What VC Firms Want to Know Before they invest in Your Startup
In today’s ever-growing competitive market, it is hard getting your startup off the ground. This is true even if you have a great business idea, a product, and a talented team. It explains why most businesses fail.
According to a report from Failory, 9 out of 10 startups fail. The two biggest reasons that cause failure include misreading market demand and lack of capital. A report from CBInsights shows that 29% of startups fail due to running out of funding. A lack of diligent research on market demand grabbed the top spot, with over 40% of cases.
So without proper funding, getting your business off the ground and surviving in such an ever-growing competitive world is difficult. To prevent this, startups turn to venture capital firms for funding.
But doing this is very tricky. Venture Capital firms do not invest in just any startup. They invest in businesses that solve real problems, have a high demand in the market they serve, and also show a good return on investment. Not to mention, it can be challenging to attract the attention of venture capitalists in the first place.
What if you knew exactly what venture capitalists want from a startup and how to get their attention? This will help you get the funding you need and create strong and lasting partnerships that will become an invaluable asset to your business.
In this guide, I’ll share what 3 venture capitalists have to say on what they look for in a startup before they invest and how founders can approach them for funding.
Table of Content
What are VC Firms?
What are Venture Capitalists?
What Venture Capitalists Look For in a Startup
How venture capitalists get involved with a startup.
Tips on how to reach out to VC firms successfully
What are VC Firms?
Venture Capital (VC) firms are institutions that provide a method of financing or private equity to startup companies and smaller businesses that show a potential for long-term growth. To name a few, investment banks, high net-worth investors, and other financial institutions provide venture capital.
Venture capital financing is provided to companies and entrepreneurs at different stages of business evolution. This involves early stage and seed round funding.
You can watch a video by Forbes that explains in detail:
However, not all venture capitals provide funding as their only support. Some venture capital firms give technical and managerial expertise to founders of startup companies. It is accessible to small companies that show exceptional growth and need financing to scale.
Venture capital financing is becoming a more popular and essential way for startups and small businesses to raise money. This is especially true if they do not have access to bank loans or capital markets.
What Are Venture Capitalists?
Venture capitalists are private equity investors that provide capital to young and small companies with high-growth potential in return for an equity stake. They provide funding for smaller businesses that need to scale and fully satisfy their market but do not have access to capital markets and other debt instruments.
Uncertainties in some startup ventures cause venture capitalists to experience a high rate of failures with their investments. However, the ones that work out tend to yield a great deal of return. This happens when a startup venture has a successful exit through M&A or IPO.
Some high-profile venture capitalists include Peter Fenton, an investor in Twitter, and Jim Breyer, one of the first investors in Facebook.
What Venture Capitalists Look For in a Startup
Are you raising money for your startup and curious to know how you can raise funding rounds from VC firms? Look no further as 3 venture capitalists share how they analyze founders and decide whether or not to invest in a startup.
- The Size of the Market Opportunity
Most venture capitalists look for startups that solve a real problem in a large market with the potential to scale. There is no room to present small ideas here. Show them how your business has the potential to become really big in a market that is expanding rapidly.
“I am looking for true change agents going after large markets with new technologies,” says Tim Draper, founder of the famed Silicon Valley venture capital firm known as Draper Fisher Jurvetson (“DFJ”) and Draper Associates.
Venture capitalists are interested in knowing the market you’re addressing, the size of the market, and the technologies you bring to solve problems better than your competitors.
2. A Great Founder and Management Team behind the company
For most venture capitalists, having a great founder with profound experience in successfully creating and exiting other companies is more important than a product or an idea. Venture capitalists want to know if the team within the startup is equipped with excellent skills, experience, and drive to grow a business.
Draper University brings us the best and brightest entrepreneurs from around the world. Our show, “Meet the Drapers” attracts thousands of contestant startups with a viewership of 12 million. 22 Draper Startup Houses around the world hold competitions for business plans. My high profile brings startups to send decks to my email address. We filter them through a system I call “outlier hunting,” Timothy adds.
What is outlier hunting you might ask? Tim Draper explains it like this:
Outlier hunting is looking for startup businesses that, if successful, could create new industries or at least improve existing ones.
“The founder is first and foremost, the opportunity is second, price of the deal is third,” says Joanne Wilson, an American businesswoman, angel investor, and founder of Gotham Gal Ventures.
As you can see, the founder is the most profound metric for venture capitalists. Some questions you should anticipate from venture capitalists when raising rounds include:
a) Who are the key founders and team members?
b) What expertise does your team have?
c) What motivates the founders to keep going?
d) How do you plan to scale the company in the next 12 months?
All of these will help the venture capitalists to assess whether the team is worth it and if the team would be enjoyable to work with
3. Perseverance Matters
Building a startup is hard and turning it into a successful business venture is harder. There are ups and downs when operating a business, and founders must be up for the challenge.
Venture capitalists look for passionate and dedicated founders. Are they dedicated to growing a business and facing inevitable challenges? A commitment is a must, and venture capitalists want to know if founders have the inner drive to face challenges and succeed.
“Since building a successful startup is hard, founders can’t be easily rattled, says Pejman Nozad, co-founder and managing partner of Pear VC.
He’s an early venture capitalist with a portfolio of iconic tech companies like DoorDash, Dropbox, and more. You can find out more about his story and success here:
I tried to start my first business in Tehran during the Iran-Iraq War. Every night, Iraqi jets would fly over the city. It’s because Iranian anti-aircraft weapons kept them from getting low enough to drop their bombs. They settled to break the sound barrier at a higher altitude, so windows down below would shatter. This happened almost every night.
So one day, before the sun went down, I had the idea to go door-to-door selling tape for shopkeepers to put on their windows to keep them from shattering. Unfortunately, nobody wanted to buy it, and after a few hours of unsuccessful sales pitches, I gave up.
A good founder would never have done that. He would have tried a different sales pitch. A different kind of tape, or even a different idea.
Years later, I remember talking to a young, dejected founder trying to get funding who said, “Silicon Valley…it’s a war zone out there.” Well, no, it’s not. I grew up in a war zone, but being successful here does require a healthy dose of tenacity”, he adds.
4. Good Return on Investment
Venture capitalists look for a higher return on investment, which is why they look for companies that scale quickly and grow exponentially. Investments with high ROI also come with a high degree of risk. So make sure you clearly explain why your company has the potential to be big. For venture capitalists to bite on your request to fund your business, there must be a clear value proposition, a growing market, and the size of the addressable market you plan to capture over some time.
“I want to own at least 1% from the get-go, and that has become much harder in the past few years as valuations have soared beyond prices that angels can actually make money on their investment. Unless, of course, you are willing to put in a big check from the get-go. I won’t do that”, Joanne adds.
Joanne Wilson in an interview with OneWire:
A good practice is a 7-to-1 rule. Investors want to take 7 dollars out of every dollar they invest in a company (this includes taxes).
How venture capitalists get involved with a startup.
Every venture capitalist wants something from a startup when it comes to the daily operations of the company. So how involved should they be?
It greatly depends on the investor and the motivation for investing in the company. Some venture capitalists simply want a financial upside or return, and others care deeply about the founders and the product.
Some angel investors and venture capitalists might contribute to the company by providing mentorship to the founders, and others will choose to have a seat with the board of directors.
When approaching VC firms or angel investors, it’s up to you to ask how involved they would like to be.
Tips on how to reach out to VC firms successfully.
Now you know what VC firms want from a startup and are ready to raise those rounds for your company. Here are some final tips to help you pitch venture capitalists successfully
a. Target investors that are interested in your industry
Almost all angel investors have investment focuses. They target industries they either:
Strongly believe in, or
Have experience within such an industry.
Don’t pitch a venture capitalist with an investment focus on personal finance when you have a company in the saas industry. Target only those that invest within your industry.
b. Target investors that focus on your location
Venture capitalists and angel investors are all over the place. Some of them invest in companies that reside in the same city, state, or region they inhabit. They rarely answer pitches from founders with companies in different cities as they are, let alone a country. However, they might be willing to give you a try if the company is exquisite and shows a lot of promise.
On the other hand, a few hardly mind branching out of their area of investments. If you live in New York, do your research and target venture capitalists with an investment focus in New York.
c. Research the competition
This is just between the two of us so for the love of God, make sure to spend a significant amount of time researching your competitors. And please, never ever tell venture capitalists that you have zero competitors.
That makes you look shady, wastes everyone’s time — especially that of VC firms (which is priceless), and shows them you have no clue what you’re doing. Every business has a direct competitor and varies in size depending on the industry you’re focused in.
Do your research and show them the competitors that operate in your industry and market. It shows them the competitive advantage you have over others. It could be new technology, product, or marketing strategy.
d. Look for potential risks
Every business is associated with risk. It could be technological risks such as patent issues or related to the market such as cryptocurrencies. Make sure you find them and present them to venture capitalists.
When you pitch them with upfront information on the risks of your business, they would appreciate you and your company. It also helps them decide whether they want to take the risk and invest.
e. Get a warm introduction first
VC firms and angel investors will respond when someone they know, like, or trust recommends you. It’s because they constantly get bombarded with unsolicited emails and pitch decks from random people. So these unsolicited emails, executive summaries, or pitch decks get ignored unless they get referred by someone they are familiar with.
The best way to grab the attention of a venture capitalist or angel investor is to be introduced by a trusted colleague — someone they know and trust. This could be an investor, a lawyer, an investment banker, an entrepreneur, or just a friend.
However, not all of them ignore cold emails. Some of them even make a habit of responding to all unsolicited emails. But all of them give priority to warm introductions.
Tim and Joanne get cold emails and pitch decks from random founders consistently.
So I asked them this question to know how to best approach them:
Some angel investors like to be approached by founders through cold email and others through an introduction from a trusted source. How do you prefer to be approached by founders when raising capital?
And here’s how they feel about it:
Either is fine — says Timothy Draper.
I answer all emails. Founders should be tenacious in reaching out to investors. I have been approached by a cold email through a trusted source and random meetings. I don’t like being approached through Linkedin — says Joanne Wilson.
To be honest, I admire the courage and diligence of these two venture capitalists. Not everyone can give attention to strangers.
Even I hate checking emails unless it’s good or super important.
By the way, Tim is up to something with Crypto:
So it’s obvious. To capital from Tim, Joanne, or Pejman is simple: Know what they want and give them what they want.
This applies to every venture capitalist and angel investor that is out there as well.
