What do investors and venture capitalists look for in a product?
Do you know that before concluding a transaction, leading venture capital companies look at an average of 101 opportunities? Are you aware that 95% of venture capitalists prioritize the founder's team above his company idea? Furthermore, did you know that 31% of early-stage venture capital companies do not predict business financials when making an investment decision? So, what do venture capitalists look for in a startup?
These figures demonstrate how difficult it is for a startup to get venture funding for its firm. And, according to a new study, it very definitely is.
Simply put, venture capital is a sort of funding provided by private equity investors to firms with high growth potential. These venture capital firms specialize in making investments in start-up companies.
According to studies, a venture capitalist's investment and skills are critical to a startup's success. This is because, in addition to funding, VCs supply entrepreneurs with their networks, expertise, and a variety of other essential tools. Before investing in a business, however, a venture capitalist evaluates several variables
As a result, understanding how VCs communicate with companies seeking capital for their company ideas is critical for entrepreneurs. Entrepreneurs must also understand what VCs look for in a business.
1. VCs want you to show that there's a significant demand for what you're offering and that a lot of money is being spent on it.
The market for the product or service you're providing will be important to VCs. They'll also want to know if it's a sizable market.
Why? Venture capitalists are in there to help you expand, and enormous markets help you grow.
Big markets are not only more stable and less prone to volatility, but they can also sustain the operations of several rising businesses. Even better if the market is expanding. This will provide you with a tailwind.
On the other hand, if the market you operate in is too tiny, there may not be enough space for development for the investor to make a profit.
What exactly is a large market?
There is no precise definition, but we're talking about $1 billion on a worldwide scale.
Within that, you may want to consider the 'addressable market,' or the segment of the market your service.
When we speak about our market, for example, we mention that there are 50 million small and mid-sized firms worldwide, of which we believe 10 million to be addressable. These are companies that need what we provide and are the right size, profile, and location for us. They presently spend $10 billion each year and are expanding at an annual pace of 8%. When we can illustrate it to VCs, they pay attention.
2. VCs want to see how your product differs from the competition. What distinguishes it from others?
It will be appealing to have a one-of-a-kind product or service. A product or service that isn't unique – that becomes a commodity – will fail to attract customers. 'Unique' indicates not just unusual and novel, but also difficult to duplicate by a rival. Your product or service must have a "secret sauce" that will keep competition from stealing your market share.
There are several techniques to make yourself stand out.
Differentiation of your product: You've got something unique (and hard to replicate).
Differentiation is the process: You're promoting a new, more efficient method of doing things.
Price point differentiation: You've discovered a technique to offer a product or service for a lower or higher price (i.e. premium pricing).
Super niche differentiation: You've discovered a market that's a great match for you.
It's much better if you have numerous differentiators.
Differentiators shift with time. Having a patent, for example, used to be a strong differentiator. However, patents are becoming less useful as technology advances and it becomes easier to circumvent them.
The most crucial thing is to build and maintain strong differentiators.
3. Venture capitalists want to see proof that you have a strong management team in place.
A venture capitalist considering investing in your business will want to ensure that the funds will be well-managed. As a result, having a top-notch management team with relevant expertise is critical.
Do not attempt to conceal a weak connection. The VC will want to meet the players and will want to know more about everyone on the management staff.
If your management team has any weak players, I would advocate deferring your hunt for VC funding until your A team is in place. If a player isn't doing well, train them to improve their skills, and if that doesn't work, replace them.
It's preferable to be without a vital player than to have the incorrect person on the squad. That's because telling a VC that part of their money would be utilized to employ a great A-level player is entirely appropriate.
So be attentive and forthright.
Aside from assessing your management team, the VC will want to learn about your company's culture and management philosophy — how your management team approaches issues and difficulties.
The VCs will spend time in your office, and they may put your management team to the test by asking them challenging questions or conducting whiteboard sessions in which they ask how your company would solve an issue. You will be disqualified if your team exhibits a dysfunctional attitude. Your workforce should be used to collaborating — and collaborating successfully.
The CEO will be highly valued by the VCs, to the point where I've heard it argued that VCs don't invest in companies; they invest in CEOs.
The VCs will spend a lot of time trying to figure out how the CEO works - how he or she handles problems, encourages and listens, and inspires and pushes the company ahead.
4. VCs want you to demonstrate how your business aligns with their investing philosophy.
Every venture capitalist has a belief system that guides investment decisions.
Some venture capitalists are just interested in making a profit. Others take a more calculated approach, focusing on startups that will benefit their parent firms.
Intel Capital, for example, is the company's investment arm. Intel is a significant semiconductor chip manufacturer. Intel Capital invests in hardware, software, and service developers and suppliers in sectors and businesses that (in general) utilise semiconductor chips. In other words, they assist in the creation of future markets. This is a calculated strategy.
Even if an investor is just searching for a profit, he or she may create a mindset based on their prior ability to select winners.
One VC, for example, could decide to solely invest in firms that sell to Fortune 500 corporations since that's where the money is. Another venture capital firm may specialize in green technologies or social companies.
A venture capitalist who focuses on a certain industry, such as green technology, will become highly familiar with that industry and will be able to comprehend the playing field, rivals, trends, and purchasing habits. They may also desire to invest in businesses that complement each other.
So, whether they're in it for the money or the long term, most smart venture capitalists will have a thesis or area of interest.
You'll also need to know what their thesis is if you're searching for their money.
5. VCs expect you to be able to back up anything you say with data and facts.
Before investing, a VC that is interested in you will take the time to get to know you. You can guarantee your bottom dollar that the VC will take notes if you talk about your growth predictions. When their analyst calls the next time your growth falls short of expectations, they'll ask why.
So be mindful that anything you say to VCs will need to be backed up by analytics and good data. That involves having concrete proof of growth for your own company.
Every industry will have its own set of criteria that VCs will consider. Numerous well-known measures are used to assess a SaaS (software as a service) firm. You may have heard of the Five Cs of Cloud Finance, for example. (It's the fifth of Bessemer Venture Partners' ten rules of cloud computing).
The Five Cs are as follows:
1. Committed monthly recurring revenue, annual recurring revenue, and annual run rate revenue (CMRR, ARR, and ARRR);
2. Cash flow — Begin with gross and net burn rates, then work your way up to free cash flow over time.
3. Payback time for customer acquisition costs (CAC).
4. Customer lifetime value (CLTV)
5. Logo churn, CMRR churn, and CMRR renewed churn and renewal rates
6. Venture capitalists expect you to be able to explain how you plan to utilize their funds.
It may seem self-evident, yet it needs to be stated explicitly. A VC investor wants to hear how you plan to utilize their money in great detail.
Will you spend money on advertising? Will you bring in fresh personnel, such as a top-tier executive or new salespeople? Will you invest the money in a small business that offers a service you need rather than developing it in-house?
The investor wants to know what you intend to accomplish with the money and how it will help you achieve your objectives.