Early-stage investors, such as angel and venture capitalist investors, can be difficult to come
by for entrepreneurs wanting to raise funding for their start-up enterprises, and once you do,
getting investment funds from them can be much more difficult.
However, angel investors and venture capitalists (VCs) are taking significant risks. New
ventures usually have little to no sales; the founders may have no prior management
expertise, and the business plan may be based solely on a concept or a rudimentary prototype.
There are numerous reasons why venture capitalists are cautious with their funds.
Despite the significant dangers, VCs continue to invest millions of dollars in small, untested
businesses in the hopes of turning them into the next great thing. So, what makes venture
capitalists go for their wallets?
The method of determining value and investability in mature enterprises is quite simple.
Established businesses generate sales, profits, and cash flow, which can be utilised to
calculate a pretty accurate value estimate. Early-stage ventures, on the other hand, require far
more work from VCs to get inside the business and the opportunity.
Important Takeaways
• VCs are known for placing significant bets on fresh start-up companies in the hopes
of hitting a home run with a future billion-dollar corporation.
• Because there are so many investment opportunities and start-up pitches, VCs
frequently have a set of criteria that they look for and consider before making a
decision.
• A VC’s decision is influenced by the management team, business concept and plan,
market opportunity, and risk assessment.
Here are some key considerations for a VC when evaluating a potential investment:
Stable Management
Simply said, management is by far the most significant issue that intelligent investors
examine. First and foremost, VCs invest in a management team’s ability to execute on the
business plan. They are not searching for “green” CEOs; instead, they want leaders who have
developed successful businesses that have provided significant returns to investors.
Businesses seeking venture financing should be able to give a list of experienced, competent
individuals who will play key roles in the company’s growth. Businesses that are short on
qualified managers should be open to hire from outside sources. Many VCs believe that
investing in a bad idea led by successful management is preferable to investing in a good idea
led by inexperienced management.
Market Size
Demonstrating that the company will focus on a substantial, addressable market opportunity
is critical for attracting VC funding. For VCs, “big” usually denotes a market with a revenue
potential of $1 billion or more. 1 VCs often aim to ensure that their portfolio companies have
a probability of increasing sales worth hundreds of millions of dollars in order to obtain the
substantial returns they expect from investments.
The greater the market size, the more likely a trade sale will occur, making the business even
more appealing to VCs searching for prospective exit strategies. Ideally, the company will
expand quickly enough to gain first or second place in the market.
Venture financiers want extensive market size analyses in business ideas. Market sizing
should be addressed from both the top down and the bottom-up perspectives. This includes
not only third-party estimations from market research reports, but also input from potential
customers demonstrating their desire to buy and pay for the company’s goods.
Excellent Product with a Competitive Advantage
Investors want to put their money into exceptional products and services that have a longterm competitive advantage. They’re looking for a solution to a real, pressing issue that hasn’t
been addressed by other businesses. They hunt for items and services that clients can’t live
without because they’re so much better or less expensive than the competition.
Venture capitalists seek a competitive advantage in the market. They want their portfolio
companies to be able to create sales and profits before competitors enter the market and cut
into earnings. The lower the number of direct competitors in the space, the better.
Risk Assessment
A venture capitalist’s role is to take on risk. So, understandably, people want to know what
they’re getting into before investing in a start-up. VCs will want to be completely clear about
what the business has accomplished and what still has to be accomplished as they chat with
the founders or read the business plan.
• Could there be any regulatory or legal issues?
• Is this a product that will be useful today and in ten years?
• Is the fund large enough to accommodate the opportunity?
• Is there a way out of the investment and an opportunity to make a profit?
VCs’ methods for measuring, evaluating, and attempting to reduce risk differ based on the
type of fund and the persons making investment choices. But, at the end of the day, venture
capitalists are attempting to reduce risk while generating high returns on their investments.
The Bottom Line
Money-losing ventures might sabotage the benefits of a stunningly successful, high-return
investment. So, before investing in a business, venture capitalists spend a lot of time
assessing it and looking for important success factors. They want to know if the management
team is up to the challenge, how big the market is, and if the product has the potential to
produce money. Furthermore, they seek to limit the opportunity’s risk.
