ?’ For a VC, that’s as good as failure,” Blomfield said. “The singles in batting are really like zero for him. It doesn’t move the needle in any way. The only thing moving the needle for VC returns is home runs, 100x returns, 1,000x returns.
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 customer acquisition cost, lifetime value, and growth rate, and articulating how these metrics will evolve as you scale.
Importance of addressable market
A proxy for the power law is the size of your addressable market: It is important to have a clear understanding of your Total Addressable Market (TAM) and be able to communicate this to investors in an attractive way. Your TAM represents the total revenue opportunity available to your startup if you want to capture 100% of your target market. This is a theoretical limit on your potential growth, and it’s a key metric that VCs use to evaluate the potential scale of your business.
When presenting your TAM to investors, be realistic and support your projections with data and research. VCs are highly skilled at evaluating market potential, and they will quickly spot any attempts to expand or increase your market size. 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 benefits your startup brings.
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 at generating leverage. We basically gather a bunch of the best companies in the world, we put them through a program, and at the end, we have a demo day where the best investors in the world basically try to invest in the companies. To run the auction process,” Blomfield summarised. “And whether you’re doing an accelerator or not, trying to create that kind of pressure situation, that kind of high leverage situation where there are multiple investors bidding for your company. This is really the only way you get the best investment results. YC builds it just for you. It is very, very useful.”[generatingleveragehatforyouIt’sveryveryuseful”[generatingleverageWebasicallycollectabunchofthebestcompaniesintheworldweputthemthroughaprogramandattheendwehaveademodaywheretheworld’sbestinvestorsbasicallyrunanauctionprocesstotryandinvestinthecompanies”Blomfieldsummarized“Andwhetherornotyou’redoinganacceleratortryingtocreatethatkindofpressuredsituationthatkindofhighleveragesituationwhereyouhavemultipleinvestorsbiddingforyourcompanyIt’sreallytheonlywayyougetgreatinvestmentoutcomesYCjustmanufacturesthatforyouIt’sveryveryuseful”
Even if you are not part of an accelerator program, there are still ways to create competition and leverage among investors. One strategy is to run a strict fundraising process, set a clear timeline for when you’ll be making a decision, and notify investors in advance. This creates a sense of urgency and scarcity, as investors know they have a limited offer window.
The second strategy is to be strategic about the order in which you meet investors. Start with investors who are likely to be more skeptical or who have longer decision-making processes, and 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 hearts
Blomfield also discussed how angel investors often have different motivations and rules for investing than professional investors: They Typically invest at a higher rate than VCs, especially for early-stage deals. This is because angels typically invest their own money and are more likely to be influenced by a compelling founder or vision, even if the business is still in the early stages.
Another important benefit of working with angel investors is that they can often provide introductions to other investors and help accelerate your fundraising efforts. Many successful fundraising rounds start with a few key angel investors coming on board, who then help attract the interest of larger VCs.
Blomfield shared an example of a round that came together slowly; Over 180 meetings and 4.5 months of hard work.
“This is actually the reality of most rounds done today: You read about blockbuster rounds in TechCrunch. You know, ‘I raised $100 million in a Sequoia kind of round.’ But honestly, TechCrunch doesn’t write about it so much as, ‘I put this off for four and a half months and finally closed my round after meeting with 190 investors,'” Blomfield said. “Actually, most of the rounds go like this. “And a lot of that depends on angel investors.”
Investor reaction may be misleading
One of the most challenging aspects of the process of raising money for founders is paying attention to the feedback they receive from investors. While it is natural to seek out and carefully consider any advice or criticism from potential backers, it is 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 justifications for a more fundamental lack of conviction or to fit with their investment thesis.
“The takeaway is that when an investor gives you a lot of feedback on your seed stage pitch, some founders are like, ‘Oh my God, they said my go-to-market wasn’t developed enough. Better go and do that. But it throws people off, because the reasons for it are mostly nonsense,” says Blomfield. “You can change your entire company’s strategy based on some random feedback an investor gives you, when really they’re thinking, ‘I don’t think the founders are good enough,’ which is a hard truth that they Will never do that. Tell you.”
Investors are not always right. Just because an investor passed on your deal doesn’t mean your startup is flawed or lacks potential. Many of the most successful companies in history have been abandoned by countless investors before finding the right replacement.
Do due diligence on your investors
The investors you bring on board will not only provide you with the capital you need to grow, but will also serve as key partners and advisors as you navigate the challenges of scaling your business. Choosing the wrong investors can lead to wrong incentives, conflicts, and even failure of your company. A lot can be avoided by doing this Do thorough due diligence on potential investors before signing any deal. This means looking beyond just the size of their fund or the names in their portfolio and actually examining their reputation, track record, and approach to working with founders.
“About 80 percent of investors give you money. The money is the same. And you get back to running your business. And you have to figure it out. 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 talk nonsense. They’re overly demanding, or push you to take the business in a crazy direction, or make you spend the money they’ve given you to hire you faster.
One of Blomfield’s key pieces of advice is to talk to founders of companies that haven’t performed well in an investor’s portfolio. While it’s natural for investors to promote their successful investments, you can often learn more by examining how they behave when things don’t go according to plan.
“Successful founders are going to say good things. But the middles, the singles and the strikeouts, the unsuccessful guys, go talk to those guys. And do not take introduction from the investor. Go and do your own research. Find those founders and ask how these investors fared when times got tough,” Blomfield advised.
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