Sourcers and recruiters have long chased after proverbial “purple squirrels,” those elusive, highly skilled candidates that represent the type of “top talent” that actually lives up to that moniker.
Their rarity, of course, has led many organizations and recruiting agencies to invest an inordinate amount of their time and energy chasing a quarry that’s nearly impossible to catch, statistically speaking.
The rich rewards, however, of overcoming these odds, much like Powerball or pyramid schemes, prove so enticingly lucrative that the promised payout can lead to even the most data driven recruiters opting for the power of possibility over probability.
Even the most blue chip retained firm or the most connected recruiter out there, however, knows the potential peril of investing a finite amount of resources into an infinitely improbable search.
This is why almost no recruiter works on only a single req at one time, effectively hedging their hiring in order to distribute risk and increase the odds of generating a successful placement (and payday).
VC: Where Myths Meet Money.
Much like recruiters and “purple squirrels,” venture capitalist firms spend their days in a similarly single minded hunt for what are commonly called “unicorns” – defined as a VC backed company with a total valuation over a billion dollars. In 2014 alone (the most recent year for which complete stats are available), venture capitalists sunk an estimated $52 billion into the technology and life sciences category alone, representing investments in nearly 50,000 early or mid-stage startups, the highest total reported since the height of the dot com bubble in 2000.
That same year, exactly nine achieved a liquidity event worth more than a billion dollars, led by the staggering $21 billion that Facebook (a former unicorn in its own right) paid for WhatsApp. This small number was actually a historical high, beating the 7 Unicorn exit events of the previous year; in the entire decade since 2005.
In fact, only 44 VC backed companies out of the literally hundreds of thousands of firms with some sort of VC funding who emerged (and mostly disappeared) achieved true “unicorn” status during these 10 years.
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As of this writing, only 138 privately held companies in the world were worth a billion dollars or more, led by Uber’s $51 billion valuation.
That you’ve even heard of Uber actually makes it something of an outlier – most unicorns, such as Chinese smartphone manufacturer Xiaomi (the second most valuable VC backed company after Uber at $46 billion) or Palantir Technologies, the biggest of big data companies with an estimated $20 billion valuation, remain as obscure to the average consumer as the funds investing beaucoup bucks into driving these staggeringly high valuations.
Few have ever heard of entities such as New Enterprise Associates or Institutional Venture Partners, two of the top 5 VC funds in the world in 2015, whose generic and mundane names undermine the fact that they’re not only responsible for investing in some of the most exciting technologies in the world, but if they were publically traded corporations would easily rank among the Fortune 200.
New Enterprise Associates, for instance, saw an $18 billion increase in portfolio value in 2014; that same year, The Walt Disney Company, by contrast, ‘only’ generated around $14 billion in total revenue, for a basis of comparison.
You don’t need a PhD in quantitative finance (which many investors actually do) to realize that the odds of finding a unicorn are pretty piss poor, to say the very least – but the potential profits prove an even less effective deterrent in the chase to find the next Facebook, Google or Genentech.
And, increasingly, more and more firms are putting their bets on the HR Technology sector, turning this vertical from a business backwater to something of the belle of the VC ball these days.
All in the Timing: When To Get Capital for Your Capital Idea.
In my most recent post, Making It Rain: A Recruiter’s Guide to Venture Capital, I discussed exactly what talent pros need to know about how venture capital firms traditionally allocate their investments, what drives their decision making and what types of risks and rewards are generally associated with raising VC money.
You can click here to read the whole post, but the moral of the story for anyone trying to transform purple squirrels into unicorns?
Only raise venture capital if you’re OK with selling your company; even if the price tag is less than you expected, it’s only a failure if you and your investors lose money. The greatest success you can have is to generate a positive return.
Hell, even WhatsApp lost $128 million the year before Facebook acquired them, proving that even for the ultimate unicorn, the formula for successfully generating a return from your investors might necessitate getting out while the getting’s good.
And while many would-be entrepreneurs have no problem stepping up to the VC plate, it’s stepping back that often proves problematic for so many founders.
Profit beats passion any day of the week. If you’re not in this to get out, then get out now.
To VC or Not to VC? 5 Questions Every HR Tech Company Should Seed.
So, let’s say you’ve read the above and aren’t phased in your quest to raise enough capital to transform your latest product or idea into the next big thing.
Or, perhaps you own or have a stake in a pretty nice HR Technology business that has seen steady revenue growth and a developed into a pretty solid business with a decent customer base after years of bootstrapping and belt-tightening.
Everything was going according to plan until some analyst at a VC Fund unexpectedly calls up one day with an invitation to meet with one of their partners on their upcoming trip to your neck of the woods.
Whatever the case, when you’re thinking about raising venture dollars for your HR or recruiting technology company, here’s how I would recommend determining whether or not it’s the right time to take on VC money – and if so, how you can make sure to make the most of any initial or early stage funding that you’re lucky (or unlucky) enough to raise.
1. Do You Have A Reason?
What’s motivating you to turn to outside investors? Is it because your competitors are gaining speed and market traction?
Is it because there’s a network effect, virality or other significant barrier to entry that any of these competitors could potentially erect to erode your business and its long term viability?
Do you have a “go bit or go home” mentality? Are you ready to be rich (without also being king)?
Whatever your rationale is, make sure it’s compelling enough to not only attract investors, but not to scare away the people who have helped your company grow to the point of even having to make this critical decision in the first place. Because without the human capital in place, there wouldn’t be a viable product in the first place.
Don’t make this decision for yourself (or by yourself). Make it for your people, for your business or for your customers. If you’re doing it just for the money, then there’s no need to ever take someone else’s.
2. Are You Ready?
Everyone has a great idea; quite few have the confidence that idea can scale into a sustainable, successful business.
This can only be done by getting past the due diligence of figuring out whether there’s a market opportunity that’s not only viable, but monetizable (the latter being far more difficult than the former, frankly).
Realistically, unless you’ve got like three degrees from Stanford, a Harvard MBA with McKinsey or Goldman on their resume or were one of the first hires over at PayPal, pedigree alone isn’t enough to attract investment.
The only background or experience that really has any equity with equity investors is that you’ve successfully exited from somewhere else in the past for somewhere north of, let’s say, fifty million bucks.
If that doesn’t describe you – and if it does, chances are you’ve got no desire to go through the associated growing pains of growing another company – then you’ll actually need some sort of proof of concept of the fact that the market you’re so confident of in fact exists.
The only way to do this is by proving traction through paid customers and a fairly robust future pipeline; the purpose of VC is to augment, rather than initiate, those efforts at gaining momentum and finding a foothold in the market.
If you’re not already booking customers, winning deals and booking revenue (the more recurring, the better) then you should go back to the drawing board, not out to VC investors.
If your company isn’t pointed in the right direction, and the infrastructure isn’t there to support hockey stick style growth in the future, then it’s going to be damned near impossible to change the course of your rocket once you hit the light speed of scaling a startup.
Make sure you’re aiming in the right direction before you fire away.
3. Are You Really Ready?
VC firms generally back up their investments with deep insights and expertise on how to build companies, but what they’re really looking for when making those decisions is whether or not there’s some sort of pre-defined, proven formula to which they can add capital. This is where the concept of what’s known as “unit economics” comes into play.
Here’s what that means. Let’s say you have a SaaS company who is buying qualified leads at $100 a pop, but your average deal size is only $100 per converted lead.
That means while you can pay for your customer base upfront and break even, but let’s say that those initial $100 customers subscribe to an additional service or product tier, which commits them to paying $50 a month, every month, ad infinitum.
Sweet, right? You’re totally kicking ass, and should have no time raking in the VC cash with that type of business model.
Of course, there are obviously a lot of subtleties and uncertainties in every sure thing – even looking at the above example – from the view of those potential investors. What’s the gross margin involved, for instance? If you sell a product for $100, but it costs $75 to bring that product to market and keep it there, this might not be as interesting.
Is your lead generation strategy scaleable? If you’re buying AdWords for $100 a month and suddenly that same word’s price spikes for some reason, then there won’t be enough cash to keep the sales funnel and deal pipeline growing…as you can see, there are a ton of complexities, and they add up quickly.
The bottom line here is your bottom line.
4. How Good Do These “Unit Economics” Have To Be?
A VC will try to grow their invested capital at a rate of 30% return every year; that’s more or less the standard success benchmark every fund measures itself by, and it’s an aggressive target. Of course, many of the companies in their portfolio will return 0%; the key is having enough that will return at 1000% to offset those losses and hit that 30% for the year, every year.
As a rule of thumb, if you’re a founder, you’ll want to double your enterprise value each year; this is especially true of earlier stage companies. The closer you are to zero, after all, the easier this is to do.
If you can’t double your revenues in the first three years, then good luck when you’re expected to start generating that sort of cash every quarter. At a later stage company – one with a cash flow of $10 million or more – then the risk profile is decreased, as is the required return for the investor.
It’s kind of like if you gave your buddy who just got out of jail some cash until he got on his feet – you’d expect the money back, of course, but since you’re obviously taking a high risk that you’ll ever see it again, you want an extra 15 or 20 bucks if he does come through as promised. On the other hand, if you gave your other buddy a bridge loan so he could relocate to a job in Silicon Valley he accepted after graduating from MIT, you’d probably only want a couple bucks thrown your way as a ‘thank you.’
An early stage company is your buddy, the parolee. For startups, you need to have demonstrative proof to credibly convince investors you’ll return 100% per year, with the ability to return a few hundred percent if a few things go your way. Once they do, you’ll start looking a little less like an ex-con and a little more like your other blue chip buddy.
5. What Does This VC Investment Mean for My HR or Recruiting Business?
If you’re in HR or Talent Technology, there are a few specific implications to consider when considering venturing after venture capital, as should be fairly obvious after going through the above.
You have to have a business that can be really big.
Huge, even. I mean, you’ve got to kick serious ass.
If a great business typically captures even 20% of a market, but that market’s only worth $10 million, then the most money I’ll ever be worth is $2 million a year in revenues, max.
At a 15% cash flow margin and an 8x exit multiple, I can only be worth 2.4 million in enterprise value ($2 million * 15 * 8) in that scenario. That’s chump change. Typically, the defined market (think: ATS, payroll, performance management) has to be worth a billion dollars or more, at a minimum.
You have to have a business that can be really scaleable.
If you’re in a SaaS business where you can support an unlimited number of subscribers, you’re going to have far more success at scaling and far fewer growing pains than if you’re doing one off consulting or ad-hoc projects.
Now, if you can combine that product with the kinds of services people are willing to pay extra for, that’s even better. The key here is finding enough reasonably smart people to sell it, which is more easily done at scale than finding enough consultants to scale a services offering (although anything but easy).
You have to have a business that has really attractive gross margins.
I’m talking, really sexy. Because VCs, as a rule, are used to investing in software companies with 85% gross margins. Go tell that to a retailer and see what they say – it’s a pretty ridiculous threshold to try to meet.
These companies, based on these margins, are able to eventually generate large bottom line profits as their base of recurring revenue increases, while their fixed costs are able to be spread across even more customers, who ideally cost almost nothing to acquire and support. Gross margin is also a great litmus test for finding barriers to entry.
If something has a 90% gross margin but is super easy to replicate, that means others will inevitably enter the market and compete with you directly until your margins are significantly decreased. If, on the other hand, that 90% margin can be maintained, you’ll have VCs lining up at the door waiting to write you a check. Doesn’t happen very often, though.
The Exit Event: What Happens Next.
Wow. You really made it through all that? All those numbers, and all those boring finance terms and math and stuff?
You, my friend, just might have what it takes to be a VC backed entrepreneur, after all. You clearly have a high enough threshold for self-inflicted pain to create a killer product.
To you, then, the biggest piece of advice I can offer to anyone out there with a great product is to find a great mentor – someone who’s been there before, and can help you navigate through the inevitable unexpected bullshit, market turbulence and cyclical stressors you’re going to have to deal with.
There’s no better way to follow a roadmap than to have someone who’s already been there helping show you the way. There’s just too much to learn and too little time to learn it well, much less execute.
But if you’re really smart, have a good business and a great mentor, then you’ll succeed – with or without VC investment.
About The Author: Phil Strazzulla is the founder/CEO of LifeGuides, a recruiting and HR technology startup which builds software to help make it easy for employers to create the content that explains why their company is a compelling place to work – and effectively attract top talent.
Before LifeGuides, he was a venture capital investor at Bessemer Venture Partners, the oldest VC in the world which has made investments in companies such as LinkedIn, Cornerstone On Demand, Skype, Yelp, Pinterest and many others.
Phil started investing at the age of 11 when he opened his first brokerage account and hasn’t stopped since.