If you prefer listening via audio, you can listen here: https://www.youtube.com/watch?v=N4yBZ6T0XFw The following is a summary of when Jeremy Cotter was interviewed regarding the fundamentals of venture capital.
Section 1: Introduction to Venture Capital
- Definition of venture capital
- High-risk nature and potential returns
- Importance of due diligence
Section 2: Layman's Terms Definition of Venture Capital
- Money invested in early stage companies
- Classification into different stages
- Goal of helping companies grow
Section 3: Contrasting Venture Capital with Debt Financing
- Risk assessment in debt financing
- Higher risk and reward in venture capital
- Examples of successful ventures (Uber, Airbnb)
Section 4: Appetite for Risk and Reward in Venture Capital
- Importance of appetite for higher reward
- Mitigating risk in venture capital
- Strategies used by venture capitalists
The traditional definition of venture capital is putting money or capital into a high-risk venture. Now, that might sound scary, but that's exactly where some of the largest returns are. However, it also requires a lot of due diligence to understand what constitutes a good return-to-risk ratio.
In layman's terms, venture capital involves investing money into an early stage company. These companies are classified into different stages, whether it be an early stage or a later stage, and the ultimate goal is to help the company grow. That's the basic gist of venture capital, and I love how you put it.
What's interesting about venture capital is its association with risk. In contrast to debt financing, where underwriting and documentation are used to determine the likelihood of repayment, venture capital operates differently. Venture capitalists play in a space that's higher risk and higher reward. They take on risks that many lenders wouldn't consider. Despite the risks, there is exponential potential for reward, as seen in extreme cases like Uber and Airbnb.
Venture capital works by embracing the higher risk for higher reward mentality. There is an appetite for higher reward that must exist in this industry. However, it's important to note that successful venture capitalists and investors, whether at the angel stage or a later venture stage, actively seek ways to mitigate risk. They recognize the potential for increased odds of success by analyzing certain factors.
Mitigating risk in venture capital is a challenging task. There are numerous uncertainties surrounding a company, but there are key actions that can be taken to understand and mitigate the risk. It's a balancing act of maximizing success while minimizing risk. Venture capitalists are constantly looking for ways to increase the odds of success and mitigate risks wherever possible.
Overall, venture capital requires a careful assessment of risks and rewards. While it operates in a high-risk environment, successful investors employ strategies to mitigate those risks. It's a complex process that involves thorough evaluation, analysis of key factors, and a continuous effort to understand and mitigate risk. I'm happy to discuss these strategies in more detail.
Venture Capital Stages
Ty Crandall: When we talk about stages, are you referring to the stages of business growth? I don't think your layperson really knows what stage of their business they're even in. So, how do you guys gauge and look at the stages?
Jeremy Cotter: :First off, the different stages we look at are named differently according to different factors. There's seed, series A, series B, C, and D. Furthermore, these days, there are even more stages added to differentiate the in-between parts. When we think about what those stages represent, they generally represent revenue, product development, and the team's size. In a pre-seed venture, there's very little to no revenue, and the product isn't fully developed. The risk is higher at this early stage, but the returns can be multiples.
Moving forward, at Series A, the company has shown significant traction, developed and distributed a product generating revenue, and built a substantial customer base. Series A is when the company is looking to accelerate growth that it has already found. It's the stage where they pour capital into the business to take it to the next level. Before Series A, there's the seed stage, which is in between the pre-seed and Series A. If we make an analogy with human development, it would be like a teenager compared to adulthood.
When it comes to finding the right venture capitalists to help, different firms focus on different stages. Some focus on pre-seed and seed, while others specialize in Series A, B, C, or D. In our case, we focus on pre-seed and seed stages. We're primarily looking at hundreds, sometimes thousands, of companies in those stages. We understand the key attributes that determine success at that stage. Private equity investors in later stages evaluate companies differently, considering metrics like revenue and existing data.
At YouRise, we look at three primary elements when determining potential investments. The first is the team. Disagreements between founders and the inability to carry the business forward are common reasons for startup failure. We evaluate the team's record of achievement and character traits like their ability to work well with others and their strength of character. The second element is the product itself. We assess if the product has a strong foundation based on reality and if it bridges the gap between the founder's vision and the product's current state. Testing the product is crucial. The third element is the market. We consider if the market is ready for the product and if it's the right time to release it.
Jeremy Cotter: The power law is a concept in investing where a small minority of investments outperform the rest and produce substantial returns. As an investor, we leverage this concept by focusing on a group of high-quality companies that have a good chance of succeeding. It's not about a "spray and pray" mentality, but rather identifying companies with potential. Monitoring customer traction and consistent growth is one indicator of success. However, sustainable growth is essential, as some companies may artificially inflate their growth trajectory without achieving profitability.
When evaluating the progress of a company, customer traction is a crucial indicator. We look for consistent customer onboarding that demonstrates a positive growth trajectory. However, it is essential to note that growth alone does not guarantee success. Some companies may experience unsustainable growth by heavily spending on customer acquisition without achieving profitability. Therefore, it is important to evaluate the sustainability and profitability of growth along with customer traction.
The venture capital industry does experience the effects of market shifts, but it is relatively more insulated compared to public markets. However, when public investors and institutions become hesitant to invest, it affects the flow of capital in the venture capital industry. Even well-funded venture capital firms may become more selective during uncertain times, impacting early-stage companies' access to funding. However, exceptional companies can still secure funding even in challenging market conditions, and it is crucial not to let market fluctuations discourage entrepreneurship.
Venture capital offers unique advantages compared to other forms of funding, such as crowdfunding or debt financing. Personally, I love venture capital because it allows me to make a positive impact on society and work closely with early-stage founders. Venture capital investing is akin to a contact sport, where the risks are high but the rewards are exhilarating. It is a rewarding experience to support and guide early-stage founders, leveraging my own entrepreneurial background. For early-stage companies, venture capital provides the necessary capital and expertise to fuel their growth, and it is a valuable tool in their journey towards success.