Understanding How Venture Capitalists See Risk
As head of a venture company, you need to include risks in your communication with venture capital (VC) investors. How you go about doing that is important. First, you must understand the types of risks that investors will closely scrutinize during the due diligence process. The more you’ve thought about them, the more easily you’ll be able to respond to questions when the time comes.
As you address your company’s risks, you can begin to weight them in your mind. Which risks are going to be easy to overcome and which are actually pretty daunting? Which risks would be smaller problems if you had more money — or more time? Which risks are completely out of your hands and in the hands of fate instead? Think about these questions as you draw together your company’s risk profile.
Betting on the jockey, not the horse
Because so much risk is involved in early-stage investment and many companies pivot in response to risks and opportunities, by the time the exit occurs, a company may bear little resemblance to the company that was originally pitched to the VC.
VCs often say that they look for five things in a company: team, team, team, large or rapidly growing market, and an innovative product or service that creates an unfair advantage in that market. The fact that the first three factors are the same (team, team and team) reinforces the idea that execution risk is the most difficult of all risks to assess.
In the case of Pinterest, the company didn’t follow its original plan shared with VCs, but the team was smart enough to spot an opportunity and to pivot into a new model, resulting in amazing success.
Your company might have started with a bunch of friends or people in a Startup Weekend group or class at business school. Although such serendipitous meetings can be great, in most cases though, the best way to build a team is to network widely in your community and put together a team intentionally, finding people you think will give your company the best chance of responding to risks and opportunities. VCs appreciate your having the best jockey in town.
See how risk changes over time
A company’s risk profile changes over time. The farther along a company gets in achieving its strategic plan and hitting its milestones, the less risk the company has. Although risk generally goes down as a company grows, new risks come with being larger and operating at a later stage.
Early risks tend to focus on technology, and later risks tend to focus on marketing. You need to understand how to address new risks as they come along and incorporate them into your overall risk profile and management strategy.
Don’t be fooled, though. The reduction of risk isn’t a straight line, nor does it always go down. Some companies have catastrophic events that occur and increase risk for a period of time. When this happens, you need to involve your VC in working out a new strategy to deal with the problems.
Your objective is to overcome any adverse incidents and get your milestone back on track as soon as possible.