What is Venture Capital Investing?

A Note from PocketVC Founder, Dan 💡 Whenever I'm explaining my job to people, I always say it's like a sophisticated Dragon's Den. Whilst it's an oversimplification for those in the area, it's concise and understandable. That's how you should be pitching your startup to the mass public anything more and you have lost half the room. I have taken a step back to answer some of the simpler questions for those just starting out in your journey of the exciting startup world! This next mini-series will hopefully analyse the world of venture capital. Today's post? What is venture capital. The outcome? Pitch the Alpha returns. Our goal this month is to equip founders or aspiring founders with the basic elements of what venture capital investors are and the fundamentals, so you can walk into a pitch with confidence. I. The Founder's First Decision: To Raise or Not to Raise So you have started a company and realised to get that unicorn status you need help? After bootstrapping the company (bootstrapping simply means putting your own money into the company to get things going) a strategic decision is needed. Do you raise money? And if so what sort of capital is available? For that you have debt and equity. More on this next week! Equity capital (money from VCs, Angels, etc.) provides cash in exchange for ownership of your company. Debt capital (bank loans, venture debt) is a financial obligation that must be repaid. Typically most founders choose venture capital to help the company get bigger. Simple right? A. The Different Capital Types Equity Capital: Provides cash in exchange for ownership of your company. It is best for companies requiring massive upfront Research & Development (R&D) and Capital Expenditure (CapEx) with no clear path to early profitability. Debt Capital: Is a financial obligation that must be repaid. It is best for businesses with predictable revenue models and strong cash flow. II. The Anatomy of Venture Capital (VC) Part 2 - What is Venture Capital So you made it this far! And hopefully you have a better understanding of the options available to you. So you might still be thinking he hasn't actually said what venture capital is yet, GTTP (get to the point)! The easiest way I can explain venture capital is a more sophisticated version of Dragon's Den or Shark Tank (if you're in a different part of the world). You have an idea, you create a document (usually a pitch deck) and present it to VC investors! So if you made it this far you're probably thinking well that's great and all but how do I know if they're interested? A. The Two Sides of the Investment Coin First you have general VCs and market specific VCs. Generalist VCs are more about following trends. Generalists will focus more on the people behind the company and are more opportunistic. Specialist VCs will take a more product led approach: does the market need this technology and how will it be used? An important clarification: it's not to say each type of VC won't take into account every area, it's just an over-generalisation of both sides of the coin. Why is this important? Well you need to know your target market. Raising capital can be treated like trying to sell your product. B. The VC Life Cycle The other critical part to VCs and this cannot be stated enough is to ask yourself: am I in the correct life cycle? I don't mean personal life! Venture Capital can be split into three/four main stages. Initial Stage: Typically called Seed Capital and it covers pre-seed to seed. This is typically very early on in the company's life cycle. Second Stage: Focuses on Product Market Fit (Series A). Third Stage: Is Growth Funding (Series B/C/D). Final Stage: You have Pre-IPO or Pre-Exit Funding. As you move up the company life cycle the funding needs get higher but the cheques get bigger! C. The VC Mechanism: The Fund So you now have a rough understanding of the different type of venture capital companies and maybe how to position yourself! But you still might be asking yourself how does venture capital actually work and make money? This is the final part to the puzzle. A venture capital company will invest through what is called a fund. Put simply, a fund is an investment vehicle that invests in a number of companies (typically called a portfolio). III. The Core Investment Thesis: The Power Law VC is governed by the Power Law, which dictates that a small number of massive successes will account for the vast majority of returns. VC Math: An average fund anticipates that 50%-70% of its investments will fail, 20%-30% will return 1-3x capital, and only 1-3 companies in the entire portfolio will deliver the 10x or greater return needed to make the entire fund profitable. The Mandate: Because of this, VCs are only interested in companies with a credible path to a billion-pound valuation. You are selling an option on a monopoly. A. The Investment Process: Alpha vs. Beta Analysing a fund's portfolio strategy helps decode their appetite for risk. Alpha Investments: These are the high-risk, high-reward bets the 1-3 companies expected to deliver the entire fund's return (the Power Law outliers). Beta Investments: These are smaller, lower-risk deals expected to return 1-3x. They provide portfolio stability but will never be the primary driver of the fund's success. Your pitch must demonstrate that you are an Alpha Investment. IV. PocketVC's Opinion: Pitching the Alpha Option The critical nuance for founders is recognizing the asset you are selling. You are selling an option on a monopoly. Don't be defensive about your current metrics. Instead, focus your pitch on the three non-financial factors that justify the massive expected return: The Competitive Moat: Clearly analyse your defensible IP strategy (patents, trade secrets) and, for R&D-heavy startups, show measurable progress on the TRL scale (the TRL is your ARR). The Team Premium: Demonstrate why your team (PhDs, scientists, serial entrepreneurs) is uniquely qualified to execute a breakthrough that others cannot. The Market Timing (The "Why Now?"): Articulate the non-obvious market shift (e.g., policy change, computational breakthrough, or consumer pressure) that makes your breakthrough necessary right now. Master the Power Law, and you master the VC pitch.