Module 1: What Is Venture Capital and When Do I Get My Money Back?

We break down who the VC players are (from angels to family offices and everything in between) and what the lifecycle of your investment looks like.

By Megan Ananian

Design by Perri Tomkiewicz

The VC Landscape—Who Are the Players?

An important first step in understanding venture capital as an asset class is understanding the players. At a high level, venture capital is a two-sided marketplace: founders of startups are raising capital and investors are deploying capital into those startups. Simple enough, right?

Let’s start with the investors:

1. Angel investors—that’s you! Historically, angels have been high-net-worth individuals (more often than not men) who are making direct investments into startups, typically at the very early stages. But today, there is a movement to democratize access to this asset class for all individuals, regardless of accreditation.

a) Angel syndicates—that’s us via Membership! Individual investors pool their capital and invest as a group called a syndicate. Instead of investing individually, we use SPVs [special purpose vehicles] to aggregate our checks into a single investment. Founders like this because it means adding just one investor to their cap table, which means fewer legal costs and fewer individual parties to communicate with. Angels like this because they have access to deals they might otherwise not, at a lower check size.

2. Venture capital funds—these are pooled investment funds that have raised capital from Limited Partners to invest in startups for financial gain. In simple terms, a venture capital fund’s General Partners make the investments, and Limited Partners provide the capital. Of the $69 trillion of private capital under management in the U.S., only 1.3 percent is managed by funds majority-owned by women and minorities, according to a 2019 survey. Despite this, funds managed by women are more likely to be in the top 25 percent of performance.

a) Micro-VC funds/ Emerging fund managers—that’s us at The Helm! In the last 10 years, there has been a boom in emerging fund managers raising their own funds rather than joining an established VC fund. These emerging funds typically have less than $100M AUM [assets under management] and apply to managers who have raised less than three funds. We are the startups of the investor world. According to PitchBook only 100 micro-VC firms were active in 2012, and as of October 2019 more than 900 micro-VC funds had been launched resulting in ~9x growth in just seven years. (Fun fact: According to Cambridge Associates, the majority of the best performing funds are actually new and emerging managers rather than the established firms.) You might have also heard the term rolling fund which is a type of investment vehicle aimed at democratizing access to fundraising for emerging fund managers.

b) Traditional VC funds—this encompasses the rest of the institutional VC world. Traditional VC funds started in Silicon Valley on Sand Hill Road back in the 1970s with names like Kleiner Perkins and Sequoia that now manage billions of dollars of capital.

The venture capital industry is still at least 82 percent male, according to an Equal Ventures analysis of about 1,500 VCs. Another study put the number as high as 91 percent.

3. Corporate VC firms—these are corporations that have allocated capital to invest in startups for strategic value. For example, you’re Salesforce and you want to invest in companies that are complementary or potentially disruptive to your business. Corporate funds usually make less than four investments per year (versus VC investors whose full-time job is to source investments) and typically do not lead investment rounds. Examples: Citi Ventures investing in Plaid, and Salesforce investing in Databricks. 

4. Family offices—think of this as general wealth management for an ultra high-net-worth family. A family office invests in all sorts of assets (public equities, real estate, art) and in the last 10 years, they have become increasingly interested in venture capital. These are either single families or multiple families who are pooling their wealth to invest. They are concerned about legacy planning and the tax implications of their investments. Finding family offices can be tough for founders looking to raise money; they are typically very private (without external-facing websites) and much like corporate VCs, are opportunistic to deals put in front of them versus actively seeking out investments. Additionally, their thesis and decision-making process for investment can be opaque. 

5. Equity crowdfunding platformsequity crowdfunding was born from the JOBS Act President Obama signed into law in 2012. It allows startups to raise equity capital from non-accredited investors through platforms like Seedinvest and Republic. Unlike Kickstarter, an investor will own equity in the business just like an angel investor does. Be careful here: while some platforms diligence the investments, some just serve as a listing platform, meaning you must do all of your own research.

6. Private equity funds—private equity refers to capital invested in companies that are not yet publicly traded. Venture capital is a subset of private equity that typically applies to startups in the growth stage.  Private equity is most commonly used to describe investments made further downstream, i.e. companies that are mature and no longer rapidly growing.

Fun fact: According to CALPERS, Private Equity and Venture Capital have been the best-returning asset class consistently across 1, 3, 5, 10, and 20-year horizons, with a 6-8 percent premium over all other asset classes (stocks, bonds, real estate, and others).
According to Cambridge Associates, the 30-year annual average for VC returns was 18 percent—2x the S&P 500. That being said, with high reward comes high risk. Venture capital is deemed a long-term, risky investment as many of the companies backed will return little to nothing. The goal is to back one or two within a portfolio that return many times their initial investment and cover all other losses.

A quick note on accreditation:

  • Accredited investors—a term coined by the SEC to determine who has the financial “sophistication” to invest in alternative investments (“Alternative” assets include private equity, private debt, real estate, and commodities. Traditional assets are defined as stocks and bonds). Historically, accreditation has been accessible to high-net-worth individuals who have either 1) an income of higher than $200,000 for an individual or $300,000 with a spouse or 2) a net worth of more than $1 million not including your primary residence. There has been pushback in recent years from people across industries who do not believe wealth is synonymous with financial “sophistication”. Instead, a more equitable entry into accreditation would be to create a knowledge certification for people who want to invest in alternative assets, but do not meet the wealth requirements.  Women control 51 percent of the personal wealth in the US, according to New York Life Investment Management. Yet, traditionally, only 5 percent of female-identifying accredited investors actually angel invest.
  • Non-accredited investors—individuals who do not meet the requirements above. In December 2020, the SEC took the first step to change the accreditation rules by allowing investment team members of funds, and holders of FINRA licenses, to be accredited investors. More on this topic to come.

Who else plays in the playground?

1. Incubators—an organization that helps “incubate” an idea for a company and takes a portion of ownership in exchange for their services. They help founders think through business models, go-to-market strategies, and building an MVP [minimum viable product]. 

2. Accelerators—an organization that helps “accelerate” a company. Companies applying to accelerator programs typically already have an MVP and product roadmap, but are looking for help from mentors and investors to quickly scale. For example, Techstars typically takes 6 percent of a company in exchange for acceptance into their program and a $20K investment. Other examples: 500 Startups, Y Combinator, ERA, Acceleprise. Demo Days are the graduation days from these programs where investors come to see founder presentations. 

3. Startup studios—an organization that builds startups from the ground up. They come up with an idea, build an MVP, then recruit the talent to lead the organization and spin it out from the startup studio. Examples: Good Machine, 25 Madison, Rocket Internet (Global Founders Capital), Human Ventures, M13, Madrona.

Who are the founders raising capital? An important distinction to make is that not all businesses are VC-backable. VCs are investing with the expectation of billion-dollar exits. Not all businesses can nor should grow at that rate, and owning a small or medium business can be a great lifestyle choice for some founders. To be attractive to a venture firm, a founder should have high barriers to entry in a new market or be building a new, differentiated, and defensible product. 

VC Timelines and Lifecycles

When is the right time to invest in a company? And when should you expect to get your money back? Understanding the stages of a startup lifecycle (from idea to launch to growth) and the unique challenges that each stage presents is important to an angel investor’s success. 

Let’s start with the typical VC funding rounds and what they mean, with a quick note for clarity: fundraising rounds aren’t nearly as rigid as they used to be. The below terms are rules of thumb—a baseline with which to approach the industry—but there are great companies that might fall outside these parameters.

1. Bootstrapping: This is when a company has not raised any, or very little, external capital. The founder chooses to put every dollar made back into the company, typically foregoing a salary. They keep their expenses lean and focus on building revenue before asking for investor money. This allows the founder to preserve their ownership until they are confident of the company’s value. 

2. Friends & Family: Investors typically want to know that a founder can convince others of their vision. Have they raised money from friends and family to build their MVP? Not everyone has a wealthy network they can ask for capital, so angel investors can step up to fill this gap.

3. Pre-Seed: A company at this stage is generally pre-product (no MVP has been built) or post-product, but pre-revenue (they’ve built it, but haven’t yet started generating revenue). There is usually a full-time team in place and there might be pilot customers or limited traction. Most valuations are in the $3 million to $5 million range.

4. Seed: A company at this stage typically is post-product and post-revenue although the revenue is limited to $0-$100,000 per month. They’ve demonstrated demand, but haven’t quite figured out product-market fit. Valuations are usually between $4 million and $9 million.

5. Series A: A company has proven product-market fit with a repeatable sales process approaching $1 million annual run rate. In fact, 82 percent of companies at this stage are revenue-generating. The average startup raises a total of $3 million to $5 million prior to raising a Series A and then they make the big leap—at Series A, they are raising, on average, $12 million to $15 million at a time.

6. Series B: A company is past the development stage, has built a sizeable user base and is beginning to scale. The average capital raised in a Series B round is $33 million with valuations averaging $60 million.

7. Series C and beyond: Generally considered late-stage VC, the focus at this stage is to scale, maximize market share, make acquisitions, and prepare for IPO [initial public offering]. Most companies will stop raising external capital at Series C, but some will continue to Series E and beyond.

8. Bridge: In the real world, you don’t always jump from front point A to point B. Sometimes you have to build a bridge to get there. That’s what bridge rounds are for. A company hasn’t quite hit the milestones for the next round of financing, but they need additional runway to get them there. To do that, they raise a “bridge round.” Usually, they do so by going back to existing investors and asking them to put additional capital in, though they can also bring in new investors at this time.

9. Acquisition or IPO: A liquidity event like an acquisition (where a company is acquired by a larger company) or an IPO can come at any point in the above lifecycle. A company “going public” means selling shares to the general public at a predetermined price. As private investors, we seek to get our capital back plus profits based on the valuation of the company at that time. Including the recent IPO of Bumble, only 21 companies with female founders have gone public. This is why it’s important we help them get there.

Nearly 67 percent of startups stall at some point in the VC process and fail to exit or raise follow-on funding. Only 48 percent of startups manage to raise a second round of funding and only 15 percent of companies go on to raise a fourth round of funding, which typically corresponds to a Series C round

What this means to you as an angel investor with The Helm: 

1. Think long-term: We are typically investing at the pre-seed or seed stages so you should expect to hold your investment for up to 10 years before a liquidity event. Female-led companies have a shorter median exit timeframe (6.7 years) than the average company (7.5 years).  

2. Infrequent information: This is not like Robinhood where you can log in and see the price of your investments change daily. Though information rights may be made available, access can depend on the ownership percentage of an investor, and the scope of information made available by each founder may vary. This also means you will, most likely, not have tax forms to file annually unless there is a material event.

3. Percentage of investment portfolio: Financial advisors recommend you pay off any high-interest debts (like credit cards) and save for an emergency cash fund (usually six months of living expenses) before allocating your remaining savings to investments. Wealth managers typically take the amount you hope to invest in total across all asset classes (stock market, real estate, etc.) and allocate 15 percent of that to venture capital.

4. Diversification: These are risky investments. Most startups fail. Because of this, we advise you to invest in at least five startups to diversify your portfolio and therefore, your outcomes. Take the amount of capital you hope to invest in venture capital over the next three years and divide by five to figure out the size of investments you can make into each company.

This module was created from our experience investing in more than 50 companies, however, each reference point is by no means textbook. Instead, we hope you use these lessons to guide your understanding of fundraising rounds, which we hope you expand upon during your time with us. Through The Helm Membership, we will connect you to founders in the early stages of their startups, typically raising pre-seed to seed rounds. By definition, we are “seeding” their businesses. They won’t have all the answers to what the future holds, but they’re hoping to grow and scale towards an IPO and we’ll be here to help.

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