Feb 18, 2022
How do Venture Capitalists choose the Right Startup to Fund?
Venture capital has been a crucial source of funding for high-growth startups for the past 30 years. The funding and mentoring offered by VCs contributed to the early success of numerous innovative companies, including Amazon, Apple, Google, Intel, Microsoft, Airbnb and many more. To create economic value, venture capital has become an essential driver. The ones incurring significant risk by investing money are Angel Investors and Venture Capitalists (VCs). The founders of new businesses sometimes have little to no real-world management experience, and the company plan may be based only on a concept or a rudimentary prototype. New businesses also frequently have little or no sales. There are numerous valid explanations for why VCs are conservative with their investment funds. Even today, VCs invest millions of dollars in small, unproven businesses in the hopes that they will one day become the next big thing, despite the significant risks involved. After analysing financial reports and surveys, the following are a few factors that VCs consider while deciding whether to invest:
Does Market Matter?
VCs will inquire about the market size for the goods or services startups are offering. They will want to know that it is a sizable market in addition to that. Why? VCs want to see startups succeed, and enormous markets encourage success. Large markets are not only less volatile and more stable, but they can also accommodate the operations of numerous expanding businesses. And it is much better if the market is expanding. Startups get a tailwind as a result.
On the other hand, if the market startup companies will serve is too small, there could not be room for significant expansion to enable investors to recover their investment. Gaining the interest of VC investors requires proving that the company will focus on a sizable, addressable market opportunity. For VCs, a market is considered "big" if it has a revenue potential of $1 billion or more.
VCs typically seek to make sure that their portfolio companies have a probability of increasing sales worth hundreds of millions of dollars to obtain the huge returns they expect from investments. For VCs looking for potential methods to exit their investment, the possibility of a trade sale increases with market growth, making the firm even more exciting. In an ideal world, the company would expand quickly enough to gain the top or second spot in the market. Venture capitalists anticipate thorough market size analyses in business ideas. It is important to convey market sizing both "top-down" and "bottom-up." This entails presenting estimations from independent sources gathered in market research studies and input from potential customers demonstrating their desire to purchase and pay for the company's product.
Teammates: The Titans
"Coming together is a beginning, staying together is progress, and working together is a success," the famous remark of Henry Ford finds its relevance in the startup funding companies and investment ecosystem too. It is crucial to understand who is behind a concept or business and, more importantly, what kind of person they are. Even if you have the best idea, the incorrect team could prevent it from ever taking off. You cannot just fill startup positions to assemble a team and launch. You must ensure that every employee is highly qualified and has the potential to advance the company. A strong team with the capacity to expand the company and take it to new heights of success is required. Simply said, management is by far the most crucial aspect for intelligent investors. VCs invest mostly in the management team's capacity to carry out the company plan. They are not seeking "green" managers; rather, they would like leaders who have developed profitable companies that have provided investors with excellent returns. Businesses seeking venture capital funding should be able to give a list of knowledgeable, experienced individuals who will be key figures in the growth of the business. Businesses that are short on qualified managers ought to be open to bringing in outside candidates.
Competitive Edge: The Secret Sauce
A distinctive good or service will be appealing. A good or service that does not stand out in some way and turns into a commodity will not draw customers. "Unique" refers to something that is not only distinct and novel but also difficult for a rival to imitate. The "secret sauce" that makes your good or service stand out from the competition is essential. Every new company is the Uber of something, which has been done to death. You need to stand out, and the only way to achieve so is by having something truly original and distinctive, as less than 1% of all U.S. startups ever receive Venture Capital funding . Your idea will only garner initial interest if it is something that the VC has not already heard presented multiple times.
Investors want to put their money into top-notch goods and services with a reliable competitive advantage. They look for a solution to a pressing issue that has not already been addressed by competing businesses in the market. They search for goods and services that clients cannot live without because they are far superior or more affordable than anything else on the market. Investors in type of venture capital (VC) seek out a market advantage. Before other companies enter the market and cut into profitability, they want their portfolio companies to be able to create sales and profits. The better, the less direct competitors there are in the market.
Financial Planning: A Key to Success
Before investing, a VC interested in you will take the time to get to know you. You can guarantee your bottom dollar that the VC will be taking notes if you talk about your growth projections. They will also inquire why your growth falls short of expectations during a particular period. Entrepreneurs seeking funding from business angel investors or accredited investors must have a solid, well-written plan for success. However, brilliant a commercial strategy may be, it will not excite investors as much as a product or service already being offered to customers. Instead of building their businesses, too many businesspeople put too much effort into honing and polishing their marketable tactics.
Conclusion: Capitalise on Capacity
Finally, numerous firms have launched their seed investment arms in the past ten years to capitalise on the promise of entrepreneurship, and they can learn from the strategies used by the VC sector. The management team plays a crucial role in informing whom to fund and influencing the success of investments. The numerous local policymakers who work to create thriving ecosystems for venture capital trends to promote economic growth can also gain from an awareness of VCs' strategies. And last, many of the innovations that end up in VCs' portfolios come from universities.