Many startups have this question: What do VCs want? The answer is that each VC is different and may have his own set of criteria. However, the good news is that there are few common things that every VC wants to see in the startup funding proposals. Leveraging our experience of working with VCs, we go in-depth and identify 7 most important factors that affect the VCs investment decision. Therefore, if you are raising funds for your startup then ensure that your business has the following essential factors
1. Traction From Customers
This is the first thing that a VC may look for in the startup. With this, VCs try to identify what problem is the startup solving and to estimate whether the targeted customer is really interested in paying for the solution to that problem.Venture Capitalists consistently try to estimate the alternate substitutes currently available. They try to understand customer’s ability and willingness to pay for the startup’s services or products. VCs predominantly validate this by looking at the current revenues, number of orders, order size, and key customers. Even for a “pre-revenue” company, VCs try to estimate the traction by looking at the number of users, Online Traffic, Daily Average users (DAUs), etc.
Venture Capitalists use these numbers to determine the capital efficiency of the startup so far. This is done by identifying metrics such as Customer Acquisition Cost (CAC) and the Life Time Value of a Customer (LTV). From a VC perspective, LTV has to be greater than CAC to create value for the shareholders. All these numbers are estimated from the current traction and the future expected traction once the company scales up. Therefore VCs will be very apprehensive if the startup is trying to solve a problem for which customers are not able to pay or do not want to pay. So, if your startup is raising funds then ensure that you have enough traction from customers.
2. Large Addressable Market
VCs are extremely particular about investing in startup that is targeting a large market. They want startups to list out their ideal target customer and then try to estimate the total addressable market size. Their goal of getting 10x returns on their investments is what makes this criteria particularly important for them. Large market mean more growth potential and VCs just love that!
If the market is not large enough, then startups seeking funding, try to sell their idea by forecasting large market share of a small market niche. But this is a very tough sell, as large market share over a period of time is extremely rare. And that does not match the risk appetite of a typical VC.
So what is a big market for a VC? $1 million? $10 million? $ Billion? Maybe $100 billion globally. And therefore it is prudent to demonstrate addressable market potential. Addressable Market is the market that you as a startup are currently able to service. For Example, globally the market size is $10 billion, but you’re only based out in the US. Hence the US market becomes your addressable market. This makes it very easy to identify the industry drivers and trends which can help you present a detailed forecast to the VCs.
Once VCs have identified addressable market, then they estimate what percentage of share of the market can the startup actually capture. This gives them the size of the opportunity and makes it easy for them to decide whether to go after that opportunity or not.
3. Quick Scalability
VCs generally provide funding to a startup with an average time frame of 3-5 years before exiting. Therefore, they look at how quickly the startup can scale up and multiply the traction that it is currently having. Generally, VCs have multiple startups in their portfolio. Hence, they prefer those startups where they can auto-pilot their way to scaling the business. However, the business model of the startup should be such that it can repeat the success. That is, if it captures one one market, can it do the same in another market without much effort.
VCs typically achieve scalability by helping the startup get B2B clients and relationships that they have in their network. They help the startup get tie-ups and strategic relationships with other bigger players that would enhance the scalability across the value chain. VCs help the company secure bigger clients, help in raw material procurement from a bigger player, appropriate distributors, etc. Therefore, VCs look for those startups which have a big enough addressable market and can quickly scale up the business capacity without fundamentally changing the business model.
4. Barriers for copycats
VCs prefer a startup that can differentiate its product and services from the competitors. Rather, they look at the possibility of a bigger player entering their industry by just copying the product service and eat into their market share. So VCs evaluate each and every competitive advantage with great scrutiny.
For example, a startup looking for funding, may have a first-mover advantage as one of the key competitive advantages. But that advantage will be nullified if a bigger player or any other player just copies their offerings and enters the market. This is a big investment risk for the venture capital investors. Barriers to entry and the financial viability of creating such barriers are an important aspect considered by VC while evaluating startups seeking funding. Therefore, proprietary offerings and patent protected startups are offered a higher valuation.
5. Founder Expertise & Track Record
VCs put a greater deal of value on the human capital than the entire product and idea itself. They believe in investing in the Founders and other key personnel instead of investing in an idea or a product. Therefore the track record of the Founders becomes a crucial point of evaluation for the VCs. Founders who have a successful previous experience of running a startup have significant advantage in raising capital from Venture Capitalists. Especially if founders have successful acquisitions of their startups in their CV, the venture capitalists increasingly get excited about the opportunity.
VCs also put a great emphasis on the founder’s background. If the founder has a relevant educational background or previous work experience in the domain of the startup, then the VCs have a higher regard for the same. They also try to identify the key personnel and the management quality before investing in the company. Therefore for a VC, it’s much more about people than the idea or the product itself.
6. Visibility of Exit Opportunities
Venture Capitalists are not there with a startup for the long haul. The time frame is usually within 3-5 years. It is very rare for a VC to invest beyond 5 years. While evaluating a startup seeking funding, VCs try to identify how quickly can the company scale up so that it can become an attractive investment for Private Equity, Institutional Investors (IPO), or a big corporate company (M&A). These are the typical exit opportunities that help them make a “VC kind of return.”
A startup with significant competitive advantages, that are difficult to replicate and with good traction can be quickly scaled up by a VC. The scaled up version then becomes a very attractive proposition for bigger players. Large corporates then feel that it’s a lot easier to acquire and merge such startup into their operations than investing separately in a similar project. PE funds typically look for opportunities wherein they can take the young company and exit via IPO. Therefore, a startup that has raised funding from VCs and has the potential to go public becomes the target investment for a PE. Hence, VCs always look for startups that can attract potential exit in the future.
7. Detailed Plan for Fund Allocation
VCs are extremely keen on understanding the founder’s perspective on how startup will distribute the funding across various functional segments. They try to identify the alignment between their vision and the vision of the founders. If there is a significant disagreement in the future capital allocation and functioning, then VCs would not put their money. They want to ensure that startup uses the funding in efficient manner.
VCs tend to look for 10x returns on their investments. And it is common knowledge for almost all startups. Therefore. all the business proposals try to convey the same as to how their company will deliver the 10x returns. But VCs go into the intricacies of the Capital Allocation and try to estimate whether it’s actually plausible and possible. Therefore fund allocation directly demonstrates how efficiently a startup can utilize the VC funding.
There are multiple ways for identifying how consistent the assumptions are w.r.t the returns that startup may be promising to a VC. For example, if a product based startup plans to spend a significant portion of the funding on marketing instead of cost-control and operations, then it may raise significant questions from VCs. A startup with proven traction would ideally spend a lot more on building up its production as compared to marketing. This also validates the underlying condition of LTV>CAC. Hence, VCs evaluate the return profile and validate the same by checking if there is a consensus between your Startup Pitch and your Financial Snapshot.
A startup with a proven track record, a large addressable market, smooth scalability, and an appropriate moat to protect its differentiation can be an ideal target for the VCs. But for successful funding, a startup should also have a great management team and a well-planned business plan that completely tips the scale in its favor. Therefore, we believe that any startup raising funding must have these 7 factors as they can make that start-up “a complete” package for the VC investors.
Are you a startup that wants to raise funds? We can help you reach the right investors (total 40,000+ investors) and have a private 1-on-1 discussion with them. Our fundraising services are affordable and discrete as we use tech and do not charge high fees like traditional investment banks. Please contact us for more details.