Understanding Venture Capital and Vendor Management

Apple TV’s WeCrashed dramatizes the real-life story of the spectacular rise and fall of WeWork, a company that promised to disrupt the co-op office industry and whose momentum depended primarily upon charismatic founder, Adam Neumann, and his gnomic pronouncements about people following “their superpowers.” WeWork burned through billions of dollars of venture capital and orchestrated a disastrous initial public offering in 2021. The streaming series lets the viewer in on the reasons why the desire to be in on the ground floor of the next billion-dollar unicorn company blinded so many journalists, employees, and investors.

While it makes for compelling TV, WeCrashed is also an advisory for the rest of us about what not to do when approaching venture capital firms. Periodically, one or two companies emerge from the zeitgeist that capture the hype of the moment so effectively that even the most rational Wall Street minds seem to lose their bearings. However, this happens rarely and, when it does, usually leads to grief. 

In today’s uncertain and volatile global economy, with inflation rising and recession potentially looming, smart entrepreneurs will prioritize both investment strategies and vendor management at an early stage. 

Understanding the role of venture capital

The first step is to understand the purpose of venture capital and the key stages of the investment cycle.

Venture capital is a form of private equity that typically focuses on the middle part of the innovation S-curve. Angel investors scan the entrepreneurial horizon for provocative ideas, while public equity investors want to see a healthy balance sheet and a viable company. Venture capitalists, on the other hand, are looking for initiatives that, with the right support (usually over a ten-year time horizon), can generate substantial returns.

Venture capitalists risk money on disruptive ideas that may turn established industries upside down and capture significant market share from incumbent players. Uber, Instagram, Airbnb, and Zoom are famous examples of venture capital investment done well. However, the National Venture Capital Association estimates that 25 to 35 percent of venture capital-fueled businesses fail, while research from the Harvard Business School suggests that the start-up failure rate could reach as high as 75 percent. 

These data suggest why WeCrashed is a cautionary tale and not a blueprint for how to approach venture capital firms. Venture capital is a necessary part of the innovation ecosystem but the firms that make these investments expect a high degree of professionalism from their portfolio companies and associated vendors. The level of financial risk is too high to tolerate hype in most cases. Throughout the investment cycle, venture capital support can also take the form of managerial expertise and assistance with research and development.

Venture capital by stages

The five key stages of venture capital investment are straightforward but essential to understand:

1. Seed money. Angel investors also focus on this initial stage in which the start-up typically has an innovative idea, but not a viable product or service. However, while angel investors risk their own money, venture capital firms invest other people’s money (including entities such as pension funds) and function as risk capital companies subject to regulatory oversight. The goal of the seed money stage in either case is to nurture the idea to the initial product stage.

2. Start-up Capital. VC funding typically shifts in this stage to support for raising awareness of and scaling the prototype product or service. The company has a business plan in place and access to marketing expertise. Vendor acquisition and management becomes key as the need to procure companies to handle essential back-end processes accelerates.

3. Second Stage Capital. Though the company is not ready for an initial public offering (IPO) or corporate acquisition, it continues to grow, with additional money now invested in production, marketing, advertising, and employee recruitment.

4. Expansion. Ideally, if the company has made it this far, venture capital investment enables it to expand into new product lines and/or markets and to scale to the point that the brand is highly visible in media and financial circles. The company may not yet be generating profits, but revenue is growing.

5. Pre-Public or Bridge Stage. This stage often signals success and is the point at which venture capital firms prepare to exit. The company has usually begun to prepare for an initial public offering (IPO) and support shifts to providing expert assistance with the merger and acquisition process and financing the IPO.

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How to approach a venture capital firm

Steve Jobs (1955-2011), the famed co-founder (with Steve Wozniak) and CEO of Apple, embodies the myth of the aggressive, hyper-focused, relentless, but brilliant Silicon Valley entrepreneur. However, though Jobs was probably a genius, and certainly a legend, he is not the best model for most people who need to approach a venture capital firm. 

The first reason is that venture capitalists typically work with a portfolio of start-ups. Your idea matters the most to you—and it should matter a lot to your investors—but having a promising idea alone will not propel anyone to long-term success and billionaire status. Silicon Valley and, increasingly, innovative hubs around the world, are full of disruptive ideas. To secure the interest of those with the money to bring your idea to fruition, it is important to focus on business essentials and demonstrate mutual respect.

In most cases, your initial approach to a venture capital firm should be through a trusted third party. This can be a friend in the industry, a family contact, or a peer entrepreneur. The important thing is that you leverage your connections to foster trust and that you remember to reciprocate in kind with new entrepreneurs if you are later able to do so. Unless you are already well known on Wall Street (at which point you might decide to become an angel investor), it is unlikely that you will break through layers of administrative staff on your first try at pitching your idea, particularly if you cold call or email the firm.

If you do get an opportunity to pitch, focus the presentation less on what you want—as venture capitalists already know that you need money—and more on the information an investor needs to evaluate your business proposition. In exchange for financing your idea, a venture capitalist incurs substantial risk and he or she probably also has numerous potential clients to evaluate and stakeholders to consider. If a venture capital firm does show interest, enthusiasm alone will not close the deal. If you do not know how to write a business plan, please find someone who does and be ready to pay them for their time. It is also advisable to have hard evidence at hand to demonstrate how your initial idea could eventually scale and who the main competitors are in your market. Hiring a graphic designer to ensure that your pitch materials are polished can also make the difference between an amateurish versus a professional approach.

Finally, recognize that venture capital firms often specialize in specific sectors. If you are pitching an idea that might disrupt the automobile industry, there is no need to approach a venture capital firm that focuses on the biotech sector, and sometimes you must do some research to know which firms are most suited to your industry. Securing venture capital is not a game for the faint-hearted, ergo it is important to spend energy not only on the money hustle but on building your visibility and reputation via attendance at conferences and industry shows, and via relevant professional associations. While you do not want to risk your intellectual property rights by saying too much too soon, securing venture capital is a business of networks and persistence, so it is crucial to commit to the process over the long-term.

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How vendors fit into the venture capital equation

The entrepreneur/venture capital relationship is essential to innovation. However, vendors are another crucial part of the equation that start-ups often overlook. In the earliest stages of a new venture, there may not seem to be any bandwidth available for thinking about all the services, from payroll to inventory, that you will need if your company begins to thrive. Yet investing in a vendor management platform optimizes the chances of success for all parties.

For investors, a good vendor management platform provides access to quality vendors that have been pre-vetted, and it allows for data-driven comparisons across vendors in the same niche. Rather than spending time on bespoke vendor acquisitions for each new venture, investors can focus on supporting their portfolio companies.

For vendors, inclusion in a proven vendor management platform signals quality and trust to both investors and entrepreneurs. Vendors can prioritize putting together the most attractive package of goods and services, and displaying these on the platform, rather than churning through time and money to reach new clients.

For entrepreneurs, a good vendor management platform helps you to cut through the bewildering number of options that are available in the marketplace. Sometimes, the best known or most expensive vendor may not best serve your needs. Working with a venture capital firm that has a strategy in place for vetting potential vendors frees you up to focus on building your business. 

Taking the time to understand the stages of venture capital investment, and the benefits of a top-tier venture management platform, are vital to success in bringing your idea to the world.

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