5 Things On Every VC’s Checklist
Everyone says that venture capital is all about pattern recognition. Well, maybe not everyone. I’m still trying to explain to my mom what VCs do, so she definitely doesn’t say that. But people in the know? Pattern recognition. That’s what it’s all about.
While working at a later-stage VC fund, it’s my responsibility to talk to anywhere from 60–100 companies per month to make sure we’re talking to the right companies. Every VC has a similar pipeline, though the specific numbers depend on the fund size and focus. Over the course of talking to these companies, VCs develop pattern recognition (an eye for things that work and don’t work). While every company is unique, success isn’t.
Granted, there are endless kinds of businesses in the world, and not all of them should, or even could, raise venture capital. The world is run on businesses that don’t need to raise VC — businesses with healthy cash flows that don’t need to grow exponentially. And that doesn’t make them bad businesses. Choosing what kind of financing to use is a business decision, not a badge of honor. But if you’re looking to raise from a VC, these are the things they’re looking for.
#1 Is the market size big enough to not sound stupid?
Everyone has seen the market size slide in any pitch. “Even 10% of a $100 billion market…” Sure, if you explain your whole market and it’s tiny, that’s a disappointment. But if you’re selling contact lenses via subscription boxes, and you use the entire $3 trillion US healthcare market, that’s just as disappointing.
VCs aren’t just waiting to hear big numbers when it comes to a market size. Without a clearly defined market, “decisions will be based on hidden, unconscious assumptions, and they’ll often be wrong.”
Ensure your assumptions are clearly outlined, and you can explain why this is actually an exciting dynamic market that just happens to be huge.
You might find yourself wondering, “but 10% of a billion dollar market is still $100 million! Why do we need to get greedy?” This comes down to plain, old-fashioned economics. VCs bet on a lot of companies, not all of which will succeed. As a result, they need the success of the winners to cover their losses on the not-so-winners.
There are lots of good resources that explain this dynamic (chapter 8 of Venture Deals for example), but Christoph Janz summarized it pretty well: “VCs need outliers to make their business model work, but that’s not your problem. If you think you don’t have strong potential to become one of these crazy outliers, maybe VC isn’t right for you.”
#2 Is everything growing that should be growing?
The companies that are most often successful are those that are able to turn $100K ARR into $10M ARR. To do that requires consistent growth.
The most common metric that VCs look for is top line revenue growth, because it indicates that you weren’t just lucky. Consistent revenue growth indicates something that “works.”
While top line revenue is the most paid attention to, full time employee counts can also be a clear indicator of an exciting company.
And finally, another necessary area we’re hawkishly looking for growth is indications that the market you operate in is growing. Every conference I go to, when I introduce myself as an investor, the one thing people know about us is that we’re looking for high-growth companies.
And a note on your financial projections, if you’ve had actual declining revenue, but you’re projecting increasing revenue, you better have a bullet-proof justification for that turnaround, because VCs tend to follow trends.
#3 How do I know this is better than what’s already on the market?
If I had a dollar for every time I talked to an entrepreneur who said, “there’s really no one doing what we’re doing,” I would have enough money to hire comedy writers to write better jokes than this. Ignorance of your competition is nearly as bad as being worse than the competition.
And while it’s important to hear an entrepreneur acknowledge their competitors, there’s not much qualitative details worth paying attention to here. This is where your metrics can paint the clearest picture. You might claim your product is better, but if 15% of your customers churn each year, and your competitors only lose 1%, that speaks volumes about your ability to compete.
Prove, with numbers, how your customers are sticking around and spending more and more money. Focus on your retention, your product stickiness, how you win sales, and why customers consistently choose you.
#4 Does this business have the potential to generate revenue profitably?
Some of the biggest companies in the world, both public and private, continue to sacrifice profits or even revenue, in lieu of growth. The lessons of the dotcom bubble of 2001 are pretty clear when it comes to betting on companies that are completely profitless. The reason the image below shows a dramatic drop in profitless companies is due to the realization that even the wonders of the internet can’t replace profitability.
More and more, you see successful companies trending towards profitability, and definitely demonstrating a clear path to revenue generation. There are notable exceptions like Snap, Inc. who can just prove massive, mind-boggling user growth, and table any substantive revenue discussion (though that’s not working out great for them.) But the majority of VCs expect revenue or revenue potential, depending on the stage of the investor. More and more, some form of profitability, or path to it, also bode well.
A lot of consumer businesses have continued to rely on the catch-all strategy of ‘advertising’ for monetization. While this might be the best option for certain companies, a catch all is inadequate for any sophisticated investor.
Instead, the focus is on a variety of revenue channels that don’t seem like they’re supported by brittle straws of assumptions about how much people will “probably pay.”
#5 If I had a relevant problem to solve, would this team be the experts I’d want to know?
When it comes to a management team, VCs are looking for more than just “do they suck?” Competency is important, but a lot of times VCs can help bring in additional management. If a CEO is weak technically, connecting them to a CTO isn’t incredibly difficult.
What is difficult is succeeding without a culture of hunger. If a company is tackling personal finance, you want to find a team of experts who eat, sleep, and breathe that industry. They’re the people who know everything there is to know, and what they don’t know, they have an action plan to find out.
A slide with your pictures and alma maters isn’t enough to convince us you’re the team. Demonstrate your unique perspective on this problem.
With big companies, you may not need the most intuitive leader at the helm when it comes to “unique perspective.” The CEO of Chanel (a $7.3B company) is Alain Wertheimer, a 69-year old French businessman.
The CEO of Rent the Runway, on the other hand, had experienced a specific problem herself, and set out to solve it.
When a company is early, you don’t need a professional CEO toting business-school models.
You need a hungry, passionate entrepreneur who will solve the problem, regardless of the obstacles. Prove that you’re that team.
Conclusion
Now, while all the things we’ve talked about are common on a VC’s checklist, the one thing true about every VC is that they’re different than every other VC. Some are focused on specific industries, growth rates, revenue amounts, user counts, traction, or any other metric they’ve decided to focus on.
While these are common high-level things that VCs need to check, what’s most important for you is to research and understand the VC you’re pitching, and know why it makes sense for you to talk to them.
