2 key things to consider when Venture Capitalists select early stage startups
September 5, 2019
2 key things to consider initially when Venture Capitalists select companies they want to invest in: the market and the founding team
Venture capitalists are very selective due to the risky nature of startups. Therefore, you need to convince investors that your company is a wise business decision to invest in.
This is primarily achieved through :
- recruiting a strong founding team,
- and participating in a new, large market.
Startup companies typically need funding. Founders often find this funding through venture capitalism. Finding the right VC firm can be a challenge. However, once a good fit is found, the journey doesn’t end there.
Investing in startup businesses is extremely risky and their selectivity reflects this. VC firms choose to invest in a very small percentage of companies pitched to them.
Valuating large scale companies is relatively simple as those companies have revenue, profit, and cash flow. Startups however have very little to none of this.
In order to avoid losing capital by funding unsuccessful companies but to capitalize off of companies that will become successful, VC’s typically keep these things in mind when choosing companies to invest in.
The Founding Team
Because VC’s can’t use startups’ cash flow to gauge the odds of return, they’ll look at who is operating the company. Having individuals who have produced solid results in previous endeavors is highly important. While some firms specialize in first time founders, VC’s generally want to mitigate the level of risk as much as possible. Achieving this partly entails investing in experienced, knowledgeable people who understand the field of entrepreneurship.
A strong founding team is much more well equipped to deal with unforeseen problems than inexperienced entrepreneurs.
Particularly with startups, things don’t always go accordingly so being able to think on your feet is useful.
Sometimes you may feel that someone in particular would be a perfect fit for the company because you feel comfortable with them. But if venture backed capital is something that you feel would be crucial to building the company, you may want to consider bringing someone who has been actually involved in other successful startups on board instead.
A large market
The ultimate goal of VC firms is to have the greatest return with the lowest amount of risk.
So, having a large market will be something they are looking for. A larger market means a larger potential consumer basis.
Being able to appeal to this consumer basis is obviously equally important.
There should be someone on the team with strong market knowledge and relations.
The product can be great but if the company can’t convey effectively why the product is so great, it might as well not be.
As always, there will be firms that specialize in niche demographics or markets but most firms will always want to be able to make the most money possible through the biggest market possible.
Just as importantly, VC’s want companies to be an emerging presence in the market or to be part of an emerging market.
Being one of the first companies on the scene will allow them to take advantage of the economies of scale.
Economies of scale provide the company the opportunity to have a more influential say in things like pricing.
This pushes out competition and gives the company extremely advantageous leverage. Establishing a company’s presence in an already established market is difficult. Additionally, the competition already has customers and understands the market far better than any newcomer.
VC’s can’t afford to be charitable. They’re very careful about investing in startups because the risk is high. This causes these firms to be exceedingly selective.
According to an article by Paul Gompers, Will Gornall, Steven N. Kaplan, and Ilya A. Strebulaev of Chicago Booth, only about 0.25% of companies receive financing through VC’s.
First and foremost, you need to find the right firm. Not all entrepreneurs and firms are compatible.
But once you’ve done your research about who you want to do business with, consider what will help boost your chances of standing out and how you will convince investors.
Recruiting a strong, experienced team and pitching a company that takes part in a large market in a creative way is a great way to start.
By Bryan Cho of IdeasVoice US