3 things venture capitalists look for in startups
Raising funds from venture capital firms is difficult. Very difficult. According to an infographic brought out in 2018 by DASH Ventures, the Jordan-based venture capital firm, they screened 169 startups for potential investment. Out of these 169, they invited 101 to pitch for investment. 36 of these were assessed further, and they ended up investing in 2 new startups that year. Two startups, which comes down to 1.1% of all startups that applied for funding to the firm. So yes, it is difficult to raise funds from venture capital firms.
However, that does not mean that you should feel discouraged. Instead, it is very important to be prepared when you apply for funding and pitch to investors, so you are not caught off-guard when they ask you certain questions. In order to anticipate these questions, you should know what venture capital firms look for in potential investments. That way, you can place yourself in their shoes. Of course, you know that your business is the best in the world, but how do they think about it? You will have to create a reason for them to invest, based on the three most important factors that they consider when evaluating a startup: founding team, product-market fit and the scalability of the product.
1. Knowledgeable and driven founding team
Unlike the romanticised version of entrepreneurship, successful founders are rarely just out of university. Instead, they are slightly more experienced professionals, who have worked in a certain industry before starting their own business.
Often, the expertise in a certain area leads successful founders to identify a problem in the market, which they then can solve with their own solution. Since they are already familiar with the space, it is much easier to set up the business and scale it successfully. Careem, for example, was founded by two ex-McKinsey consultants that identified a problem with transportation while they were working at the consulting firm.
Additionally, venture capital investors are looking for people with so-called ‘grit’, which refers to determination and drive. They look for entrepreneurs that will not take no for an answer, and are able to break through walls in order to get their startup working. Hence, experienced and driven founding team members are the first key.
2. Product-market fit
Aside from a knowledgeable and driven founding team, it is important that your product or service has the so-called product-market fit. Very often, entrepreneurs are building a product that has no real use in the market, which is detrimental for the startups and its founders.
Product-market fit refers to market-based validation. Have you had your first customers or users yet? What did they think of the product or service? Are they paid users, or are they willing to pay? These first two questions refer to the product-market fit, as it is important that you are effectively able to gain customers for your business, and that they see value in what you provide them.
The third question, about willingness to pay, is important from a monetisation perspective. It is not necessarily the users of the product that need to lead to a revenue stream for your business – just look at the ad revenues for Facebook and Google. However, it is important that you have a solid business plan in place to monetise later on. After all, it is almost never worth investing in a company that has no revenue potential.
3. Scalability of the product
In addition to the product-market fit, the scalability of the product is also very important. Think of products like Instagram, which are very scalable – the number of users does not necessarily mean a linear increase in the amount of work. Famously, Instagram was bought by Facebook for $1 billion in 2012, while it only had just 13 employees and over 30 million active users on the platform.
When creating a business model and pitching to investors, it is important to emphasise the scalability. While there is nothing wrong with creating a small business for yourself, like a bakery shop, this is not necessarily what venture capital firms are looking for, as they want to create a return on their investment. Hence, the scalability of the product, as well as the (potential) size of the market that you are entering, are crucial to the success of your business. These aspects show the potential for growth, like Careem, Souq and Fetchr, which is lucrative for both the investor and yourself.
These three points, the founding team, product-market fit and scalability of the product, are among the most important points to keep in mind when talking to potential investors. Put them into their perspective and frame of reference, and you will have an easier time raising funds, and be amongst the 1.1%.