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5 factors venture capitalists evaluate when deciding whether to invest in a startup

Posted by Deepshikha Shukla

May 13, 2022    |     5-minute read (838 words)

You’ve probably heard a lot of buzz around venture capitalists but have only a fuzzy idea of how they work. In short, VC firms use capital raised from limited partners to invest in promising startups, in exchange for a minority stake in the company. 

As a startup grows, it might go through different stages of venture capital; for example, starting with a seed investment, then early-stage and late-stage funding rounds. 

What VCs look for in an investment opportunity

Every investor has a separate set of criteria for evaluating a business. Some may be highly risk-averse and base their decisions purely on numbers, while others embrace a greater degree of risk.

Why does this matter? Because business owners need to know the type of investor they are targeting. Knowing what they expect in return for an investment means they can tailor their pitch accordingly. Below we outline the criteria you’ll need to satisfy to convince a VC to invest in your startup.

A solid management team in place

VCs prefer to invest in startups with leaders that have good business experience and a strong background in their industry. Typically, they seek a management team that is reliable, trustworthy and dedicated. 

The previous experience and skills of the startup’s key members occupying business-critical roles will play a huge role in determining whether a VC will invest in a startup. To gain the trust of a VC, be ready to prove your credibility, or get a recommendation from someone your investor finds reliable.

Capital requirements and utilization plan

Most VCs are interested in investing in a business that has already gained some traction in its target marketplace. In addition to favorable financial growth projections and a debt repayment plan, they look for a stable business opportunity with a high potential of supplying a significant ROI. 

VCs will also want to know:

• Why do you need funding?
• How will you use the funds to grow your business?
• What is your expected burn rate (spending on overhead before generating profit)?
• How much capital do you need?

Understanding your initial capital requirements will help VCs calculate how much to invest in the various stages for your startup as it grows. 

Proof of concept of innovative product

VCs prefer to invest in unique products or services with proven market potential to make their investments worthwhile. They will also consider intellectual property protection, such as patents and trademarks, and compliance with federal and industry rules and regulations before making their investment decisions. When assessing startups, they also pay attention to the efficacy of its marketing strategies to figure out the chances of profitability. 

Investors will be more likely to invest if you have a proof of concept or minimum viable product and convincing market research. Unique selling points and marketing potential will further compel VCs to place their confidence in your startup. 

Investors will also evaluate market demand for your product or service by assessing: 

• Whether you’re addressing a niche demand or improving an existing product.
• What makes your startup stand apart from competitors.
• Your business’s unique selling proposition.

A detailed plan for how the capital will be put to work

Potential investors will be interested to understand your business model before investing in your startup. Entrepreneurs should explain to VCs why they need their investment, how they will use the raised capital and how their business model will help them become more profitable. If you’re raising funds for new products or services’ development, explain to investors how this will help you to reach new customers, and create more profit opportunities.

Investors pay attention to both market and financial risks of a business model. So, identify all risks that your business could face and devise a risk management strategy to detect, analyze, and mitigate them. A VC is more likely to invest in your startup if they’ve confidence that your business risks outweigh your business benefits. 

Ensure that you have the accurate data and resources to back up your business idea. You need to show investors your business progress with analytical reports. To prove the scalability of your business model to investors, you should use the latest technology and scalable services for your product development.

Revenue potential

The growth potential of a startup is high if its offerings are both unique and serve customers’ needs. In the eyes of VCs, satisfying these criteria indicates the startup won’t have close competitors.

VCs also want to know whether your target market size is big enough to sustain your product/services. Also, your business should be scalable to cater the needs of different markets in your industry.

Further, investors want to see your financial projections to determine whether they are practical, and be sure to obtain your startup’s valuation before making a pitch. The valuation will help VCs to get an idea of how much return they can expect on their investment.

Finally, investors look for startups that can grow quickly and sustain that growth through an effective revenue-generating model.

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