Finding Gems: Our Investment Thesis & Parameters

Originally posted in 2018, this blog has been updated as of March 2022 to reflect Laconia’s current investment focus, strategy, and process. If you remember reading something different before, you’re (probably) not hallucinating! For additional resources, you can check out our FAQ, sign up for an office hours session with our investment team, or submit your information for funding consideration.

This is part 2 of a 5-part series. If you haven’t done so already, you can read the first post here.

Very often when we meet founders, whether they are pitching their company for investment or just asking for our insight during one of one of our office hours sessions, they ask what would make them a “sure venture capital investment opportunity”. The short answer we give is that there is no such thing, because every single VC firm has different investment theses/parameters. One perspective we can offer is the overview below of our own strategy.

Solving High Pain-Point Problems in Existing Markets & Workflows

On a broad level, we invest in the next stage of legacy industry digitization. We are focused on companies using technology to solve high pain-point problems and inefficiencies within existing markets and workflows. We still see massive opportunity in traditional sectors, as they transition from pen & paper processes to digital solutions, from fragmented digital solutions (e.g. Excel spreadsheets & in-house tools) to better workflow platforms, from workflow platforms to AI-powered analytical systems, and so on. As technology evolves, new business use-cases emerge, creating an endless loop of investment opportunities.

To be clear, we are not investing in incremental solutions. Much of our analysis of companies’ potential is through the lens of a founder. As an investor managing a portfolio, you have multiple shots at success.  As an entrepreneur, you place your bet on one shot, typically for a minimum of 5 years. A quick mental model we use to evaluate the upside potential of an opportunity is “Would I be excited to join this company for the next 5 years?” If the answer is yes, we’d seriously consider the investment opportunity.

Pre-Seed & Seed B2B Software

To dive into the specifics, we invest in pre-seed & seed-stage B2B software companies, predominantly headquartered in the US & Canada. We typically write checks of $250,000 - $1,000,000 in rounds of $1M-$4M. Within B2B, we are sector-agnostic, with investments in fintech, e-commerce infrastructure, supply chain, hospitality tech, retail tech, digital health, and more. Depending on the company’s stage and capital needs, we have some flexibility beyond these guidelines, but this is where we are spending the bulk of our time.

Below are the considerations driving these investment parametrers:

• Capital efficiency:

  • Focus on fundamentals: Our <$1 million investment amounts are best utilized in capital-efficient companies that can achieve “break-even optionality” before/after their Series A round. While we are, of course, seeking outsized returns (i.e., companies that have the potential to reach $100M+ in annual revenue), we believe that setting a strong and sustainable foundation in the early stages — before raising tens of millions of venture capital dollars — is critical to ultimately achieving that outcome. As we all know, the more money is raised, the higher the bar is for an exit. We are cognizant not only of our own equity stakes but also our founders’: we want them to be in the strongest position for their best possible personal outcome rather than pricing themselves out of most lucrative exit options.

  • Early B2B traction: Typically, B2B companies are more capital efficient (at least in the early stages) than B2C ones, which typically require significant upfront capital for user acquisition before activating any revenue models. We typically like to see some validation of market demand and ideally early revenue & customer engagement metrics before investing.

  • Software scalability: Though we are typically sector-agnostic, we do focus on software & avoid capital-intensive segments such as energy, agriculture, most hardware products, and two-sided marketplace models with high capital requirements for “chicken or egg” user acquisition models.

• Business resilience:

  • Active support: We build concentrated portfolios driven by strong conviction and and high support. As a result, we are intensely committed to all of our portfolio companies; we don’t write off & walk away from them when they hit a rough patch. Given our expectations of a higher-than-average portfolio success rate, we focus on companies that are solving mission-critical problems.

  • B2B inevitability: While many B2C companies rely on customers’ (somewhat unpredictable and fickle) tastes, B2B problems and solutions are typically objectively definable, identifiable, and quantifiable. In most cases, you can put a number to how much time and/or money is wasted by or allocated toward solving a given business inefficiency. Additionally, solutions to high pain-point problems typically have an “inevitability” to them. As just one example, AutoFi connects car dealers & lenders to enable the purchase & financing of vehicles instantly online from home, a solution that is undoubtedly bound to exist.

  • Market validation: While we don’t have hard revenue minimums to consider an investment, we like to see validation of customer demand, product stickiness, and, if possible given the company’s stage, high retention. Though the actual metrics and key indicators will vary from company to company, we are fundamentally looking for evidence that a given product is a “must have” rather than a “nice to have”.

  • Headquarters in US & Canada: The past two years have drastically changed the way we invest. While historically we’ve been focused on companies in Northeast major markets (largely NY, Boston, Philly, and DC), we have adapted to running our investment process and supporting our portfolio companies largely remotely. For Fund III, we have broadened our aperture to include all of the US and Canada, with a particular interest in regions that are historically underserved from a capital perspective. We also have the flexibility to deploy 20% of the fund’s capital internationally beyond the US & Canada, allowing us to take on opportunities beyond our more traditional filters.

• Alignment with Laconia’s strengths

  • Core team expertise: We stick to what we’re good at. While there are many investors looking at B2B software, we specialize in this, bringing deep expertise in B2B sales, marketing, and business development that moves the needle on getting seed startups to Series A and beyond.

  • Network value: Our LP relationships and extended networks are a strong fit for B2B as well, enabling us to open doors to customer intros as soon as we dive into due diligence.

We hope this overview provides some insight into our thinking. Next up, we’ll dive into the entrepreneur profile we seek. Until then, let us know if you have any feedback here or on Twitter — @jsilverman22, @djarcara, @geri_kirilova, @JailwalaReena.

Chasing the Money: Making Capital a Strategy

Over the past 9 months, we have screened thousands of companies, had introductory meetings with about 200 founders, and conducted deep due diligence on about a dozen. Whether we’re doing a full dive into a company’s history, projections, and vision, or just having a quick chat about short-term goals, one topic that almost always comes up is the alignment of entrepreneurs’ operating strategy with a thoughtful and defined capital strategy.

We have been repeatedly surprised by how few entrepreneurs see capital as a strategic activity. Raising money for the vast majority of entrepreneurs we encounter (even some really excellent operators) is a glorified form of securing what may be referred to as allowance money. VCs are pseudo-parents, there for the asking in order to get cash in one’s pocket!

But, venture capital functions so very differently from merely being money in the bank. And trouble will brew if it’s not seen in its full utility.

The benefits of a sound capital strategy are numerous. For one, disciplined management of optimal cash resources allows founders to foresee operating pitfalls that may have otherwise gone unnoticed for months. This attention to strategy and capital needs provides founders with the tools to adapt and make adjustments in a timely manner. Beyond merely ensuring the survival of the company, a sound capital strategy maximizes a company’s leverage in subsequent financings. Planned and controlled runway is a strength that will be rewarded in higher valuations and dollars raised. A position of strength and operating integrity will be created through an optimal capital strategy.

While the benefits of an optimal capital strategy may be somewhat obvious, the mechanics of actually building it are less so. Let’s start with the numbers. Operating a startup is like navigating through a jungle Tarzan-style. The entrepreneur swings from one milestone vine to another in order to progress toward scale and sustainability. Swinging too far or not far enough is dangerous.

As such, clearly defined milestones must inform the raise amount. In nearly all cases, the amount of capital raised should lead to either the next round of financing or profitability within a given time frame. A raise amount should not merely allow for X months of runway. To determine this optimal round amount, build a financial model that granularly accounts for the drivers and variables of both revenue streams and costs, making sure to factor in some leeway/optionality. It is often helpful to have 2-3 different scenarios modeled with varying round amounts, hiring plans, and sales projections to truly understand what can be ramped up or slowed down. Use this information to raise optimal cash that tightly supports the execution vision in month-to-month detail.

After mastering these numbers, the next earnest consideration is the investment partners. Much has been written on the topic of choosing “value-add investors”, but the point remains: as hard, long, and disheartening as fundraising may be, putting in the sweat to secure VCs and strategic investors that contribute their networks and expertise to your company is immeasurably more worthwhile than settling for the low-hanging fruit of funding simply for the sake of moving on. Choose your partners wisely. Do your due diligence. As we always tell the founders we meet with, ask a VC’s portfolio companies what working with them is like, not just when things are going well but especially when they aren’t. A strong investor network, in combination with a solid Board of Directors (more on that in our next blog), can make or break a company.

In addition to the right partners and the right capital, founders also need to be mindful of capital structure itself. Some of the elements to keep in mind are below:

•  Number of investors (both individuals and entities) -- having a cluttered cap table with dozens of investors can become a logistical nightmare regarding updates, information requests, and general communication. While the diversity of perspectives that comes with a varied investor base is valuable, there is an inflection point after which the utility of numbers begins to decline.

•  Investment vehicles -- venture rounds can come in all shapes and permutations, with combinations of notes, SAFEs, preferred equity, common stock, etc. Though notes are often touted as being simpler to structure and execute, this is not necessarily true for early stage rounds; term sheets are quite vanilla and can be done comparably quickly and inexpensively. For everyone’s benefit, keep structure as simple as possible. Particularly avoid stacked notes with varying caps that reduce transparency for both founders and investors alike. Fred Wilson’s post on Convertible and Safe Notes adds additional color.

•  Terms -- in line with the previous bullet, again, keep terms as simple as possible. Atypical preferences, ratchets, etc. have no place in early stage financings. Brad Feld’s timeless Term Sheet Series is a fantastic resource for those unsure of what to expect or avoid.

Often, we use a “clean cap table” as a proxy for a deliberate capital structure: if the above is done correctly, a neat cap table will reflect it. If prior financings were suboptimal and unnecessarily complex, a new round is the perfect time to reset the overall strategic direction, as a mess of a cap table is often a deterrent of future investment interest.

Finally, make sure that the capital strategy leaves the founders with enough skin in the game to want to play. Nothing makes us as investors more miserable than seeing founders crammed down into a miniscule amount of equity that will require nothing short of a miraculous exit for the venture to have been worth their while.

Applying strategic thought to capital, rather than treating it as a temporary, painful and necessary evil, will pay off in building a sustainable venture. With some luck, you may even find the ordeal rewarding.

Swimming through the Buzzwords: Our VC Summer Internship

If you ever want to make a college student cringe, usually all you have to do is ask, “Have you found a summer internship yet?” Luckily, after developing mild carpal tunnel syndrome from scrolling through our respective college career sites for countless hours, we were both given the opportunity to enter the venture capital world as summer interns at Laconia Capital Group. Just completing our sophomore years at Penn and NYU, we began our internships at Laconia unsure of what our summers had in store for us. On each of our first days, we walked into the office uncertain but excited to gain experience in an industry that would give us exposure to a variety of businesses and accomplished people. However, ten weeks later, we now find ourselves participating in office discussions with confidence and an eagerness to absorb all of the information thrown our way. As our internships come to an end, we reflect on our experiences and the invaluable lessons we have learned this summer. We’ve outlined the top five takeaways from this summer that are relevant to those working in the VC industry, as well as those thinking about their own business.

Keep Your Friends Close:

One of the key lessons we both gained from our internship this summer is the importance of cultivating relationships. After attending multiple networking events, it is evident that one of the ingredients crucial to becoming successful in the VC world is to maintain strong connections with entrepreneurs as well as other VC firms and personal networks. Establishing strong ties with other venture capitalists has the potential to increase exposure to high quality deals, while also nourishing relationships with possible co-investors for future investments. Even if a VC firm decides to pass on an entrepreneur for the time being, forming valuable connections with founders allows investors to keep communication ongoing and open new doors for business.

Keep Your Eyes on the Prize:

“Your capital strategy is just as important as your operating strategy.”

This is a message we have had drilled into our heads almost daily over the past ten weeks. Far too many times, entrepreneurs overlook the importance of a well organized cap table or capital structure. It is rare that a CEO would say that they love fundraising; however, having a detailed plan going into your capital raise is crucial to the success of your business. Ensuring that your company will always have enough money in the bank to meet your KPIs allows founders to go into negotiations in a position of strength rather than weakness. Companies run into trouble when leaders fail to raise the appropriate amount of money needed to reach their milestones. Additionally, building strong relationships with VCs prior to needing to raise capital can be advantageous to the entrepreneur down the road.

Perfect Your Pitch

After going through dozens of pitch decks and sitting in on presentations, we can now properly identify the good, the bad, and the ugly. What makes a pitch stand out to us is the founder’s ability to develop an easy-to-follow storyline that the audience can relate to. Oftentimes, founders get too tied up in jargon and struggle to simplify complex concepts. Even though you may know each and every detail of your business, remember that outsiders need to be walked through each step to fully understand the problem you’re trying to solve. Keep in mind that although you might be the smartest person in the room, you still need to illustrate your business as if you were speaking to a five year old (with an MBA).

Be Ready for Anything:

One lesson learned as an intern is to come prepared. You are not expected to know how to write an investment memo on day one. However, it is helpful to familiarize yourself with the language used on a daily basis. One book that expedited the learning process for us in our first few weeks was Venture Deals by Brad Feld and Jason Mendelson. We highly recommend this read to anyone interested in venture capital or starting their own business, as it will help you understand not only the financial aspects of a venture deal but also the legal and technical sides.  

On the entrepreneur side, VCs appreciate those who come prepared to meetings and have materials ready to go once the due diligence process begins. These documents oftentimes include financial statements, customer referrals, a well-thought out pitch deck, and team bios. Each VC firm varies on their level of due diligence; however, it is helpful to have these resources on hand for whatever might be thrown your way.

Back to the Future:

It’s hard to imagine what the world will look like in 5-10 years; however, as an entrepreneur or investor it’s important to evaluate a marketspace and try to imagine how it will evolve over time. VCs are interested in understanding the vision of your company and how you would adapt to a change in the competitive landscape. We have learned at Laconia that it is not about finding the “unicorns” of the industry but rather seeking out scalable, reliable businesses that will be able to stand the test of time.

We’d like to finish this post by telling you about the best parts of the job. For starters, what normal twenty-year-old gets to sit in on meetings with the founders of some of the most innovative companies in the world? In VC, this is the norm, and we were lucky enough to get to sit in on at least two each week. In addition, interning at a micro-VC firm allowed us to work side-by-side with Laconia’s two partners, exposing us to the minds of investors and the way in which they think about potential investment opportunities. Finally, we were able to gain access to accelerators, incubators, and pitch events, introducing us to the larger VC community. We hope these tips come in handy as you attempt to enter the daunting world of VC or take on a new business venture.