This video of David Teten speaking at Startup Grind NYC in 2014 contains a number of good insights into concepts both VCs and startup executives should be working through during the fundraising process.
An interesting concept he discusses is Systemic risk vs Idiosyncratic risk when evaluating early stage companies. Teten applies the concept when investing in startups, stating that the venture fund should be able to manage or aid in the Systemic risks of a particular startup, while the startup team themselves need to be able to handle the idiosyncratic risks inherent within their company.
This basically means that the startup founders should be domain experts with a vision and the VC should be the business professionals willing to aide in execution. Let's take a deeper look, we'll pull some tips from my experience.
SYSTEMIC RISKS: THE MACRO-LEVEL RISKS ASSOCIATED WITH SCALING A COMPANY
Systemic risks are macro-level risks associated with scaling a company. Good VC’s should be able to mitigate these risks to a certain extent. These are risks like understanding how to build a company at a later stage, making the next great hires or raising the next round of financing.
While these are key for a VC to be able to help with, it is important for a startup to weigh this into their decision when choosing which investors to work with. You obviously have to take money where it is offered, but often enough startups cast too wide of a net when having initial conversations.
From my perspective you should be able to answer these questions, either before meeting or during the initial conversations:
- Does this VC have a track record of helping a company with their next round either by follow-on investment or a network of later stage investors they’ve worked with in the past?
- What investors have they co-invested with in the past?
- How closely does my vision align with their investment and market thesis?
- Are they experts or enthusiasts? How excited are they about my specific company or are they just trying to be in the space we are in?
- Do they have domain experts that can help when we should be seeking external advice or validation?
- Can they help with business functions we’ll need to scale post fundraise? Where do we fall short in business knowledge and execution experience and where will we need help?
- Do they have a network of other founders, partners, etc that can add value to my business?
- How active is this investor with their current portfolio? Do they take board seats? For b2b startups, have they facilitated large sales or partnerships?
- How accessible are the partners? Are we just another company or are the actually invested in our specific success?
IDIOSYNCRATIC RISK: THE MICRO-LEVEL RISKS ASSOCIATED WITH THE STARTUP'S EXPERTISE
Idiosyncratic risks are essentially the micro level risks associated with the startup being able to solve the problem it is trying to solve. This is basically saying the founders need to be experts in what they are doing, and are skilled enough in this are to be able to accomplish their vision.
While this is an inherently more important set of risks for a VC to understand during the evaluation process, it is the startup’s job to communicate the answers to these questions effectively. I also believe the more a VC can help with these risks, the better the match is for partnership.
- How much do we fundamentally understand the problem we are trying to solve? Do we have the domain expertise to tackle the challenge at hand?
- How are we positioned to be successful compared to the competitive landscape?
- What is proprietary about what we are building?
- How are we leveraging our unique talents in-house?
- How will we be acquiring talent when we need to?
- Have we done enough customer development and validation to pinpoint the exact problems we are solving?
- How does new market entry by other companies effect what we are building?
At the end of the day, these risks and sets of challenges and concepts are essentially mitigated by having a great team, the ability to attract and retain the best talent, and the willingness and ability to dissect and take advantage of the opportunities that exist for founding teams today. Both the startup founders and the VC's should be able to help with these challenges, but it is never too early to be thinking about them and understanding what you'll need down the road.
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