Here’s how a VC identifies a ‘VC-fundable’ startup

Photo credit: Jrg Stber / 123RF

This article is part of Tech in Asia’s partnership with Monk’s Hill Ventures where we publish articles that feature the firm’s valuable insights. For more articles in this series, go here.

I’ve received a lot of queries (sometimes with raised eyebrows) from founders about why we decided not to invest in their startups. In many cases, the answers were simple: it was a hardware business (which we don’t typically invest in) or it was out of our geographical focus.

However, when it comes to explaining why a startup might be “too early” for us even if it ticks all the boxes, I often find myself looking deep into its founders and business models to come up with a reasonable answer. This article seeks to shed light on our thought process in determining whether a startup is VC-fundable and ripe for series A.

Driving a startup like a Ferrari

Monk’s Hill Ventures is known as the homegrown VC fund in Singapore that invests in four to five startups a year, with an average deal size of US$1 million to US$5 million. Our portfolio companies must be successful so that we can return the original capital of our investors (limited partners or LPs), along with returns expected of an asset class.

This is because we are paid by the LPs to take risk, and risk needs to come with return. It is the LP’s expectation on returns that shape our risk-return appetite and, consequently, the deals we invest in.

Let’s say we deploy US$100 million into 20 individual startups (US$5 million each for a 25 percent stake). Between five and 10 years or by the time they progress to series C or D, we expect that our diluted stakes (say, 10 percent) in two startups would be valued at US$50 million each (on a reasonable worst case scenario). This is so we can return LPs their US$100 million. The rest is the upside.

However, within that quick breakeven analysis lies a fundamental assumption that both startups would need to grow its value by approximately 25 times more. In other words, we would need to hit home run on those deals. And while businesses with stable cash flows and steady linear growth are perfectly fine investment opportunities for many investors, VCs might not always be the right people to fund them.

In fact, funding often comes after a display of exponential growth and only accelerates it.

I often ask founders whether they would be happy to drive their startups like an E-Class or more like a Ferrari. This is because if they are looking for funding from VCs, they are really telling investors they no longer want to bootstrap (i.e. self-fund) to grow their startups. They are striving for an exponential growth by going after a sizeable total addressable market (TAM) and potentially do an IPO one day.

Many founders see this as a chicken-and-egg problem. They think funding is required before their businesses can achieve exponential growth. But based on our experience, funding is not a causal factor for an exponential growth trajectory. In fact, funding often comes after a display of exponential growth and only accelerates it.

So, how do I identify evidence of an exponential growth trajectory in a startup? There are two leading indicators: (1) a real business model targeting a big TAM and (2) demonstrated scalability.

A must-have for all startups at all stages

A real business model is a must have for all startups at all stages. It must provide a solution to address a top-of-mind pain point suffered by a large audience who have enough means to afford and benefit from it. The more severe the pain point you are solving, the more fundable your startup.

Too often we come across ideas that attack a valid pain point but is not felt by enough people to warrant having a business around them. A founder who succeeds in a series A round often displays a strong understanding of what their customers look like and why they will pay him/her to solve their pain points.

A strong sign of a series A-ready startup