For venture capitalists who want to learn how to evaluate deals at scale, Skyler Fernandes is a great person to turn to.
Fernandes is the founder and general partner of VU Venture Partners, a global venture capital firm with a global, 80+ person team that sources 20,000 deals per year.
With 2023 on the horizon, Affinity interviewed Fernandes on his systemic approach to deal flow and evaluating deals at scale. Watch the full conversation or keep reading for the highlights, with time-stamps to help you dive deeper where you want to.
Tip #1: Evaluate startups beyond the LTV-to-CAC ratio
When evaluating a company, most investors start by comparing two metrics: LTV (lifetime customer value) versus CAC (customer acquisition cost). But Fernandes says that, historically, many failing companies had healthy LTV-to-CAC ratios at some point—so he’s come up with what he calls a “no-BS way to calculating capital efficiency.”
“When I evaluate capital efficiency,” he says, “I'm looking at the company’s current annual run rate of revenue compared to the amount of capital spent specifically on scaling the business. I ask, how much capital has the company raised? How much of it has the company spent? I compare what’s been spent on building versus spent on everything else, then compare that ‘everything else’ to ARR [annual recurring revenue]. This just cuts to the chase a lot faster than LTV.”
Tip #2: Market is more important than team
Fernandes knows it’s controversial, but: market is more important than team … at least in early-stage venture capital from pre-seed to Series A.
Fernandes says, “If you had the best team in the world going after a small- or medium-sized market, they’d never be acquired for a large amount of money.” But if the team isn’t the best of the best, Fernandes thinks they can still do extremely well if the market is huge.
One example from VU Venture Partners’ portfolio is Bear Flag Robotics, a pre-revenue, pre-product startup that was acquired by John Deere for $250M 14 months after VU Ventures invested.
Fernandes says, “Why did John Deere, a big tractor company, buy an autonomous driving tractor company for $250M? Why not $50M? It really came down to what John Deere felt the future market size opportunity could be—and they decided that buying it for $250M was nothing.”
Another reason Fernandes prioritizes market over team is that you can change a team, but you can’t change market size. “A great team going after a small market will need to pivot—which can be good or disastrous,” he says. “If you organize your priorities by market, team, then product strategy, you’re ordering them from the hardest to change to the easiest.”
While some wonder whether to prioritize market over team, research shows that 2023 is going to see more investors focusing on prospects that have clear paths to profitability. As Lucian Wagner, General Partner at Privilege Ventures SA, told us as part of Affinity’s 2023 Investment Predictions Report: “VCs are focusing on real companies with actual sales. The fluff is out.”
Tip #3: Customize your CRM with your own market calculations
Fernandes is so disciplined with his market evaluation frameworks (watch the webinar to learn more about those, or take a look at the VU Ventures template for due diligence tips) that he’s customized his deal flow tracking platform with a field specifically for market size.
Using Affinity, VU Venture Partners added columns next to each deal for a calculation of market size—which is mandatory for presenting a deal to partners. “We don't allow anyone to present a deal during a partners meeting,” Fernandes says, “if they haven’t filled out the market size calculation themselves.”
And Fernandes pushes to make sure this number is as real as it gets—it doesn’t count that a company claims to have a $50 billion target market. “We do our own calculation of the true target market of that company: the target number of potential customers based on demographic multiplied by the average revenue per customer.”
At the end of every quarter, VU Ventures will pull data from this one field to sort deals by the largest market opportunities. “We really see a huge spectrum of opportunities,” he says, “which helps us evaluate risk and go into deals with eyes wide open. Scaling in this way without Affinity would have been pretty much impossible.”
If you’re looking for more advice on how to strengthen your venture capital or private equity firm for 2023, read Affinity’s 2023 Investment Predictions Report. Here are five things you can expect from the report:
- More advice from experts on how to prospect more efficiently
- Predictions for how the investment landscape will evolve in 2023
- An analysis of current deal flow, and how firms plan to spend their resources
- Evidence-based recommendations on what venture capital firms can do to stay ahead of market changes
- An answer to the question: Should we feel optimistic about 2023?