Venture capital investment memo
A friend from business school recently asked me to help him understand what goes into a venture capitalist’s investment memo. He is thinking of joining a startup and may ask some friends and family for seed financing, and so wants to be discuss the idea with them in the same way that a VC would. After this discussion I realized that most startup entrepreneurs probably don’t understand the inner workings of a venture firm or sophisticated angel group. In an attempt to help demystify a part of the venture fund raising process I’ll explain the typical VC investment memo. Understanding the documents that a VC uses to discuss a startup internally to get approval for (or socialize the idea of) an investment may be helpful to your startup as you seek funding. After all, knowing how a venture capitalist is likely to internally publicize, share and memorialize the investment in your company can help you anticipate where some of their questions are coming from.
I’ve worked for/interned for a few of funds, so feel like I have a pretty good idea of what is standard investment memo material. I am not going to talk about any “special” or unique things I’ve seen in any particular venture firm’s investment memos, only the sections and themes that are recurring across all the funds I’ve spent time with.
Keep in mind that the purpose of these memos really vary by firm. Some firms use the memo to educate the investment committee on the startup and the memo is an important part of the deal approval process. Other firms circulate memos as more of a heads up to the other partners, alerting them to the deal and seeking advice and introductions that can help with due diligence. Regardless, someone at the VC is consolidating the learnings on your company, market, technology and team and putting that information into a format that helps the the investment team efficiently reach a funding decision on your startup.
Typical contents of a venture capital investment memo
A. Intro/executive summary – This part is usually only a page long; it needs to very concisely summarize the opportunity; depth and discussion of diligence findings will be found later in the document in the respective sub-sections
- Business Summary – Couple of paragraphs to set the stage on the opportunity
- Proposed Financing – $ invested; size of round/sources of capital; (go into more dept in the Deal Description/Details section)
- Pros of the Investment/Reasons to Invest – Bullets on why the investment is exciting. Usually mention management, market and technology differentiation. (If you don’t have these, why are you investing?)
- Cons/Key risks – Highlight the key issues that could derail/destroy the company/the investment’s return potential. Holes in mgmt team, competition with deep pockets/stated interest in the space, etc.
- Deal goals – Use of proceeds; milestones to be hit with the funds from this funding; alignment with management and other investors on goals and direction of company (if a complicated investment or many other investors may require its own section later.)
B. Market opportunity – After the introduction comes the meat of the investment memo. Each section is as long or short as required for the particular investment opportunity. The market section tried to explain how big the potential market is and how/where the startup fits into that market.
- Market - Size of market; discussion of analysts’ opinion on market; summaries of customer and ecosystem reference calls
- Problem to be addressed – Does management’s description of the problem match up with the VC’s diligence findings?
- Pain point/value proposition – Not a description of the product, but a description of the “relief” that is felt by customers; what customers/potential customers has the VC talked to and what have they said?
- Competition - Very important section. Articulate what the competitive landscape is NOW and in the FUTURE. How does the company fit into the ecosystem.
C. Product – What does the product look like; who is buying it; why are they buying it and does this match up with the market opportunity/stated pain point addressed; is the product defensible; can you actually make it and how much R&D is required
- Product description – include who the buyer is at the customer
- IP – if an important part of the investment thesis; did a lawyer conduct an IP review?
- Product development timeline/roadmap
- Price points/margins/economies of scale – who is actually “making” it and what is required to get “production” to scale; if a web based business what are the key costs of delivering the product
- Highlight issues on the product/features to be developed from the reference calls with potential customers/existing customers
D. Sales/marketing strategy
- Re-define ideal customer – how reach them/where are they
- How much cost to acquire/what is the sales process timeline – are there different costs by different channels
- How does this fit with the reference discussions/market analysis conducted
- If company has current customer then case studies and list of major customers/revenue concentration
- Are partnerships/business development tactics to be important in the startups marketing/customer acquisition plans
E. Team/advisory board - This is perhaps the most important section. Sometimes it should be put right after the Intro/Summary. There needs to be real detail on each team member and the people to be hired/needs analysis. VCs usually have an honest write up of which team members are scale-able and which will need to augmented
F. Operational plan - The more “grown up” the company is the more detail will be spent on historical financial statements.
- Quarterly or monthly burn rate
- Historical financials – only important/included if the company has real historicals; if of a certain size, say over $5 million in revenues, then an accounting review may be required; not usually included in detail if the company is still developmental stage
- Use of funds – make sure the metrics highlighted in the “Deal Goals” section match the metrics you will be funding towards…
- Revenue plan/revenue model and build up
- Margin discussion
- Staffing plan – looking at the staffing needs from a “how much it will cost” perspective
G. Deal Description/Structure/Details
- $ invested; size of round/sources of capital; ownership;
- Type of security
- Any other interesting facts such as what management is putting in or is a convert note rolling in at a discount/etc.
H. Long-term financing plans
- Reserves set aside for the investment in the fund
- Total amount of capital needed to get the business to self-sustainability
- Going forward financing plan – milestones that will be hit with the current fund raise & explanition of how those are valid value creation metrics for the industry
J. Deal history - Source of deal; who has met; what diligence has been done;
- Capitalization Table
- Other supporting documents
- Some funds put the references and due diligence findings in the investment memo, others reference them and make them available to the partnership on a server or in a database
I’m not suggesting that you try to manage your venture funding process to the fund’s investment memo. However, I strongly believe that if entrepreneurs have a greater understanding of VCs’ internal deal procedure then they are more likely to be successful in raising venture capital. I hope this discussion of the venture capital investment memo is helpful, and welcome your comments.