This Q+A was contributed by Annie Kadavy, venture capitalist at Charles River Ventures. CRV is one of the nation’s oldest and most successful early-stage venture capital firms, focusing on consumer and enterprise technology companies.

Follow Annie @akad on Twitter. 

Raising venture capital – often in the form of financial capital provided in exchange for shares or a role in your company – can be an exciting prospect for any business owner. The process behind it, though, is complex, and its implications for your business shouldn’t be overlooked.

We sat down with Annie Kadavy, seasoned entrepreneur and venture capitalist who works with Charles River Ventures, to hear her thoughts on subscription commerce, raising capital, and the big questions business owners like you need to consider before seeking out funds:

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What’s the first piece of advice you recommend for a business owner looking to raise capital?

Simple: Know your investor and what their financial return goals are. Almost all venture capitalists (aka VC’s) invest on behalf of their “Limited Partners” who have invested in them. These are the people who have provided a venture group with the capital to make their investments. The goal is to make money, ideally a lot of it, for those Limited Partners. Understanding the goal of your target investors is the first step into making a solid, compelling pitch.

What’s considered a lot of money for Limited Partners?

The best way to figure this out, aside from asking a VC directly, is to look at the size of their fund. Most funds of, say, $200M+ will need to be able to paint a picture where their investment will “return the fund” or yield $100M+ to the firm itself. That’s a lot, especially when a VC will typically own ~20% of your company. So, to yield a return of $200M, that company would need to some day be worth $1B. Later stage investors, who invest when the business is already off the ground and has less risk associated with it, have different thresholds, often below 10x.

Can a subscription business be worth a billion dollars?

Absolutely. However, the vast majority will not. So, as a general rule, I personally have been quite bearish on investing in them as often it is hard to see a path to that sizable of an outcome.

If the target is so big, what kind of subscription box businesses would a VC bet on?

This is a more nuanced than simply naming an industry or box idea.

First, if you have started or are thinking about starting a subscription business and want to raise capital, you must consider the potential size of your target market. It’s a fundamental question when considering scale: How many people could want or use your product(s)?

For most ecommerce businesses, including subscription ones, the next thing to look closely at are the unit economics of your company. Ask yourself: How much will your customers pay every month? How much will it cost you to source the thing(s) that go inside the box and ship it to them? Will you take returns? Will you have to source on an ongoing basis or is it the same item month to month? Will your shipping be more expensive if the item is really heavy, very large, or made of something liquid or fragile that requires other special attention?

A subscription business that appeals to a wide market (lots of people will use it), yields a high margin (the amount customers pay allows for sizable profits), and provides a continuously unique and valuable experience to customers is one that is more likely for a VC to bet on than one that does not do these things.

What are some examples of subscription businesses that have successfully raised funding, and why?

There have been several subscription business that have raised venture capital. Below are a list of qualities and examples of startups that have received VC funding; it’s by no means exhaustive, just a few that come to mind:

• Big Market Opportunity (Lots of potential customers): Dollar Shave Club, Harry’s, and Blue Apron
• High Margin for High Profits (Products that allow for better purchasing margins): RocksBox, Birchbox
• Unique Product Offering based in Discovery (Compelling or valuable experience): NatureBox, ClubW, Conscious Box
• Unique Value Proposition leading to Long Lifetime Value (Demonstrable lifecycle/continued need by customers): Petflow, Kiwi Crate

(Note: Lifetime value, or LTV, is the expected number of months someone will keep that subscription. Read more about LTV and other Key Performance Indicators.) 

What are the most important questions to ask yourself if you’re a business owner looking to raise capital?

If you think that you do want to pursue venture capital funding for your startup, here are the questions that you should be able to answer:

• How big is the market for this?
  • For example: Are you selling dog food to any and/or all the ~45M households in the US who have a pet? Or are you selling Pascagoula Panthers dog coats that fit only teacup poodles and cater to only adults with children who also attend Pascagoula High School? Clearly, there is a vastly different market opportunity between these two examples.
• What is the all-in cost for your box, from procurement to shipping it out, each month?
  • This includes questions like: Do you have to pay for what goes inside or are you getting it for free? How much ongoing sourcing will you need to do to continue filling these boxes to delight your customers? What will shipping cost you?
• How much will you charge per month and what will your profit margin be?
  • For example: If you charge $30/month and it costs you $24/month to source, pack, and ship that box, you make $6/box that goes out, or 20% gross margin. This is not bad, but it’s not great.
• Where and for how much will you acquire new customers? How long will your payback period be?
  • Using the example above, say that it costs you $30 to acquire a new paying user on Facebook. It does NOT take you 1 month to make up that cost when he/she pays you $30. Instead, it will take you 5 months to break even because you are only making $6/mo in profit from that person.
• For how long do you think your customers will stay/what is the average Lifetime Value you can reasonably expect?
  • For example: If your customers are pet owners, will they stay for as long as they have that pet (many years)? If it is getting beauty samples, do people want to keep getting those 12 months later?
  • One way to think about this is to ask, “Is my subscription a “must have” or a “nice to have” type of service?”
• The most important question to ask yourself is this: Do you want to pour your heart and soul, and perhaps your net worth, into building this company, or do you want it to be a lifestyle business or something in between?
  • One benefit to subscription businesses is that they’re highly predictable and more manageable to run than your typical e-commerce business. Building a business of any size is hard. Deciding you want to build a billion dollar company over many years is a huge decision. Be sure you want it, as your investors will require this commitment from you.

What should I expect the size of my business to be?

I would say that 99%+ of subscription businesses will not grow to be worth hundreds of millions or a billion dollars. And, that’s more than OK – that’s great! Running a subscription business can be both lucrative and fun. Part of the beauty of subscription commerce is that we, as consumers, can choose any sort of thing that is highly personal and relevant to us. Maybe it’s bowties or makeup, or dog treats or specialty cheese, perhaps it’s local tickets for things to do in your hometown or seasonal decorations. While it’s not the size of business that most VC s will invest in, they are still amazing businesses to build.

A Summary By Us: Key Takeaways from Annie Kadavy

Take a moment to reflect on the big lessons explained by Annie – they’re extremely valuable when considering if venture capital is right for you:

• Know Your Target VC’s Goals: What is the size of the fund? What returns are expected? Target and adjust your pitch appropriately.
• Subscription Businesses Who Can “Make the Case” Can Be Funded: Big goals don’t mean subscription businesses can’t raise funding. When your business addresses a large market, shows a positive financial model (with high margins), and provides a unique and demonstrable solution to a real problem, you can make the case for venture capital.
• Ask Yourself the Right Questions: Business owners who astutely understand their business model – from Cost of Goods Sold (COGS) to Lifetime Value (LTV) to Customer Acquisition Costs (CoCA) – equip themselves with the rhetoric needed to speak fluently with investors. Learn it!
• Be Passionate about Your Craft: Venture capitalists want to see true passion in their prospective portfolio companies. If you just want to run a small, sustainable company, worrying about venture capital probably shouldn’t be on your list.