February 2023
Deepthi Madhava
In any given year at Oregon Venture Fund, we meet hundreds of new startups that could potentially fit our investment thesis. Roughly 15% of those receive a screening meeting, the next stage in our evaluation process, and about 20% of those progress into formal diligence. As a result, only 1% or so of all companies we meet end up receiving an investment from OVF. My review of other top-performing VCs show they are similarly selective.
A key question we are often asked is, why is the selection rate so low?
We rely a great deal on our management team’s investing experience and our network of venture partner’s expertise to help determine which companies might fit our return profile. There are, and will be, lots of successful businesses out there that may not fit the VC return model. Sometimes, despite having all the success elements, companies might still get declined for an investment. Each year we often commit a few “sins of omission,” or false negatives, where we pass on a startup that years down the road ends up generating a venture return for its investors. We also commit a few “sins of commission” each year – false positives - where we invest in a company that fails to generate a venture return. Despite everyone’s best efforts, roughly 20% of our investments fail to generate a positive return, 60% generate a decent return [2X to 5X], and roughly 20% generate a superior return [>5X]. Like any learning organization, we try to keep an open mind and learn as much as possible from our failures and successes.
In many ways, a VC fund is like a startup organization. VC funds are typically operated by a management company that deploys its product, i.e., capital and services to serve its customers, who are the founders and leaders of our portfolio companies. Our services include industry and functional expertise and connections to talent, customers, and downstream investors. Limited partners are the investors in the fund and include institutional as well as individual investors. A subset of our investors are venture partners. These are individual investors who are often exited entrepreneurs themselves or leaders in their field and they assist with the work of the fund.
A fund's investment thesis typically spells out the key areas of focus and differentiators that make the fund unique and provide a competitive advantage. In our case, OVF’s regional focus on Oregon and Southern Washington, our desire to invest early in a company’s life cycle, our ability to re-invest across multiple financing rounds, our relationships with downstream investors, and the power of our venture partner network are a few of the things we uniquely bring to serve our portfolio companies.
Why do so few startups meet venture funding criteria? Portfolio companies are expected to generate at least a 5X return on investment – ideally, much greater – within the typical 10-yr life of a fund. OVF’s performance is among the top quartile of funds nationally and our minimum acceptable annualized rate of return for each investment is 40% and our minimum target return to investors is 3X of their contributed capital. If a portfolio company takes the full 10 years to exit, it will need to return at least $29 for each $1 invested to generate our minimum acceptable annual return of 40%. For example, if a company is valued at $10M post investment, this means it will need to sell for a minimum of $290M for a fund like OVF to generate a minimum acceptable return. That’s a tall order for most startups, who are often constrained by factors such as their business model and market size, which can limit the ability to grow revenue and value quickly.
So, to all the entrepreneurs out there looking to raise VC capital, please ask yourself, are you comfortable signing up for this wild ride of 10 years where there is extreme performance and liquidity pressure? The ability to grow rapidly depends hugely on the market and vertical you are targeting, as well as your ability to rapidly test and iterate on your product to achieve the elusive product-market-fit, your ability to attract top talent, and all of this while you are consistently acquiring and retaining customers. From an investor standpoint, any of these factors could look too risky for a VC to take on. At the same time, from an entrepreneur’s standpoint, the tradeoff of venture capital vs. the additional pressures and scrutiny may not be worth it, or appropriate, in every case.
If you have a startup with the potential to grow quickly in revenue and value, please let me know. I’d love to meet with you and see if we can be helpful. My colleagues and I try to be helpful to all founders in our region, not just to those we invest in. You can reach me at Deepthi@OregonVentureFund.com