Attracting VC interest can be the difference between success and failure. Established companies seek outside investment at different times, while for a startup securing funding can be a necessity if it is to get up and running and become visible in its market.
The nature of what VCs do means they are effectively placing a bet every time they invest in a company. Sometimes that bet will work out, and sometimes it won’t. There are no ‘sure things’, but that does not mean VCs will be casual with their funds. On the contrary, it is precise because there are no guarantees and that they bank on ‘hits’ to cover the cost of ‘misses’ that VCs will be extremely particular about whom they partner up with.
There is always room for some ‘gut instinct’, but first and foremost VCs will have a set of criteria that they assess a company against, and they will most likely pass at the outset on any prospect that doesn’t tick those boxes.
With new ventures, there are frequently little to no sales, the founders may have limited management experience, and the business plan could be based on a concept or prototype. There are plenty of reasons VCs won’t casually part with their investment dollars.
As well as that, while 2020 saw year-on-year global venture funding increase by 4% to $300 billion, few start-ups, relatively speaking, are successful in attracting VC money. Some recent United States-based estimates maintain that no more than 6% of start-ups secure this kind of funding.
That being the case, companies looking to attract this kind of investment need to be clear on what VCs are looking for and attempt to package themselves accordingly. That doesn’t mean pretending that you’re something other than what you are; more correctly, that information will guide you on what you need to be to give yourself the best chance of making that all-important deal.
So, what are the key points and questions that VCs will want to see addressed as they assess the merits of an investment proposal? Below are some examples of what VCs tend to focus on:
1. Demonstrate that there is a sizable market for your product
Generally speaking, VCs won’t be interested in niche products, they will want to invest in a company with the potential to become a massive commercial success. That means you will need to demonstrate that potential by clearly showing the gap you intend to fill (filling a niche, as opposed to being a niche product – note the distinction!) and that it can be a lucrative market.
2. Show why your product is special
Identifying a gap in the market is one thing, developing a product to fill that gap is another entirely. What’s so special about your product? There are never any guarantees, but can you plausibly pitch your product or business as being one with a strong chance of success?
3. Have a credible and convincing management team
When you’re looking to sell the merits of your business to a VC, whether you realise it or not, you are also selling your management team. From the VC perspective, when they consider a business plan, they will also evaluate the ability of the management team to deliver on it.
With that in mind, they will be looking to see experienced and qualified people in key positions. There is always room for young talent with new ideas, but VCs will also want to see evidence of know-how and a track record of achievement at the top of the company.
4. Make sure you’re in the right industry
Informed observers have noted in the past that for all the talk of good people and exciting ideas, VCs will ultimately tend to back companies in the ‘right’ sectors, that is, those deemed to offer the best opportunity for big returns on investment.
In the United States, recent reports have indicated that the bulk of VC funding has gone to specific industries with Internet-based businesses well out in front, followed by healthcare, telecommunications and software.
5. Have an up-to-date, VC-friendly data room
A data room is one of those foundations stones for attracting great investment – you technically don’t have to have one, but a good data room will make the due diligence process much more efficient.
From legal documents to business plans and company financials, the data room is the window for an investor to look at your business. One of the most important (if not the most important) is your cap table showing who owns how much of your company. Speaking of which…
6. Have a clean cap table
This can be an issue for both startups and established companies. For a startup, in the early running when money reserves will be low (or non-existent), it is tempting to pay for early development-related activities in equity as opposed to cash. Equity handed out in this way becomes dead equity, which will not look good on a cap table. It might make sense at the time to do so but may lead to headaches later, which doesn’t make for a clear cap table.
With an established company, the implications of previous funding rounds can also make the cap table look messy, in that previous investors might hold substantial chunks of equity. Ideally, VCs want to see a neat, clean cap table, with the founders holding up to 75-90% of equity and for that to be spread relatively evenly among those founders (unless there is a clear reason for why one of the founders should hold more).
The further a cap table strays from that basic template, the more reticent the VC will become, even if they are genuinely interested in the company.
VCs will look at a wide range of points when assessing a potential partner. If you’re a company looking for funding, it’s not just about offering reasons for VCs to say “Yes”, it’s also about removing possible reasons for them to say “No”. By tackling issues such as those listed above before you reach out to a VC, you will improve your chances of success.
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