Many entrepreneurs looking for funding from Venture Capitalists know nothing about how the venture capital investment process actually works.
Accessing venture capital is a slow process and requires lots of time and trust. Taking on venture capital investment is taking on a partner - a partner who will want an active say in how you run your business.
Before they invest, Venture Capitalists will do extensive due diligence and ask you some very hard questions. You will need to be ready and have the answers.
Although you need to showcase your passion and commitment when sharing your vision and the opportunity before you with your Venture Capitalists, this is not a time for puffery. This is a potential partner you're talking to. The best approach is to be truthful and authentic.
Here are the six things Venture Capitalists will want to know before they invest in your company:
1. Venture Capitalists want you to demonstrate that there's a vast market for what you're selling.
Venture Capitalists will want to know about the market for the product or service you're selling. More than that, they will want to know that it's a very vast market.
Why? Venture Capitalists invest to help you grow, and vast markets support growth.
Not only are vast markets more stable and less inclined to volatility, they are also able to support the operations of multiple growing companies. And if the market is growing, even better. That will give you a tail wind.
On the flip side, if the market you operate is too small, there may not be room for enough growth for the Venture Capitalist to get a return on his or her investment.
What is a vast market?
There's no firm definition, but generally speaking we're talking about $1 billion globally.
Within that, it may make sense to look at what's called the 'addressable market' - the part of the market you serve.
2. Venture Capitalists want you to show how your product is different from what's out there. What differentiates your product and makes it unique?
A unique product or service will be attractive. A product or service that is not somehow different - that is or becomes a commodity - will not attract venture capital investment. 'Unique' means not only different and new, but also difficult for a competitor to replicate. Your product or service needs to include a 'secret sauce' that will prevent a competitor from taking you out, will serve as a barrier to entry.
There are several ways to stand out.
- Product differentiation: You've got something completely different (and hard to replicate).
- Process differentiation: You are selling a new, more efficient way of doing things.
- Price point differentiation: You have found a way to sell a product or service for less or for more (i.e. premium pricing).
- Super niche differentiation: You've found a market that's a particularly good fit for you.
If you've got several differentiators, all the better.
The important thing is to have and keep developing strong differentiators.
3. Venture Capitalists want you to prove that you have a solid management team in place.
A Venture Capitalist about to invest in your company will want to know that the money will be well-managed. So having a top-notch management team - a team with experience - is crucial.
Don't try to hide a weak link. The Venture Capitalist will ask for details about everyone on the management team, and will want to meet the players.
If there are any weak players on your management team, I would recommend holding off on the search for Venture Capitalist financing until you assemble a top team. If you have a weak player coach them to improve their abilities - and if that does not work, replace him or her.
It's actually better to be missing a key player on the team than to have the wrong player. That's because it's perfectly acceptable to tell a Venture Capitalist that some of their money will be used to hire a solid A-level player to join the team.
So be aware, and be up-front.
In addition to vetting your management team, the Venture Capitalist will also want to understand your company's culture and your management's philosophy - how the management team handles problems and challenges.
The Venture Capitalists will spend time in your office, and they may test your management team by throwing some difficult questions their way or organizing whiteboard sessions - asking how your team would handle such and such a problem. If your team has a dysfunctional approach, it will disqualify you. Your team should be used to working together - and work well together.
The Venture Capitalists will also put a lot of value on the CEO - to the point that I've sometimes heard it said that Venture Capitalists don't invest in a company, they invest in a CEO.
The Venture Capitalists will put a lot of effort into understanding how the CEO operates - how he or she deals with issues, motivates and listens to other team members, and inspires and drives the business forward.
4. Venture Capitalists want you to show how your company is a good fit for their investment philosophy.
Every Venture Capitalist has a philosophy that underlies their approach to investing.
Some Venture Capitalists are strictly in it for the return. Others take a strategic approach, looking to support startups that will benefit their related companies.
Investors simply looking for a return often develop a philosophy nonetheless - usually around their past ability to pick winners.
For example, one Venture Capitalists might decide to focus only on startups that sell into Fortune 500 companies, because that is where there's big money to be made. Another Venture Capitalists may focus on green technology or social enterprises.
A Venture Capitalists who specializes in a certain area - say green technologies - will come to know that area very well, and be able to understand the playing field, competitors, trends and buying behavior's. They may also want to invest in companies that have synergies with each other.
So whether they're in it strictly for the return, or whether they are doing it strategically, most good Venture Capitalists will have a thesis or area of interest.
And if you are looking for their money, you need to know what their thesis is.
5. Venture Capitalists want you to be able to back up whatever you tell them with metrics and solid evidence.
A Venture Capitalists who is interested in you will take the time to get to know you before investing. If you chat about your projections for growth, you can be sure that the Venture Capitalists will be taking notes. And if your growth falls short of projections the next time their analyst calls, they will ask why.
So be aware that you will need to back up everything you tell Venture Capitalists with metrics and solid data. For your own firm, that means having solid evidence of progress.
What Venture Capitalists look for won't be the same for every industry.
Investors will be able to tell a lot from these metrics, but not every Venture Capitalists will react to them in the same way.
For example, earlier I mentioned how investors want you to operate in a big market. You need to be able to provide figures to show how big the market is. And if the market is growing, you need to be able to show the rate of growth.
And evidence doesn't just come from facts and figures: It also comes from 'soft' sources like customer testimonials.
Our Venture Capitalists have always talked to our customers before signing up with us, and chances are they will want to talk to yours.
So you want your customers to be able to say things like "I love this!" or "I'd be lost without this product/service" or "We have no qualms about paying for this product/service, and we recommend it."
6. Venture Capitalists want you to be able to explain how you are going to use their money.
It sounds self-evident, but it really needs to be spelled out. A Venture Capitalists investor needs to know - in some detail - how you intend to spend/invest their money.
Will you invest in advertising? Will you hire new talent, either a top-flight executive or new sales staff? Will you use the funds to acquire a small firm that provides something you need so you don't have to develop it in-house?
The investor needs to know what you plan to do with the money, and how your plans mesh with your goals and what you plan to generate from the standpoint of revenues and/or profits by investing their money.
Ready to find a Venture Capitalist? Get introduced.
As I've said many times, a Venture Capitalist will speed a company's growth. Bringing in the right Venture Capitalist will increase the likelihood of things happening. A top-tier Venture Capitalists is inherently valuable, because winners deliver winners. The top five Venture Capitalists in the United States produce a disproportionate percentage of the capital returns in the Venture Capitalists market. In addition, the top Venture Capitalists have better, deeper relationships with the bankers who produce the IPOs.
If you understand what Venture Capitalists are, how they work, how they make their money, how they can help you grow and what they're going to ask you - you're ready to go out and look for one.
A few final pieces of advice:
Don't cold-call a Venture Capitalists.
And don't rush to take part in those public pitch fests in which entrepreneurs get five minutes to wow a room full of Venture Capitalists.
If they cold-call you, be friendly and take the time to talk.
But the best way to meet Venture Capitalists is to get introduced by someone you know.
And once you have been introduced, try to find Venture Capitalists whose values and objectives are a good fit with yours. After all, this could become a long-term relationship.