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Understanding the questions behind a VC’s questions: Part 2 — How deep is the hole?
This is the second in a series. To see part 1, What the F is “fit?” please go here.
How deep is the hole?
one quetsion before I jump…How far down is it?”]
Early stage investing is about the excitement generated by a big idea in a big market being built by a great team. But it is also about understanding how much capital the company will require over its life and what this means for the value of the current investment in terms of dilution (or required follow-on to avoid dilution). These questions also helps set reasonable expectations for the entrepreneur’s ability to de-risk the business with the current financing. For example, a business currently raising 10% of its total projected capital needs may not be able to significantly de-risk the business prior to raising additional capital and may want to think about getting a little more runway to be able to make more progress before raising more money.
The outside capital needs of a business help investors assess the level of “fit” that the business has with the investment model. In my time with First Round, I have seen lots of great ideas that we were not able to fund because of the long-term capital needs of the business or industry.
When an investor asks some of the following questions from Brad’s post, they are really peering down a hole and looking for the bottom.
WHAT ARE YOUR PLANS FOR FUND RAISING?
- What funds have already been raised?
- How much money are you raising and at what valuation?
- How will the money be spent?
- How long will it last and where will the company “be” on its milestones progress at that time?
- How much additional funding do you anticipate raising & when?
HOW DO YOU ACQUIRE CUSTOMERS?
- What is your cost to acquire a customer?
- How will this acquisition cost change over time and why?
- What is the lifetime value of a customer?
WHAT IS YOUR REVENUE MODEL?
- How do you make money?
- What is your revenue model?
As an entrepreneur, targeting potential investors who are comfortable with the capital requirements of your business and have knowledge of the industry you are entering will make this part of your meeting much more successful. You will find the fit with someone who understands why you are raising the level of your current round, agrees with how you plan to utilize the money and the time you are allowing your team to iterate and learn in order to show meaningful progress prior to the next round of fund-raising begins.
The next step is figuring out how long we will be working to climb to success and if the core methodology of the team will allow for the learning required to discover product/market fit. Eric Ries has written about this here and here. I hope to add to this conversation when I put together my thoughts on the climb toward sustainability tomorrow.