Adam Rudowski

Venture Capital Way

or the Founder v Fund Game

If we were to define Venture Capital in simple terms we’d say that it describes a capital investment in early stage business ventures. Investments are made by highly specialized VC funds, which start by raising capital from Limited Partners – such as pension funds, state funds, foundations, private investors, etc. – and then transfer capital to organizations at early stages of development (i.e. startups). Importantly, investments are made in return for equity. We are talking about investing in companies that are still looking for the right business model, testing the market, their target groups, and revenue streams; that’s why venture capital is a high risk affair. But a simple definition does not reflect how nuanced that industry really is, and skips over the unwritten rules that you need to know in order to succeed.

VCs base their portfolio strategy around a process that enables them to minimize risk when choosing young companies to invest in. They are thus able to pick companies that display the greatest potential for global development and, in a five to seven-year term, may score them a hundredfold return on investment. Granted, not every company will secure a ROI in this region and not every company will turn out to be a unicorn (i.e. reach a valuation in excess of USD 1 bn). Numbers are very clear here – approx. 100 out of 1000 VC-supported startups will bring a severalfold profit, and only a few of these may carry on to become unicorns. That’s the reason it is crucial for a VC to diversify its investment portfolio, both in terms of the target market, business model as well as monetization. It’s worth pointing out that venture capital is an attractive asset class – it’s been valued at USD 172 bn globally in 2021 and regularly posted the highest returns among different asset classes across the past decade.

Three VC Pillars – Disruption, Investment Trends, and the Investment Horizon

VCs are doing a straightforward job – take the capital entrusted to them by Limited Partners and multiply it. When successfully executed this leads to global scaling and growth of innovative companies which is a positive economic effect that stimulates the growth of entire economies. This is obviously the case in countries with a mature VC landscape. There are a number of pillars that instruct and define how VCs are making their investments. A fund is looking for a top young company showing signs that it’s ready to grow at a rapid pace, gain global market share, and deliver a high ROI. So what kind of a company ticks all the boxes? One that will permanently change the way a particular industry operates or one that will influence the behavior of a large group of clients. VCs are looking for startups that deliver innovative products, and – even better – startups that deliver innovation which stems from market disruption. COVID-19 or the war in Ukraine are prime examples of disruption as they have initiated what is known as investment trends – waves of new products and companies that significantly affect our civilization progress and economic development. We also like to focus on the speed of scaling as ROI should be generated within seven years. That’s a relatively quick turnaround when you’re talking about building a global brand that generates revenues to the tune of hundreds of millions of dollars and is valued at over USD 1 bn.

Startup – a Smaller Version of an Enterprise?

Simply put, a startup is created with a view to find a repeatable and scalable use case. Company structure should enable steady market share increase as well as rapid and global growth. It should also take into account the interests of investors funding the scaling, i.e. their lucrative exit at a certain point in time.

Keep in mind that a startup should not be looked at as a smaller version of a mature organization. Its growth depends on different factors. The VC Way is a set of globally valid standards designed to enable businesses to grow and scale from zero to a global level over a short period of time.

The VC Way or What Comes After the Pitch Deck?

I already mentioned that a founder who pursues the VC Way decides to play the game according to certain rules. Most startups operate with next to no capital and resources, and in order to secure them they must regularly obtain external funding. This is what investment rounds are for.
The capital thus secured enables investments in product development, product/market fit search, hiring staff, and – finally – moving onto sales and marketing in vertical and geographic markets.

Go or no go or the Make or Break in 5 Minutes

Every VC receives between several hundred to several thousand pitch decks (i.e. startup presentations) per year; and the largest among them, such as a16z or Seqouia Capital, even up to tens of thousands. It comes as no surprise that the initial project evaluation time boils down to about five minutes on average. In case a VC finds the five crucial pitch deck components to be unappealing, then… well, that startup is basically out of the frame. The above components are: market size, gravity of the issue the company wants to solve for, team experience and competence, product profitability, and the market entry strategy.

What makes these components so significant? First of all, the chosen market must grow at a fast rate and, ultimately, prove to be large enough to provide the company with enough room for development. A small or a shrinking market preclude the creation of a large company. As long as venture capitalists are in a position to exit the company before it peaks, they can achieve extraordinary and relatively low-risk profits. The problem that the company wants to solve for should be well-defined and of great import. This is where you often see the genuine difference between people with industry backgrounds and those who think they know how companies in this industry are supposed to operate. Also, founders should have the necessary competences required to actually develop a startup – from designing its strategy and product development, through to sales, marketing, management, technology, all the way to HR. Previous experience in building companies, both positive and negative, is welcome. The product itself must be innovative (or at least delivered within an attractive business model) and guarantee profitability. At this juncture allow me to quickly return to the notion of investment trends resulting from disruption. Why is that? There’s a straightforward explanation – VCs are well aware that markets expand the fastest within the perimeters of such trends and thus ‘drag’ the startups along with them, in turn enabling startups to benefit from the markets’ expansion. Finally, we’re left with the market entry strategy, which should be consistent and provide opportunities for exponential growth. Every startup should have a well-structured plan describing the way it’s going to spend the money it’s after and what milestones it plans to achieve once the funding is secured – but that’s an obvious thing I don’t want to dwell on for too long. Pitch deck is every startup’s promise of what the investors are going to get in return for their capital. And if a startup is serious about talking to VCs then their pitch deck must be credible.

From Seed to Exit

A startup which satisfies demands posed by the five components above has potential to succeed. However, the founders are facing a long and arduous journey from this point onwards – starting from having an idea written down on a piece of paper, through to building a product and the company, scaling the business on international markets, all the way to an exit – most often via an IPO or acquisition by an industry investor. They will also have to deal with at least several funding rounds, from early pre-seed, seed, and Round A; through the growth phase, i.e. rounds B, C, D, and beyond. What should happen in each round so that further funding can be secured in the following round(s)? What are the VCs actually looking at?

In the seed phase, startups focus on problem definition and the product/market fit. At this stage a project’s success hinges on early validation which is designed to determine whether a product solves for an existing, important problem experienced by potential customers. If successfully validated, the building a Minimum Viable Product (MVP) comes next – that’s the product’s initial version. Afterwards we move onto customer acquisition which is linked to generation of recurring revenues. It is desirable for the end of the seed stage to be marked by a team’s ability to demonstrate an increase in recurring revenues coming from the domestic market and robust plans to launch the product on foreign markets. It must be emphasized that sales should be underpinned by constant product improvement, development of new features, as well as taking all the necessary measures to protect intellectual property. Round A is about securing funding aimed at expansion of the domestic customer base, entering one large or several smaller foreign markets, and further product development. Following Round A, a startup should be able to demonstrate permanent revenue growth, i.e. prove its market traction, preferably when sales reach the hockey stick curve period (synonymous with exponential growth). If proper market traction is achieved on foreign markets as well, then preparations for the growth phase may commence. Round B – the initial stage of this phase – validates scalability, which means it assesses whether sustained growth in a number of markets is being achieved, looks at the efficiency of processes, as well as the ability to execute a long-term globalization strategy. Round C and the following rounds making up the growth phase usually focus on expanding and solidifying a startup’s market share, both by entering new foreign markets and by means of a local acquisition strategy.

In high funding rounds attracting new investors often boils down to a few elements: the company’s ability to deliver on its plans or, even better, whether it’s able to exceed its delivery plans; defensibility – or, simply put, how difficult is it to engage in direct competition with it; and whether there are quality investors and advisers present in its cap table. VCs will always assess one’s ability to deliver on one’s plans, not only in terms of revenues or geographical expansion, but also by looking at margins, customer acquisition cost, churn, product development outlays, and the ability to constantly increase the company's value. These are just a few metrics and, given they’re industry-specific, more may come along depending on what industry a startup operates in.

The VC Winter or in other words – prepare for the worst and hope for the best

Every founder's life is punctuated by peaks and troughs, so it makes perfect sense to brace oneself for when difficult times kick in or Plan A does indeed fail. The VC industry witnessed several periods of significant freeze already. Known as the VC Winter, it was most often the result of a collapse in the share price of technology companies listed on US stock exchanges and a growing economic uncertainty. The drop in the valuation of listed companies resulted in the inability to carry out IPOs (exit) as well as declines in valuation multiples. This, of course, was paired with the outflow of investment capital towards lower risk instruments. Spreading globally, it generated a widespread decline in startup valuations – even by up to 90% – and rendered the task of obtaining further funding rounds a truly difficult one. Available capital levels dropped drastically relative to the period of prosperity, competition among startups intensified, and investing conditions – from the founders’ perspective – seriously deteriorated. After the corrections of 2001 and 2008 we are currently dealing with one right now. This should ring alarm bells as funding may be hard to come by.

A number of things are of paramount importance during the VC Winter period: budgetary discipline, the ability to cut costs, and knowing one’s key resources needed for development. It basically comes down to drawing up and implementing a survival plan, often enabling the breakeven point (BEP) to be achieved. Experience shows that startups with a robust business model, a good strategy, and ones not shying away from difficult decisions to cut resources – are going to find joy in the eyes of investors. And, as is the case with any business cycle, the VC Winter is always followed by a rebound. Successful startups can expect significantly better valuations in the future. Additionally, they will know how to do business during an economic downturn. And you can’t put a price tag on that.

Related articles

Magdalena Pawłowska

Ensuring alignment of vision and values

Magdalena Pawłowska

Fundraising in a Challenging Market Environment

We are


Level2 Ventures B.V.

De Boelelaan 7

1083HJ Amsterdam