How does the venture capital industry work? What do investors think about when they decide who and what to invest in? What is the framework they use? Tim Schigel—the founding and managing partner of Refinery Ventures—is all about investing in fast-growth companies. If you want to get inside the head of someone who runs a venture capitalist fund, this is the episode you need to listen to.
Outline of This Episode
- [2:21] Tim’s background in venture capital
- [3:22] How the venture capital industry works
- [9:39] The track record of the investor = an important metric
- [14:16] The importance of experiencing hyper-growth
- [18:47] The misconception(s) about raising money
- [23:38] How does the negotiation process work?
- [27:20] Key things entrepreneurs need to keep in mind
- [32:08] How to connect with Tim Schigel
How the venture capital industry works
Tim notes that the venture industry has changed a lot. It used to be fairly secretive. It was hard to anticipate what was coming your way. How could you prepare? Now, you can Google nearly anything and get an answer. Plus, the National Venture Capital Association (NVCA) publishes a term sheet. It’s a lot easier to be educated now.
Tim shares that most investors have a specific stage or specialty they invest in. Tim and his partner invest in post-seed rounds in companies that have raised less than $3 million but are approaching $1 million in revenue. They need to be able to scale to $10 million in revenue in 24 months or less. It can be referred to as “Series A” or “Seed Plus.”
Tim calls it “Early Scale.” The entrepreneur has a product-market fit and is trying to figure out the metrics needed to scale. They’re familiar with what the companies look like, the benchmarks, and what the valuation might be.
Every fund likely has a portfolio construction. They have a fund of a specific size that invests in a certain number of funds (i.e., 20). There is target ownership that they aim for. If they get 15–20% of a company on average, and it does well, it has the potential to return the capital/investment of the entire fund.
Another rule of thumb is that you’re looking at a 20–30% dilution in a funding round. If that goes well, there should be another funding round 12-18 months after the first and an increase in value of 2–3x. None of this should come as a surprise.
Why is the track record of the investor an important metric? Listen to learn more!
The importance of experiencing hyper-growth
Tim looks for educated entrepreneurs that understand the market. But it’s even better if they’ve worked in a company that has experienced hyper-growth. The key difference between Silicon Valley and the Midwest is that most of the midwest doesn’t have that experience.
Tim emphasizes that high growth is managed chaos. It’s disruptive. You don’t have to be the founder to have experienced it. The head of product, engineering, or marketing is the next founder. You probably learned a ton—and delivered a ton—in the process.
Roughly 35% of venture-backed founders in Silicon Valley have prior hyper-growth experience. In Cincinnati, it’s about 5%. It’s a big disadvantage—but it doesn’t mean you can’t do it. Leaders are refined by their growth experience and overcoming adversity. They recruit people that grew up in the Midwest, left, and want to move back. They add a lot of experience.
The misconception(s) about raising money
The misconception is that when entrepreneurs are raising money, they’re making money. That’s not the case—you make money on the exit. The idea is to help the company grow as much as possible as fast as possible to get to that exit. There’s the idea that the money being raised is “profit.” It’s not true.
The average venture-invested company has 6–7 years to go before an exit—and that’s a good one. There’s no guarantee that you’ll even get an exit. If you don’t generate enough growth, you may not have any buyers.
The overall venture market follows the power law: If you invest in 100, only one has to make it to get a big return (and it accounts for 99 losses). The chances for success are low. Raising money is a major milestone and validation—but it isn’t the end result. You must celebrate—then grow. There is a cost to that money. It isn’t free.
38–40 companies that are well-known are “unicorns” that didn’t raise any outside money. One example Tim can think of is Mailchimp. The more capital-efficient you are, the better.
You need to focus on the metrics
Often, entrepreneurs think they can raise money because other companies did. But people raise money because they could—not because they had to. Tim’s “law” is that capital follows growth. People are looking for metrics. If you had good metrics and are capital-efficient, it’s easy to raise money.
Tim could call an investor and walk them through the metrics of a company, and they’d be on the plane the next day not knowing what the company does. When you see thousands of business plans a year, pattern recognition begins to form. You recognize good numbers quickly. If you want to have a conversation with an investor, they don’t want to hear anything you say until you quantify yourself by talking about your numbers. If you can show a steady acceleration of sales, that gets you in the game. You can’t convince them you’re a genius without the numbers.
Execution and growth have to support the return the investors expect. If you fall behind, they have to explain to their investors why your company is underperforming. It’s not a situation you want to be in. You have to think in a hyper-growth mindset from the start. You need to understand the risks and the unknowns. A good investor can help you overcome those risks before the next round.
What does the negotiation process look like? What should entrepreneurs keep in mind as they approach the negotiation table? Listen to the episode to learn more about the inner workings of the process!
Resources & People Mentioned
Connect with Tim Schigel
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