How a VC Thinks in The Year 2022

Norman Winarsky

Norman Winarsky

Author

VC-in-Residence

role

November 1, 2022

Published

In response to Covid and its impact on economies around the world, governments all over embarked on a massive stimulus. Interest rates declined, money flowed freely, and investors were anxious to find the next unicorns. VCs raced to invest, startups could choose among many offers, and valuations skyrocketed. It felt like capital was free. VC diligence was not so intense. Unicorns were being created at a stunning rate.  I hadn’t personally seen this kind of positive economic climate for ventures since 1995 - 2000.

We are in 2022, and the world has changed. Sequoia, for example, warned founders of a “crucible moment” of uncertainty and change. Inflation, the Ukraine/Russia war, rising interest rates, and more had fundamentally shifted the economies of the world. The expectation was an “economic downturn impacting consumers, labor markets, supply chains and more.” Companies were warned to maintain cash reserves, and encouraged to prepare for a long winter. Capital is expensive now, and VC diligence for investments is intense.

How will the best venture capitalists analyze your venture in 2022? They will almost certainly approach it by using and merging two complementary ways, similar to the Right Brain/Left Brain model.

VCs will usually start with their Right Brain analysis:

When they are presented with a venture concept by a team of founders, they dive deep into both the team and their breakthrough idea. Because they have seen potentially hundreds of ventures in the same market space, they seek to understand the power of the team, the idea, and its solution. They will try to understand how differentiated it is from all the ventures they’ve seen, which is usually in the hundreds, and how hard it will be to build and scale the venture. As the VC explores the concept with the founding team, beyond making their own judgements as to whether they agree with the idea, they are rapidly gaining insights into the team character and capabilities. Here is what they are seeking to answer:

The Team:

  • How did the team get to us? Was it from someone we trust and respect? Did they make a strong referral?
  • Do we like the founding team - do we believe they are the best and most capable people to execute the vision?
  • Do they have a high level of integrity, experience, knowledge of the market and technology, and a passion to make a difference?
  • Is the CEO a great storyteller? Does she have gravitas? Do we think she’ll be capable of raising the money?
  • If the CEO is a great visionary, will she be capable of execution?
  • Can the CEO hire great people? Is she respected in the community
  • Does she have a cadre of people who would come and follow her?
  • Does the CEO and founding team work well together, or do they speak over each other?
  • Do they react well to hard questions, interruptions, or other elements that might cause concern?
  • Do they listen to us, and thoughtfully answer our questions?
  • Do they talk with us as potential partners, or are they just trying to market to us and gain our investment?
  • Do they honestly share the risks?
  • Do they tell us why we might NOT want to invest?
  • Do they have “smarts, goodness, and grit”? - that is - raw intelligence and intellectual horsepower, a moral compass, and an approach to life like “they won’t give up”?

The Value Proposition:

  • Is there a large and growing unmet need? Do we believe in this need? Is it a major pain point for the customer?
  • Do we believe their solution is a breakthrough and can be built?
  • Do we believe the solution is the basis of a company, or is it a feature of some other company’s solution?
  • Do they have a key insight into building the solution?
  • When they tell us about this venture, do we feel “surprise and delight”?
  • Do they have a plan to execute that we believe in?
  • Do they have a “base camp” plan as they “climb Mt. Everest”?
  • Are they honest about the risks and the difficulties? Do they tell me how to mitigate them?
  • Do they focus the plan on the most important elements?
  • Do they understand their competitors? Is their solution a “10X” better solution?
  • Are they able to maintain a competitive barrier, at least for a year or two?
  • And much more …

Most VCs will tell you that this right brain type of analysis of the team and the venture’s value proposition is a high percentage of their decision.

Many of you reading this post will (rightfully) argue that some of these right brain elements are not right and that we will potentially miss great opportunities. For an extreme example, many would point out that some highly successful CEOs didn’t have ingredients like integrity, honesty, and goodness.  This is where you will get different opinions from different VCs. I for one would not invest in an individual where this was a concern. It’s true that I might very well miss a unicorn. With no regrets.

For many VCs, their analysis is dominated by their Left Brain analysis. They are attempting to analyze the fundamentals and financials, and determine if this venture has the chance to be the home run they seek.

The VC Left Brain Analysis:

  • Does the team point vaguely to a large and rapidly growing market ($10Bs or more), or does it focus deeply on explaining the size and rate of growth of the specific market they are addressing?
  • At what stage is the venture? Will we be able to invest enough and maintain a high enough percentage of the company to satisfy the power law?
  • Has the venture already built the product, or a demo of the product?
  • Has there been customer adoption? How happy are the customers?
  • Has the team defined the winning metrics?
  • What is the market channel?
  • What is the customer satisfaction, retention, churn, and unit economics?
  • What is the plan for the next eight quarters?
  • Will the venture achieve sufficient success with this round of funding to attract the next round of funding at a significantly higher valuation?
  • And much more…

The Left Brain Analysis implicitly requires a great deal of work to have already been accomplished by the startup. So VCs will often tell founders to seek funding from family/friends/Angels at this stage. But sometimes VCs are so enchanted by the right brain analysis that they will give up some on the left brain.

My experience is that the vast majority of early stage startup CEOs reach out to the venture capitalists’ right brain, and talk about their terrific venture concept. They give short shrift to the left brain analysis. They talk about the overall market size, and it’s always many $Bs, and then go on to describe their idea.

Perhaps this might have worked in the period prior to 2022. But we are in 2022. And VCs are deeply aware that they are investing scarce funds from their limited partners in order to provide a high rate of return on their behalf. If the VCs are excited by your idea, enjoy the concept, believe in its value, see its benefits to the world, but cannot foresee a return, they will not invest.

So do your best to reach out to both the VC’s Right Brain and Left Brain. If you do, your venture will already be distinguished from many of your competitors.

And if you have a venture concept you’d like to bring to Platform Venture Studio, we’d like to see it. https://os.platformstud.io/guild/optin.

Norman

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