What VCs look for in startups before writing the checks

October 12, 2018 17:27
Carman Chan (2nd from left) of Click Ventures; Herbert Chia (2nd from right) from Sequoia Capital China; and Wayne Chu (far right) from Mindworks Ventures join in a panel discussion on startup funding challenges from an investor perspective. Pic: HKEJ

Entrepreneurs often turn to venture capital (VC) firms when they want to finance and grow their startups. VC firms can provide capital, strategic assistance, and other kinds of support to startups, in exchange for a portion of ownership in the company and rights to its potential future profits. It is a critical decision point for every startup: are you ready to raise capital?

The Hong Kong Economic Journal recently sat down with some veterans in the VC industry -- Carman Chan, founder and managing partner of Click Ventures; Herbert Chia, venture partner of Sequoia Capital China; and Wayne Chu, a partner at Mindworks Ventures -- to discuss the startup funding challenges and how to overcome them.

Excerpts from the conversation: 

HKEJ: We have seen Hong Kong startups complaining that it is difficult for them to get investors' support. Any thoughts on that?

Chan: When I was working as a startup entrepreneur, I learned how difficult it is for startups seeking investor financing. I believe that to build a successful startup, other than creating an outstanding business plan and market traction, entrepreneurs need to have an excellent mentality.

When I look at startup founders as an investor, I will have a negative impression about a person's performance if he or she lacks confidence. The lack of self-confidence will change the way you behave, as well as how you show your understanding of your business and your skillset in analyzing data.

Chia: As an investor, I focus on evaluating if the startup has a logical business model, whether the business is forward-looking, and scalable. Startup entrepreneurs have to be capable of exhibiting logical analytical skills and they have to be persuasive.

Startup ideas can be crazy, because businesses with a familiar business model are much less likely to deliver a hundredfold return. For the founder, he or she must have strong confidence in the business; otherwise, it will be difficult for them to convince investors and get them on board.

Chu: If the founder has sufficient funds to support the company's operations for a period of time, and is not eager to raise funds, I would suggest him or her to focus on optimizing the product and make a nice business plan. There is a saying in the Silicon Valley, “Revenue shows everything." When your business succeeds in entering the market, it will be easier for you to seek investors’ financial support.

Q: Some startup entrepreneurs have faced potential investors who want to take a large equity position, say 30 percent to 40 percent of the stake, in the startup, in exchange for their funding. Is it a common situation in the startup and VC circles?

Chia: This situation is not uncommon, but it is unhealthy if it occurs in the startup’s first round of financing, as it is still too early for the startup founder to get his or her ownership diluted. If so, there will be very little left for the founder’s equity, when the startup goes through the following series of funding rounds. Then, there will be much fewer incentives to motivate the founder to keep developing and improving his or her product.

Chu: As for the startup founder, he or she must first have a thorough understanding of the company’s business and investors. Before seeking the funding, the founder should have a long-term business plan, say on the markets the company has to expand in, how much working capital it needs in the next 12 to 24 months, and the current market valuation it can get. The founder can't let investors lead the entire negotiation process.

Chan: In case the founder’s shares have been diluted, there are some remedies the person can take. I suggest they can renegotiate the distribution of company equity, or create an equity incentive scheme.

Q: As an investor, how do you establish a healthy strategic partnership with the startup founders?

Chan: For the startups we have invested, the founders will take the initiative to actively follow up and report the business development after receiving our financial support. Other than the weekly, monthly, and quarterly reports, we encourage the founders to list the problems encountered during the entrepreneurial journey, so that the investors can help them overcome the difficulties.

Chu: In the meetings with their investors, we believe the startup founders have to exhibit their recent strategic decisions, manpower arrangements, and difficulties they face in their businesses, and others, otherwise, the investors would not be able to help them solve the problem.

We have seena startup get trapped in operational problems, with the revenue plummeting by half. The founder team chose to expose the issue to the board, and the investors used their business network to help solve the problem in three to four weeks. For the startup founders, there is a message: tell the truth to your investors and you may receive a great benefit.

This article appeared in the Hong Kong Economic Journal on Oct 12

Translation by Ben Ng

[Chinese version 中文版]

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Hong Kong Economic Journal