Fundamentals of Venture Capital
Written by William Lin. Published by Wiley in 2024
The author is an experienced VC who used the well known Three Ts with its 3 key factors: Team, Total Addressable Market (TAM), and sometimes Technology or Timing. However, the author felt this was insufficient. He found that investing into innovative industries lacked success metrics.
With help from his colleages he developed “The Venture Capital Investment Framework” (VCIF). It’s built on the following six crucial components to evaluate investment opportunities:
1: Who = Team
Start by assessing the founding team of the startup. Look for qualities like curiosity, resilience, and complementary skill sets. Consider the team’s ability to navigate challenges and work well together.
2: What = Problem
Identify and understand the problem a startup aims to solve. Deep questioning and first principles thinking are encouraged. Use common sense and avoiding personal biases. Solving one problem well and building the right solution are key factors.
3: When = Timing
The rise and fall of companies is often in relation to timing. Assess the environmental factors, market trends, and potential disruptions that can impact the startup’s success. Evaluate how the timing aligns with the market and industry dynamics. Generational timing and the relationship between timing and disruption are also important.
4: Where = Market
Venture capitalists evaluate the size of the market or the Total Addressable Market (TAM). Strategies depend on the size of the firms. Know how to calculate TAM and know its implications.
5: Why = Solution
Is the startup building the right solution to address the identified problem? It’s import to solve one problem exceptionally well and to build a sustainable business.
6: How = Scale
A successful startup needs to focus on both internal alignment and customer focus to achieve growth. Is there a well-structured sales team for acquiring new customers as the sales department? Is the product what the clients want? Does the technology support both sales and customer alignment during scaling?
You can apply the Framework Iteratively. The VCIF is not a linear process. It involves continuously revisiting and reevaluating each component as you gather more information and insights during your due diligence process.
Venture capital impacts investors, startup teams from founders to junior employees, customers, suppliers, vendors, communities and the economy. Successful investments often come with a high rate of failure.
Being a VC requires more than just financial expertise. Specialization in a sector is also important. And building genuine connections with entrepreneurs. Strive for long-term, win-win partnerships. Also identify promising companies (sourcing), conduct thorough financial and qualitative due diligence, and present them to senior leadership in a concise manner.
Entrepreneurs seeking venture capital funding should:
- Understand venture capitalists’ perspective and align with their expectations.
- Develop a compelling pitch that clearly communicates value proposition and differentiation.
- Showcase traction, validation, and market demand.
- Highlight the capabilities and expertise of the founding team.
- Address risks and mitigation strategies.
- Build relationships and leverage networks to connect with investors.
- Familiarize yourself with the funding process and be prepared.
- Be open to feedback and iterate on the business model or strategy.
Limited Partners (LPs) who invest in venture capital funds should understand the sector, as well as the considerations and due diligence processes.
You can conside starting a Venture Capital Firm with establishing a fund structure, do fundraising, and build a team.
The availability of capital, investor sentiment, and market dynamics fluctuate over time. Understanding these cycles can help venture capitalists make informed investment decisions.
Venture capitalists should maintain a diverse portfolio and be open to exploring different paths and opportunities as they arise. They should also be flexible in considering various approaches, such as investing in different stages of startups, different sectors, or different geographic regions.
This flexibility allows for greater adaptability to adapting to industry disruptions. Stay informed about emerging technologies and market trends to identify potential investment opportunities arising from disruptions. Also wWatch out for regulatory and policy changes. Regularly re-evaluate the long-term prospects of their investments.