Navigating the VC Landscape: What Tech Startups Need to Know

Tech startups face considerable uncertainty at the outset of a new venture. Will a novel product or service meet the needs of the market? Will customers embrace the new offering? Will you achieve scalable product market fit? Will competitors launch similar products? While launching a new tech enterprise will inherently include a host of challenges, navigating the venture capital (VC) landscape doesn’t have to be one of them. Understanding key aspects of the venture capital ecosystem can help set up your enterprise for success – and leave you with confidence to tackle the myriad challenges that come with growing, scaling and managing a successful tech startup.

VC Funds: Crucial Metrics to Know

Venture capital funds are focused on providing returns to their limited partners (LPs), who are the investors who provide capital to a venture fund. VC funds focus on several metrics, but perhaps the most important is “distributions to paid-in,” or DPI. VCs use DPI, sometimes called the realization multiple, to evaluate their investment performance. DPI is the ratio of cumulative distributions to the total capital investors have paid into the fund. A DPI above 1.0 means that total distributions exceed the amount of LP capital invested. Early on, before startup investments have time to yield returns, the ratio is often below 1.0.

In addition to understanding DPI, venture-backed technology companies should focus on two key areas: revenue growth and achieving positive earnings before interest, taxes, depreciation, and amortization (EBITDA). Startups have several tools available to them for achieving revenue growth. For example, adding new logos is one strategy. In the context of a tech startup, “adding logos” typically refers to acquiring new customers or clients. When your startup secures notable investments, leveraging that support can demonstrate to potential customers the viability and potential of your enterprise.

Net revenue retention (NRR) is another important piece of the revenue growth puzzle. Net revenue retention is the total retained, contracted and expanded revenue over a set timeframe. NRR can be calculated as follows: the sum of monthly recurring revenue (MRR) at the beginning of the month plus expansion MRR less MRR that churned in the month all divided by MRR at the beginning of the month. As many businesses scale back their software spend, tech startups need to demonstrate the immediate and long-term worth of their product or service. Doing so will help limit customer churn, thereby improving net revenue retention.

Achieving positive EBITDA is another key strategy for pursuing VC-backed startup success, and you can expect VC partners to emphasize this metric in this current economic environment. Startup leadership should set specific EBITDA-focused goals across teams to create alignment and incentivize actions that drive positive EBITDA outcomes. For example, consider reducing non-essential spending around personnel, consulting, travel and marketing; negotiating discounts for bulk purchasing (such as cloud resources) to leverage economies of scale; and adopting a subscription-based model to provide recurring revenue and better visibility into future earnings.

Additional important terms to understand at the outset of your VC/tech startup journey include the following:

• Realistic projected revenue, which is an estimated future income for your startup that is considered achievable and credible based on thorough market research, historical data, and a well-defined business plan;
• Burn rate, or the rate at which your startup spends its venture capital in order to cover overhead before positive cash flow is generated from operations;
• Customer acquisition cost, which is the average amount of money your startup spends to acquire a single new customer; and
• Lifetime value, or the predicted net profit attributed to the entire future relationship with a customer.

Finding a Good Fit

Tech startups also need to do their homework before securing funding through a VC firm to determine the best partnership for their unique needs. Make sure you understand a potential investor’s investment thesis. Learn about the stage of companies that a fund prefers to invest in, as well as any geographic preferences. Find out what an investor’s DPI goals are and be realistic about your startup’s ability to meet them. Remember: not all investor money is good money for a particular company.

As you navigate the ins and outs of a VC fund, consulting with a business advisor with experience in entrepreneurship and technology can be helpful. An advisory firm can help you understand the landscape, including the increasing expectations of a startup’s performance as well as how to prepare and improve your pitch. Knowing your numbers, such as realistic projected revenue, burn rate, customer acquisition cost, and lifetime value, will ensure you make the best case to potential VC partners.

Finally, tech startups should consider the overall strategic value of potential VC partners. Beyond money, VCs offer mentorship, networking, and strategic partnerships. Look for VCs who bring value beyond capital.

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Aprio is the brand name under which Aprio, LLP, and Aprio Advisory Group, LLC, deliver professional services. Since 1952, clients throughout the U.S. and across more than 50 countries have trusted Aprio for guidance on how to achieve what’s next. As a premier business advisory and accounting firm, Aprio Advisory Group, LLC, delivers advisory, tax, managed and private client services to build value, drive growth, manage risk and protect wealth, and Aprio, LLP, provides audit and attest services. With proven experience and genuine care, Aprio serves individuals, entrepreneurs, and businesses, from promising startups to market leaders alike. Aprio has grown to 2,000+ team members providing solutions to clients in industries including manufacturing and distribution, non-profit and education, professional services, real estate, construction, restaurant, franchise and hospitality, government contracting and technology and blockchain.

Alan Langelli advises a diverse group of companies operating in the technology, life sciences, e-commerce, and software industries, partnering with and providing customized service for these high growth and scaling companies that have operations across the U.S. and around the world.