Behind the Scenes at a VC Fund, Part 1: Deals, Deals, Deals
My fund, Susa Ventures, just added Natalie Dillon to our team. She’s our first-ever investment team hire and we’re very excited to work with her. While speaking with dozens of wonderful candidates for the role, I was reminded of how opaque venture capital is as a profession. Many of the candidates asked what a typical day and a typical month are like for a VC. Is it schmoozing at parties for 40 hours a week? Taking back-to-back investment calls while lounging on some tropical beach? Making million-dollar decisions using coin flips? Reading technical research papers? (Answers: no, no, no, and hardly ever.) Now that I’ve been doing this job for a while, I thought it might be useful to document what working in venture capital is like for anyone who may be curious. This 3-part series is a summary of my experience being one of three partners at Susa Ventures, a seed stage fund. Single-partner funds and later stage funds might operate a little differently. YMMV.
Table of Contents
VCs have 3 principal jobs: picking startups to invest in, helping startups after investing, and raising capital for the fund. Each of these jobs will be covered in its own post.
Part 1: Deals, Deals, Deals [this post]
A post on how investors interact with companies after investing, and how they allocate their time on a day-by-day basis.
A post on the basic mechanics of how VC funds are structured and raised, how VCs interact with their own investors, and venture capital FAQs.
Portfolio Company – a company that the fund has already invested in.
Deal – a startup investment opportunity. Common usages: “we did a drone deal last month” and “did you see that autonomous car deal from Boston?”
Finding Startup Investments
When looking for startups to invest in, most funds rely on many different sources:
Accelerators and Incubators (Y Combinator, Techstars, Alchemist, Acceleprise, etc). Most of these accelerators have demo days every 3-6 months, and a typical demo day features 10-30 companies. Y Combinator is an exception, typically showcasing 100+ companies over two days.
Earlier stage investors, like angels or pre-seed funds. These investors might get involved with a company 3-6 months before its seed round. Once the company makes a little bit of progress, its early investors will introduce it to seed funds.
Other seed funds. A typical seed round in Silicon Valley might include 2-5 seed funds. Because no seed fund takes up the whole round, whenever one fund invests, they will usually introduce the founder to other good seed funds.
Series A funds. Sometimes later stage funds see companies that are too early for them, so they forward those companies to seed funds that they like working with.
Introductions from founders. These introductions might come from founders in an investor’s portfolio, or from founders whose companies the investor has previously passed on. These intros are an incentive for investors to be as nice and as helpful to founders as possible.
Miscellaneous intros from service providers, friends, ex-colleagues, your parents’ neighbor’s best friend, etc. These intros are good, but often weaker than founder intros. “You should invest in Bob’s company because Bob is my son’s best friend” just isn’t that compelling.
Cold inbound emails from founders. Investors often receive dozens or even hundreds of inbound pitches every month.
Cold outbound emails to founders. Many VCs will actively reach out to founders. This commonly happens if an investor lacks a warm intro to a company that they’ve heard about, or if an investor is doing a deep dive into a sector and trying to talk to as many promising companies in that sector as they can.
The Due Diligence Process
In order to figure out which companies to invest in, most seed funds have a standard diligence process. A typical process will contain the following steps:
Screening. One of the partners sees a demo day pitch or gets a cold email or a warm intro offer to a company. The partner spends 0-15 minutes on research to decide if the company might be a good fit for the fund.
1:1 pitch meeting. If the company might be a fit, the partner will do a 30-60 minute pitch meeting (either in person or via phone).
Research. If the 1:1 meeting goes well, the partner will do some more research and ask the founder additional questions – either over email or another 1:1 meeting/call.
Group meeting. If the research phase goes well, the founder is invited to do a pitch meeting with all of the fund’s partners.
Customer and founder references. For companies that do very well during a group meeting, the partners will do customer and founder reference calls. The purpose of customer calls is to get more insight into how customers view a product, how much they value it, how they’ve liked working with the startup in question, how they discovered the product in the first place, and so on.
The investment funnel for a single calendar year might look like this:
*2000* screened companies -> *500* 1:1 partner meetings -> *300* further research -> *150* group meetings -> *25* further diligence (customer/founder calls) -> *12* investments
Pitch Meeting Structure
Pitch meetings are usually 30-60 minutes. They tend to be shorter during the early phases of diligence and longer in later stages where more partners are involved.
A typical meeting might start with a few minutes of friendly chit-chat. After that, everyone introduces themselves, and then the founder walks through their pitch. Sometimes the walkthrough is a few minutes because everyone around the table has been doing homework and research for a while, and sometimes it’s 15-30 minutes when the material is new to everyone.
After the pitch, investors will ask a lot of questions about the startup. Their goal is to figure out if they might be looking at one of the top ~1% of companies they’ll see all year. Whether something might be in the top 1% is based on many things, and common topics of discussion include:
The founding team: what are the founders’ backgrounds? How long they’ve known each other? What are their individual strengths and weaknesses?
The problem being tackled: how severe is the problem (the old vitamin vs painkiller dichotomy)? How many people have it? How much would customers pay for the solution?
The solution being proposed: how is it different from existing solutions? How much better is it? How long would it take to build and how much has been built already? Is there a demo? What are future directions for the product?
Traction so far: are there users or customers? How many? How fast is usage growing? How engaged are the customers? Do they ever churn, and if so, why?
Competitive landscape: who is the company competing with? How does it differentiate from its closest competitors? Is there a sustainable competitive advantage (i.e. moat) that ideally gets stronger over time?
Fundraising plans: how much does the company want to raise? How will capital be used? How much time will the seed funding buy, and what kind of milestones could be reached during that period? Is the valuation for the round set, or is the company looking for a lead investor to set the valuation?
Finally, pitch meetings usually end with the founders having a chance to ask the VC questions. (The two most common questions that founders ask, by far: “How can you help beyond capital?” and “What’s your decision-making process and what are the next steps?”)
Partner Meeting Structure
Partner meetings are weekly multi-hour meetings where the bulk of a fund’s decision-making occurs. A typical partner meeting agenda could include:
Updates on portfolio companies. Each partner discusses updates on companies they’ve met with or emailed with since the last partner meeting.
Back office discussions. Partner meetings are a good venue for discussing upcoming hiring decisions, accounting or legal TODOs, fundraising plans, and so on.
Industry analysis. Partners often talk about trends they’re noticing, observations about the funding climate, and other macro topics that are worth discussing with the entire group.
Decisions on startups that are being diligenced. Partners will go one-by-one through the active companies in their deal-tracking tool (e.g. Affinity). For each company, there’s a decision made about whether to invest, continue doing diligence, or pass. This is the longest, most important part of partner meetings, and it will be discussed next.
Making Investment Decisions
A typical seed VC that’s exposed to 1000-2000 companies per year might only make 10-20 investments. As you might expect from these numbers, picking companies to invest in is probably the hardest part of being a VC.
Most Silicon Valley investors aspire to find companies that have the potential to reach $1b+ exits because those mega-exits are the source of the majority of venture returns. The challenge is that while a 50th percentile company looks very different from a 90th percentile company, and the 90th percentile is distinguishable from the 97th percentile, the top few percent of companies are all very good. It’s hard to to guess which of those top companies have a shot to exit for $1b or $5b (which would be amazing for a seed fund) and which ones are more likely to top out at $40m or $100m (which is still very good, but far from amazing for the fund).
To help make these educated guesses decisions, investors usually think about three attributes: the quality of the founding team, the size of the market, and the product itself. Each investor tends to weigh these attributes differently – i.e. would they prefer to invest in a stellar team with a good product or a good team with a stellar product? A stellar team and a stellar product would be ideal, but that’s (unsurprisingly) rare.
If a fund has multiple partners – and most do – then all of the partners’ votes for each investing decision need to be weighted. Here are different vote-weighting strategies that I’ve heard of:
Every partner has to love a deal.
Most partners have to love a deal.
If one partner loves a deal, the investment happens regardless of what anyone else thinks.
Additionally, some funds allow partners to veto investments, others do not. Finally, funds where investments require buy-in from multiple partners sometimes grant each partner a “silver bullet,” which is the right to make a unilateral investment once every few years.
After all diligence for a company has been completed, the partners will discuss their thoughts at the partner meeting. Each person talks about what they like and dislike about an investment opportunity, and then offers their vote. After the votes are weighted, the final decision is made on whether to invest or to pass.
If the partners decide to pass, one of them will notify the founder over a phone call or via email. Ideally, the decision to pass is conveyed along with the reasons for passing. In reality, some investors give great feedback, others say something generic like “sorry, this is too early for us,” and others just go cold (which is a jerk move).
If the partners decide to invest, one of them will reach out to the founder and make an offer. Sometimes the founder might negotiate the terms, or ask to speak to a few of the VC’s portfolio founders as a reference check. After that’s done, the deal enters the legal paperwork phase, which can take anywhere from a day or two to a month or two.
This post talked about how funds source, analyze, and choose companies to invest in. The next post in this series will cover how investors try to help their portfolio companies and how they spend their time in general. To give a sense of the latter, the post will include a numeric breakdown of where I spent my time over a 2-month period where I tracked and categorized every meeting.