Behind the scenes of VC deal screening
Trying to shed some light on one of the entrepreneurs’ bugging mysteries and frequently asked questions I have been receiving from a number of founder friends — What do investors look at and what impact will each element have on the chance of the deal passing through to the next step.
1) Source of the Deal — the track
Impact: Screening priority
The quality of the deal’s source can be used as a rough proxy for the quality of the deal itself because VCs know much more about the recommending sources than the incoming deal leads. Most of the VCs rely heavily on their network of trusted CEOs, engineers, investors, lawyers and other contacts as their major source of quality deals — because great people, by nature, will bring in great companies and great companies always deserve the priority lane.
Suggestion:
- Having a healthy and strong network is very critical because entrepreneurship is an apprenticeship business and you will always need some help one way or another. Start building your network from today.
- Plan ahead and get connected to investors in any other way than cold emails if your time is not running out. At least you should have the chance to meet and chat with the investors a few times before officially approaching them for an investment opportunity.
- Relationship with investors is not a one-off so make sure you regularly give a positive impression to investors in every interaction so that even they pass your company today, they don’t hesitate make recommendation to other investors or even reconsider in the near future.
Side note: Having a remarkable investor in your company can be an alternative ticket for your company to the fast track, but in such case that investor should have already helped you with introduction in the first place.
2) Geo, Sector & Stage — the roadblocks
Impact: Screening filter
Each VC fund has its own set of investment policy which commonly involves these three basic criteria for filtering.
- Geography — VCs expect to have active interaction with the founders as the company evolves and thus their natural preference towards companies within their territory of operation. Because the market size of each Southeast Asian country is too small, almost every VC fund in this region chooses to define their geographic focus as the whole region. Therefore this first roadblock is not a big problem for local companies seeking regional investors.
- Sector — Obviously VCs couldn’t have a sufficient knowledge across all spaces to understand every deal opportunity. In ideal case, they would prefer to make investments in the domains they understand well and can add value, but again, due to the market size and maturity, investors in smaller markets cannot focus on a few limited verticals and tend to make their funds available to all internet and mobile companies, with a few particular verticals (e.g., marketplace, fintech) as priority.
- Stage — So far the most popular roadblock from my experience, particularly for cold emails. Founders should understand there is a considerable gap between the seed/1st money and growth-stage investors (often clearly mentioned on the their websites). Most of the deals I screened out until now were the proposals from pre-revenue and pre-launch companies while the current fund I am working for focuses on post-revenue companies.
Suggestion:
Spend some efforts to learn about each investor’s investment policy and check that your company passes at least these three filters before your official contact. Approaching investors without any clue will not do any good for your reputation, and again I couldn’t emphasize enough how small the investor community still is. However, policies are not always written on the stone so it’s good to regularly check out the VC’s portfolio and recent news.
3) Business Plan — the gateway
Impact: Screening decision
The final part and the gateway to the next step due diligence is the business plan. The quality of the submitted business plan conveys the quality of the entrepreneur, which is the most important, in many aspects. If the entrepreneurs could not present their business and thoughts in a quality way, they would not be able to convince other people that they are worth investing or working with. The submitted business plan will also be the key foundation for the following due diligence of the VCs.
Suggestion:
While each VC can have a slightly different checklist and order, below are the high-level topics under five categories I typically look for in a coherent and compelling business plan.
- The Market — Opportunity Size, Trends
- The Product — Differentiation, Revenue Model
- The Competition — Competitive Advantage, Barrier to Entry
- The Team — Background, Diversity
- The Traction — Key Customers/Partners, Milestones, Financial Data
Side note: Some VCs may also consider the deal-side information (e.g., use of fund) or synergies with their portfolio as part of the screening mechanism.
Bottom line
Get to know each fund’s investment policy to ensure you give a good impression to the investor community and target the right investors. Plan ahead your fundraising plan so you have enough time to build a solid connection to your targets. VCs share a pretty much common love for hard-working and smart founders, and the key is after making yourself the most knowledgeable person in your area, you have to be able to demonstrate that in your business plan.
This post is a part of my Venture Fundraising Basics series where I will try to share the fundamentals of raising venture capital for entrepreneurs and some local perspectives from my experience in Southeast Asia. For the complete outline and links to other posts, please visit here.
Note: All contents and opinions expressed in this story are humbly of my own and do not represent those of any of my current or previous employers.
