February 2017: I’m in the middle of my first year in MIT Sloan’s MBA program, and unlike most of my classmates, I don’t have a summer internship lined up. If you are in the process of earning your MBA or have already earned one, you’ll know that this time of year is recruiting season. It is, for most, the primary reason they pursued an MBA. It’s also a good chance to try out what might become a new career.
Pursuing job opportunities requires time and focus. Unfortunately, by zeroing in on one industry, you forfeit many other opportunities. Consulting firms and investment banks were the first to make me offers, but like a few others in my class, I was holding out for the “right thing”. By February, most of my classmates were feeling secure, having received placements for the summer. The ones who hadn’t were increasingly stressing out.
I was part of the latter group.
I had spent my post-university career working on my own tech startup, which blew up, then transitioning to Boston Consulting Group, where I earned a sponsorship opportunity to pursue an MBA. When it came to a summer internship, even though it sounds like a cliche, I was committed to working on something exciting, dynamic, meaningful — and different. I decided to pursue venture capital for the summer, as I wanted to learn what it was like from “the other side of the entrepreneurial table.” I believed that with my previous experiences I could contribute to a VC firm in different and meaningful ways.
A fortuitous encounter with Rhapsody Venture Partners finally signaled the end of my summer job search. Rhapsody had placed an advert that intrigued me: “You are an entrepreneur, not a banker. We are in the business of venture creation, not just financing.” I applied, and after two tough rounds of interviews, I was fortunate to receive an offer. Now, after 10 weeks at Rhapsody, I can confidently say that it was the learning experience I expected it to be.
Here are the three key lessons from my internship:
Lesson 1: This is a good time for venture capital. There are still great opportunities in spaces where few investors are looking.
When we think of venture capital, most of us think of software. Software is hot for many reasons. The time to create an MVP is short. R&D costs are low. Regulations are few. Exit valuations can be stratospheric. Because of that, software is flooded with capital, making it very hard for new funds to access the “better deals”.
The truth is that there are many other industries that are currently being underfunded despite being good places to invest. Over the past 10 weeks, I met dozens of entrepreneurs and scientists who are dedicating their lives to creating innovations to transform “old school” industries, such as construction, agriculture, air conditioning, and energy, to name just a few. Innovating in these sectors is difficult, as entrepreneurs face many challenges — among them, long development cycles and high funding needs to get to a “market ready” position. Regulations can also be more challenging, and adoption from potential clients is slower. These complexities often discourage classical VCs who don’t have enough expertise to assess if the opportunities are worthwhile investments.
At Rhapsody Venture Partners, we focus on market spaces where few others are looking. We invest at an early stage in intellectual property-driven startups, operating in markets such as agriculture, materials, polymers, semiconductors, and others. These companies are IP-rich, yet have scarce financing opportunities. Rhapsody helps scientists “launch their innovations out of the lab” by providing funding to accelerate their transition to market and by connecting them with industry partners to de-risk that transition. This model has proven to be extremely successful, with seven current investments with unrealized gains above 10x and a 100% active portfolio — which means no failures to date.
Lesson 2: Venture capitalists are missing the opportunity to shape average opportunities into great ones.
If you’ve raised money like I did for my software startup, you’ll agree that the diligence process for traditional VCs is slow and, frankly, lousy. They receive hundreds of inbounds each month, so the game is all about separating the wheat from the chaff. Associates at VC funds spend most of their time passively hearing out deal opportunities, trying to guess which one will magically turn into a unicorn.
At Rhapsody, I was told not to look for great deals, but rather to create great deals. At the beginning, I was confused and skeptical of this approach. But as the weeks went by, I came to understand that our diligence process is defined by proactivity and action. We deep-dive on each of our potential investments. We leverage our industry expertise and networks to discover whether the market really needs the product/service that the entrepreneur is offering. The general partners at Rhapsody are entrepreneurs, not bankers. As part of the diligence process, they find corporations and try to engage them in the launch of the product, committing to either a purchase order, a pilot program, a JDA, or any other form of commercial partnership. After all, is there any better way of validating a market than by finding someone willing to put money in early for a product/service?
At the end of our diligence processes, we often end up creating value for the company by finding their first industrial client. The entrepreneurs win and we win by collecting valuable insights on the commercial opportunity, thus lowering the investment risk. When the commercial opportunity is there, we invest and naturally progress the work we already started in the diligence process. If the commercial opportunity is not there, we don’t invest, and the entrepreneur has a chance to change course or give up on a technology that might be genius but that doesn’t have a market.
Lesson 3: Higher startup valuations limit the founder’s exit opportunities.
VC funds want their money back for sure, but only at the right exit valuation. Early-stage VCs aim for a 10x multiple during a 10-year investment period. Simply put, if a VC invests in round A at $10M post money, it will aim to exit at $100M. If it invests at $100M post money, it will aim to exit at $1B. This summer I heard entrepreneurs and early investors recount stories of being washed out and ending up with nothing after an exit because of having raised too much at inflated valuation (entrepreneurs should fully understand the consequences of liquidation preferences!).
Sometimes entrepreneurs received exit opportunities that would have been life-changing for them, but VCs had blocked them because they didn’t meet their return expectations. The lesson is to always have in mind what potential exit is reasonable for the startup you are working on. Exit valuation of similar companies should help you assess at an early stage what your maximum valuation is, enabling you to grow to an exit scenario that could make all stakeholders happy — and that will frankly maximize the chance that you end up with something after your long and hard journey.
There are many underserved spaces that have a great investment outlook. Diligence needs to be strong and value-creating to reap those opportunities. Finally, negotiating valuation with entrepreneurs is key for the VC’s returns, but also for the entrepreneur’s chances of achieving a happy ending. Having learned all this, I’m returning to my second year at MIT Sloan pumped and with the satisfaction of having had a great working summer experience!