Getting it right and pleasing investors can be difficult. From my personal experience in the startup world, here’s what VCs look for before investing in your startup.
We’ve all seen the headlines: «Tal Startup closes $50 million funding round.»
If you’re an entrepreneur or working at a high-growth startup, this may seem like a dream come true. Funding and partnerships with experienced business professionals are big business. However, you have to navigate the sharks before that sweet VC money becomes a reality. Pitching your company is about more than just showing a pro forma and telling a compelling “it started in a garage” story.
Just as your startup’s products and services provide value to your customers, your startup as a company provides value to your investors.
Getting it right and pleasing investors can be difficult. From my personal experience in the startup world, here’s what VCs look for before investing in your startup.
While your startup is still young, VCs need to see concrete validation that your business is viable.
When you pitch your startup to a VC for investment, you’re saying:
- We offer something that people want
- We can make money profitably
How do you prove you offer something people want? By getting customers. Having a small but satisfied customer base serves as proof of concept.
This is basically a market test, as your business is operating on a small scale.
Proving that you are making money profitably is as simple as showing your financials for the past 90 days. If you are not already making money at a decent profit margin, it becomes a pretty tough sell.
Venture capital firms aren’t looking for an unproven idea with great potential, they want to see the building blocks.
When you pitch to investors, you’re not presenting your company. You’re presenting yourself and your ideas.
An investment involves a partnership, mutual goals, and a deep belief in your company’s mission. This means your pitch shouldn’t focus on the bells and whistles. Instead, focus on the problem being solved and the value your company brings.
In addition to believing in the mission, investors must believe in the team behind the operation. After all, they are part of the company.
Ask yourself if now is the right time to seek additional funding. Will you be able to grow once you get the investment? Do you need investment now?
The ideal startup for a VC is one that has a proof of concept but is still young enough for investment to make sense.
This stage of your company’s life cycle is the adolescence stage.
A company that is too young will not have enough data for investors to make a decision and has no traction.
A company that is already established will not present enough potential advantages for investors to take the risk.
Niche products for a niche audience rarely get venture capital investment, and for good reason.
At this point, you should have a pretty good idea of what your ideal customer looks like. With this knowledge and research into your industry, you can put together a general SOM (Serviceable Obtainable Market).
Your SOM is the amount of money there is in the market for your product. A large SOM shows investors that you operate in a high-value market.
All investments involve risk. Investors are attracted to large potential markets that are worth the price of entry.
The amount of money you have and how quickly you spend it is your cash burn ratio. A low cash burn ratio is how investors measure your company’s efficiency. A quick formula for the cash burn ratio:
Operating costs + expenses – income = cash burn rate
Your business is a machine that needs money to run. The more efficient it is, the greater the impact of your investment dollars.
This will also make your financial forecast more attractive. This is where you detail how you will spend the investment money and how it will impact your income.
Aside from your speech and your company, who you are addressing is equally important.
Venture capital firms, like any other company, have a business philosophy, a brand, and a portfolio to diversify. As with all potential partnerships, there needs to be a good fit between the two parties to ensure a mutually beneficial relationship.
Private equity firms want to make sure they can provide value to you, as this is a partnership, not a sale.
Ensuring your investor is the right one will help both parties benefit from the partnership.
Let’s face it, investing in a startup is a risk. In fact, even the most successful venture capital firms invest in companies that go to zero.
In fact, 25-30% of VC-backed startups fail.
Knowing this, VCs are always looking for the “unicorn” that will help recover losses and ensure profitability.
The unicorn has a 10x potential, meaning the return on investment has the potential to be 10 times the initial investment.
How do you reach unicorn potential? A good starting point is to check the other 6 points above. Then, make sure your finances are in order, send out those applications, and take the next step in your entrepreneurial journey.
