How VC's Evaluate Start Up Investments

After many conversations with venture capitalists, and accomplished entrepreneurs I have put together what I believe are key points that investors look for when investing in a high-growth start up.

1.) It's All About The Market - VC's are always looking for a market opportunity in a fast growing sector, with a market potential of atleast $500 million to $1 billion in size. The favorite type of company is the kind of company that is doing well despite itself and upkept because the market is so strong.
This does not mean that investors will turn a blind eye to start ups in niche markets, but it does mean that will be more wary if it is a highly specialized product or service that can only be applicable to a small group of people.
2.) The Business Model Matters A Lot -  VC's focus heavily on analyzing a company's market strategy, differentiation strategy, revenue strategy, and pricing and cost control strategy when evaluating start up business models. 

  • Market Strategy - The company needs to be pursuing one of three strategies: 1.) Better execution of an existing product in a proven market 2.) A new business model 3.) Targetting a completely new market.
  • Differentiation Strategy - The company needs to have a clear focus on whether it is going to pursue a low cost strategy or if they are differentiating themselves another way, whether through innovative technology, better processes, or a premium product/service.
  • Pricing And Cost Control Strategy - Companies need to have an idea of what their burn rate is or will be, and start developing mechanisms to ensure that they don't run out of money before they hit a home run. For example, if your company will be using a direct sales force to push their product/service, this will be very expensive so the entrepreneurs need to know that they will either need highly priced products/services or manage a large volume of customers. 

3.) A Great Team Inspires Confidence - When judging a start up CEO, VC's look for a sales oriented entrepreneur with domain expertise. You don't necessarily have to have years of experience in a certain industry, but you do need to show you're highly knowledgeable in your industry. You will be your company's biggest advocate, expert, and sales person (atleast at first). Apart from the CEO, there needs to be a team that is robust, and where every person brings different skills to the table and that is willing to work themselves around the clock for the success of the company. Last but not least, the entrepreneurs involved need to be flexible and willing to learn... constantly reaximing assumptions, willing to be coached, and willing to pivot and adapt to change.

4.) Due Dilligence Is A Must -  VC's conduct both internal and external due dilligence. Internal due dilligence refers to analyzing what the feasibility of making the product/service is and whether the company can get the resources in place to do it the right way. This also includes investigating the team, collecting references (sometimes blind references) and spending a lot of time with the entrepreneurs.  External due dilligence focuses on the customer and the market. This involves talking to industry experts, surveying, and running focus groups, and figuring out how the venture can be better positioned to ensure its success. 

5.) Financial Analysis For Start Ups Is All About The Future - Some VC's put a lot of faith into financials, but most of the time these predictions for early stage companies are not even close to reality. However, you can never go to a VC or angel and expect to get money if you don't have some drawn out financial projections.  Having well thought out financials shows credibility and that you have thought about revenue, costs, projections, and financial sustainability. VC's like to see financials to see if the entrepreneur is reasonable and consistent with the operational needs of the business. If the entrepreneur is undervaluating or overvaluating the business it is a red flag that they might not have good business sense.

My next post will be on raising a seed round as a start up!