The 7 “C’s” of Venture Investing

As a reformed banker (I repent, I swear) I have had to be open minded and learn to take a different perspective when thinking about venture investing. The contrasts are more readily apparent because at Lorimer Ventures we focus on investing at the earliest stages of a company’s journey. Despite our differences to banks in terms of risk appetite and time horizon, you can apply a remarkably similar framework to help diligence and decide on investment.

We’ve adapted a traditional credit underwriting approach to venture, adding 2 additional “C”s to round out our perspective.

Character: Most important and most challenging to measure. We use words like “Grit” and “Hustle” as terms of endearment. We’ve found over time that consistency and transparency are also hallmarks of strong founding teams. Achieving and maintaining mutual trust are paramount to successful investing relationships. We think communication is key in helping bridge trust.

Cashflow: This metric may get eye rolls from the other reformed bankers because frankly the majority of companies at the early stage are burning through a substantial amount of cash to build and scale rapidly. Taking a longer-term perspective, we are more interested in revenue growth and the product roadmap. Revenue growth demonstrates the product-market fit and the quality of the roadmap helps drive conviction around future margin expansion.

Capital: It is both an art and a science understanding a company’s capital structure. Sometimes this is as simple as asking “Do they have skin in the game?” But, dollars are not the only relevant metric here. Depending on the other investors’ diligence process and track record we get confidence or pause to join them in the investment syndicate. Understanding if the company can readily raise additional funds from value-added stakeholders is key, particularly if the company projects needing another raise before they achieve cash flow breakeven and scale.

Collateral: We are still early in the digital age but understanding and developing a risk framework around digital collateral is important. Traditional collateral appraisals utilize 3 valuation methodologies: sale, cost and income. In the digital world, collateral is all the things that have been built and could stand-alone without the founding team’s involvement. This is the architecture, the hours of code and development, the “IP” that brings the product to life and drives the company forward. We are using the sale methodology when we say, “based on the current valuation would somebody buy or build a competing solution?” We use the cost methodology by saying, “How much have you spent to date?” and compare that investment to the current valuation. When we use the income methodology we say, “Is this solution scalable and can it stand on its own without the founding team?” We are ok with weak collateral if we believe in the development prowess of the team.

Capacity: In lending we think about capacity as whether a borrower has the ability to repay a loan against other recurring debts and fixed costs. We approach this slightly differently, trying to focus on the intellectual capacity and bandwidth of founding teams. At the early stage, understanding who is full time and is the team ready to scale for growth. Does the company already have a team of builders, a team identified or is just starting the hiring process? Human capital is a common challenge for startups. Capacity to execute on hiring should be considered here. Being spread too thin drives execution risk.

Counterparty: After the 2008 financial crisis, we realized single counterparty risk- particularly related to funding- was something that had to be understood and monitored. Start-ups often have many single point counterparty risks. Maybe the company develops exclusively on the Salesforce platform, or utilizes a single sales distribution avenue. It’s ok to have counterparty risk, but its even better if there is a mitigation plan in place.

Catalyst/ Covid-19: “Why now?” It is not good enough to just solve a problem, we must understand why this problem is solvable now. Customers also need a catalyst and without a compelling one, it is hard to convert the sale. Covid-19 has been an astonishing catalyst for new and old businesses, allowing for pivots and digital transformation success stories. Continue to refine your catalyst thesis to understand your investment conviction over time.

Investing has and continues to be a humbling endeavor and we are trying to refine and get better over time. To that end, we would love to hear your thoughts, especially if there is anything glaringly missed here. Please feel free to reach out anytime Nick@lorimerventures.com