Fred Wilson is one of my favorite venture bloggers. Over at AVC, he wrote a post a little while ago entitled What a CEO Does. Speaking on a panel this weekend at Harvard College on careers in finance, I had to describe what I do and realized that people still view VC as something of a “black box.”
The intent of this post is to give entrepreneurs (and the rest of you) a bit of a peek inside.
So, what does a VC do? Five basic things:
- Sourcing (outbound & inbound)
- Due diligence
- Selling deals (externally & internally)
- Helping companies
- Exiting companies
(There’s actually a #6, which is incredibly important: raising money / investor relations. Since the audience of this blog is entrepreneurs, though, I’ll save that one for another day.)
How do VCs find companies to invest in? The answer is a combination of outbound and inbound sourcing. Outbound sourcing consists of attending conferences, networking events, and firm-sponsored events. It also consists of good old fashioned cold-calling every now and then. Every VC does some portion of this, although the hit rate on outbound sourcing tends to be lower than for inbound. That’s not to say that outbound sourcing doesn’t produce a great investment every now and then (especially if the VC is consistent in his/her outreach), but that the probability of finding one is lower on average.
Why’s that? Our inbound sourcing already has a filter on it — our network. Inbound consists of friends, executives at big companies, portfolio company managers or customers, service providers, other VCs, and (occasionally) investment bankers. Because inbound deals tend to have a higher hit rate, VCs like to maximize their productivity by preferentially focusing on them. This is why a “warm introduction” is often so much better for entrepreneurs when raising money.
#2: Due Diligence
Once we decide an opportunity has passed the initial hurdle, we dig in deeper and kick off some form of due diligence. The degree of breadth and depth of a due diligence process varies greatly with sector, stage, and the VC’s prior experience with related companies. However, at a minimum, a good due diligence plan typically consists of:
- Management references
- Market size and growth outlook
- Customer interviews
- Technology/IP deep dive
- Competitive assessment
- Customer unit economics / value proposition breakdown across use cases
- COGS breakdown and roadmap (if applicable)
- Detailed financial plan (to some reasonable degree of precision)
Much of this must be done “off-list” to avoid inevitable biases. Good VCs have great networks with customers and industry experts and can answer their own questions in a fairly expeditious manner.
#3: Selling deals
This one is often overlooked, but is absolutely crucial. The best deals are often competitive, and everyone’s money is the same color. How does a VC convince a compelling entrepreneur to work with him or her? There’s obviously no formula, and a lot of it comes down to personal fit. Also important are perceived value add, timing, and sometimes deal terms.
Selling deals internally is also important. Most venture firms are partnerships, and some firms have partners with different practice areas. Part of the job of a VC is to educate his or her partners on the merits and risks of a particular deal, incorporate their feedback into the due diligence plan, and make a recommendation to proceed or pass. It’s almost never the case that everyone agrees 100% on an investment, so managing that process internally is an important skill.
#4: Helping companies
If you read a lot of VC blogs nowadays, you may think that all we do is #1-3. VCs, micro-VCs, angels, super-angels, etc all talk about getting deals done ad nauseum. I like to think of #1-3 as a sprint, followed by a marathon.
The marathon is #4. And, winning the sprint is totally irrelevant if you lose the marathon. (The sprint is fun, but it’s all about the cardio if you want to finish the race.)
How do we help our companies? For one, we’ve collectively “seen the movie” several hundred times before. The most intangible, but significant value add is therefore the advice we can provide based on contextual awareness from decades of helping great people build great companies. In addition, we also do the following:
- Help recruit senior executives, board members, and advisers
- Make introductions to customers, suppliers, partners, other portfolio company executives, etc.
- Give feedback on specific startup competencies (e.g. building an inside sales force, how to price your product, etc.)
- Provide guidance during fund raising, M&A, or IPO processes (see #5)
#5: Exiting companies
When you start a company, especially your first, the exit is often a distant thought. Yet, by definition, this is where all that value you created is captured, so it’s very important you have someone on your side who has been through an M&A or IPO process before. It’s also not uncommon for companies to have several acquisition offers before the eventual exit. These offers can come from customers or business partners, so you need to handle the conversation carefully. A little guidance from a VC who has, once again, “seen the movie before” can go a long way in these situations.
So, that’s what we do.
While the public discourse tends to center around #1-3, we actually spend most of our time on #4, trying to help our portfolio companies succeed. During a VC’s career, he or she will typically start at #1 and shift towards #5 over time.
Hopefully, this post gives you a better understanding about what VCs do all day long. We have, without a doubt, the most fun job on the planet; but we also work hard to find great entrepreneurs, back them, help them grow their companies, and eventually help them capture the value they have created.