When I meet with entrepreneurs, I am often asked about the VC “pipeline.”
How many deals do we see? How many meetings? How often do we conduct due diligence? How many of those companies do we invest in?
I thought it would be helpful to provide visibility about the VC pipeline, while also outlining what helps a company move from an intro meeting into a closed investment.
In order to make 10 investments, the average venture capital firm reviews approximately 1,200 companies.
Leads: These 1,200 come from network introductions, conferences, in-bound inquiries, proactive efforts, portfolio company referrals, and seed investors. Of the 1,200, we find that approximately 500 lead to face-to-face meetings with someone on the investment team.
The most important factor in securing a meeting is the background of the founders. Do they have the skills and experience for the opportunity they are pursuing?
Of course, the pitch also matters: Is it concise and compelling?
In addition, most venture firms like to make sure that a company is not competitive with a current portfolio company.
Personally, the primary reason I don’t meet in person with in-bound requests is that the entrepreneur was not vetted by someone I trust.
Meetings: The average venture firm has approximately 500 face-to-face meetings each year, yet only 10 percent progress from that stage. What makes a venture firm want to dig in and spend the time required to do proper due diligence?
First, most early stage VC firms look for demonstrated product/market fit. At Emergence, we also want to confirm that the company is solving a problem that is relevant outside of Silicon Valley. Too often only customers are in the Bay Area, and they are friends of the founders, which means no proof of a real market.
One of the reasons that a meeting doesn’t go well is that the founding team will say they expect $50 million in revenue in 5 years, but they have difficulty articulating how they’ll get to their first $1million.
Due Diligence: Of these 500 meetings, a mid-sized venture firm may perform due diligence on approximately 50 companies in a year.
Due diligence consists of a product review, customer references, executive team references, financial modeling, market analysis and competitive analysis. Passionate customers who are very engaged with the product can really make a difference during due diligence.
Venture firms also look for at least 100 percent annual revenue growth in the first few years. However, often companies don’t meet short-term projections set in earlier meetings, and firms can lose confidence in their future projections.
Venture firms are also wary of high rates of churn and customer concentration.
Investments: In a typical mid-size venture firm, the 50 companies may generate 10 investments. Why do these companies stand out? A couple items are critical, such as efficient customer acquisition and a magnetic CEO that people follow. It’s a huge red flag if former employees don’t want to work with the CEO again.
With respect to market size, at Emergence, we like to see a reasonable path to $100 million in annualized revenue. For an industry focused solution, a $300 million market size is sufficient since if they become an industry standard they can get 30 to 50 percent of the market. For a horizontal solution that solves pain points across industries, a company needs $1 billion market size, since the market leader may only get 5 to 10 percent of the market.
While it may seem that one percent represents depressing odds for a founder to secure VC funding, in reality, the process tends to help entrepreneurs refine their strategy. If the first meeting didn’t result in moving to the next phase, a good venture firm will provide specific feedback and guidance. Most venture firms stay in touch with founders they have met in the past, and it is exciting when future meetings highlight changes that have led to more traction.
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Sean Jacobsohn is a venture partner at Emergence Capital Partners. He joined Emergence Capital after being an executive and advisor at portfolio companies Hightail and Doximity, respectively. In addition to being a sales and alliances executive in the technology enabled services space for 13 years, he is cofounder and co-president of the Harvard Business School Alumni Angels, the largest university-affiliated angel group in the world.