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As entrepreneurs we know the odds of raising a professional VC round are extremely low. If you didn’t know that, let me tell you… The odds of raising a professional VC round are extremely low! Forbes  recently suggested it was about 1-2% of companies that pitch venture capitalists actually get funded.

Why is this?

Well, there are many reasons, so let’s focus on a really big one.

You don’t understand their business model.

A few common misperceptions:

Misperception one: If they have a lot of capital, writing a small check is easier than writing a big one.

You have a great idea right? You only need $1 million and the VC you are talking to has a $100 million dollar fund. It says on their website that their average investment is $5-7 million so it would be even easier to get $1 million from them.

Wrong.

Misperception two: If you have a profitable company and can turn their investment into a $15 million dollar business they will be thrilled.

If you already have a product and are generating revenue and you know you can build a $15 million dollar business on say a $1 million dollar investment, you would think the VCs would be thrilled.

Absolutely not.

Misperception three: If they invest in ten companies Venture Capitalists would rather have two failures and eight successful small exits, than 8 failures and two big exits.

Nope, not even close.

So, why don’t these work?

Venture Capitalists have a very specific model. The returns in a venture capital fund typically comes from only 20% of their investments. So if they make ten investments, two will be responsible for their returns and eight will likely fail. So this means that if they are investing from a $100 million dollar fund they will likely need to write $5-7 million dollar checks in ten companies, reserving some capital for follow on rounds and administrative purposes. So those two investments of say $5m have to provide massive returns to provide a $100 million dollar fund enough capital to make a profit for their investors and pay themselves (think somewhere between 25-100x each).

So, a $1 million dollar check is way too small. If you get a 5-10x return it candidly doesn’t do much to help them. And how about the profitable $15 million dollar company you built? Same problem. You have a profitable company that is so small it would have to sell for a big multiple of revenue (not profits) to give them a return that moves the needle in their fund.

(For more details please check out great posts by Marc Andreessen – Founder of Netscape and Co-Founder Andreessen Horowitz here and another good primer from Wealthfront here).

You want a shot at raising Venture Capital?  Study their economics, how they invest, how they make money and THEN make sure your startup fits. If so, make it clear using their economics to explain it to them.

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