Venture Views: VCs and founders exercise greater selectivity around investments

Venture capital (VC) funds and start-ups are becoming more selective around the deals they accept and who they partner with, writes Real Deals' Talya Misiri.

According to Forsters partner Stuart Hatcher, start-ups are no longer rushing to take investment from VCs, but are instead taking a more considered approach and vice versa. He told Real Deals: “Businesses are much more focused on, for example, is the VC the right house for them [...] I think it’s like this on both sides, there’s more professionalism in the approach to deals.”

Hatcher adds that the profiles of founders seem to be “a lot more advanced” in understanding the formalities and business considerations when it comes to diligence prior to securing an investment. “It’s no longer a group of tech geeks who don’t know anything about business. Now we speak to clients on their first meetings where they’re already quite advanced in terms of understanding what the term sheet looks like, what they’re willing to give up and what a deal is going to mean for them.”

VCs are also being more selective about the businesses that they back. According to a 2021 report from the Harvard Business Review, which surveyed 900 venture capitalists, for each deal a VC firm eventually closes, the firm considers, on average, 101 opportunities. Of these, 28 will lead to a meeting with management; 10 will be reviewed at a partner meeting; 4.8 will proceed to due diligence; 1.7 will move on to the negotiation of a term sheet with the start-up; and only one will actually be funded.

With increasing levels of competition, VCs are certainly upping their diligence. “There’s a move towards slightly more robust businesses even at that VC level,” Hatcher notes.

In addition, VCs are no longer willing to invest in a business with a speculative revenue deck. Instead, investors need to have a greater idea of revenue rather than just deploying capital to dot-com businesses or those with AI infrastructure. Nonetheless, start-ups are also taking a more thoughtful approach by seeking capital when they need it to scale rather than getting investors in as soon as possible, as has previously been the case with some businesses.

However, finding investment in the current landscape can be challenging for some founders regardless of their business’ success. Harvard’s report notes that securing VC investment in the first place is largely related to having the right networks. According to the survey, more than 30 per cent of deals come from leads from VCs’ former colleagues or work acquaintances. Other contacts also play a role, with 20 per cent of deals coming from referrals by other investors and 8 per cent from referrals by existing portfolio companies. Only 10 per cent result from cold email pitches by company management. But, VCs are still on the hunt with almost 30 per cent of deals generated by VCs initiating contact with entrepreneurs.