December 16, 2021

What do Venture Capitalists Look for in Startups

So you have the next brilliant idea for a startup and all you need now is the funds to make it happen. All too often, entrepreneurs are great at executing the ideation phase, but fail in bringing the product to fruition due to lack of both funds and business experience.

The fact of the matter is that capital[money] is what keeps a business running; not only do you need cash to spend on the business itself, but also to generate a revenue. Operating capital is critical in proving that your business model works.

Starting a successful business is not as simple as coming up with an idea and raising capital; VCs hear great ideas all the time.  There are many factors that influence their decision to back a business.

Here’s our list of some of the top factors we consider with every investment opportunity. Keeping these in mind can help you attract the right investors for your business.

  1. Quality Leadership – A great leader can bring his or her vision to fruition and can clearly visualize the final product and its market before anyone else. These abilities enable him or her to lead a quality team and run a business run smoothly, making decisions in the best interest of the company. VCs want to see a strong leader with a clear vision for their business and a determination to succeed. Some of the key factors VCs look for in a founding team are: experience of the founding team, the balance of the team [do you have a builder, marketer, and leader?], commitment to the idea, and past successes. They want a leader/leadership team who knows his/her company and product inside and out and is willing to adapt to any input they provide, which brings us to the next point:
  2. Coachability – This is one of the key aspects VCs look for in founders; VCs bring a lot of experience and a strong network that can support early-stage companies, and founders who can tap into this have a better chance of success. Being open to listening to VCs or advisers helping your company is very important.  Many founders and their teams are set in their ways or are susceptible to group think.  If you’ve seen an episode of “Shark Tank,” you know this type of person. Business owners who won’t listen to advice rarely succeed and rarely attract VC funding.
  3. Personal Connection – People love to work with those they enjoy being around and can understand. Developing a strong relationship with VCs is hard, and a warm introduction through their network of investors they have co-invested with or founders in their portfolio is the best way to start cultivating a relationship. Even if they don’t invest in your current round, you will have a better chance of raising money on the next round if you understand what metrics or type of companies they invest in.
  1. Innovative Products with a Competitive Edge – Let’s be honest here, not every product or business model can be classified as “innovative.” When you really break down what your company does, or what the product is, is it truly innovative?  What makes your product different from others on the market? How is it better? How is it worse? or is your business model significantly different from what is out there already.

    Venture capitalists are not looking for another company that is doing the same thing as five others on the market.  Think this through and make sure the differences of your business are important to the customers/clients and that this “competitive edge” is unique and strong enough to build a high-quality business.
  2. Proof of Concept – Would you invest in an idea with no proof that it works?  Real results are what matters. If you’ve never sold your product, tested it on the market, or even developed a sample, a VC likely won’t trust it to succeed.  Just because you believe it’s a great idea doesn’t mean anyone will actually buy your product.  
  3. Investments that fit the VC’s portfolio – If your business doesn’t fit a VC’s portfolio in terms of stage or industry (which you can determine by browsing their portfolio and looking at what stage they invested on, the likelihood of them investing is very low.  It doesn’t mean it’s a bad business or model; it is simply not a good fit for them. Most VCs have a clearly defined investment thesis that allows them to focus on certain stage of venture investments with defined focus areas and sectors of investment.
  4. Large Market Size – Total addressable market (TAM) is one of the most important factors that VCs look for in any new business. To generate a large enough return, venture capitalists want to see that your target market is substantial enough and that you’ll be able to capture a significant chunk of that market.  Smaller markets (although having a niche is important) will limit the possibility of significant returns. VCs as a rule of thumb won’t invest in businesses that target markets under $1B in value.
  5. It’s all about the Numbers! – The venture capital firm that is reviewing your business will perform due diligence before committing any capital and will ask for past financial information, monthly sales numbers, POs, contracts, etc… They want to see how you spent, are spending, and will spend the money, as well as the basis for the use of funds for the current fund raise.  They will do a deep dive into all of your financials to see if it all adds up.
  6. Risk assessment – There is always a certain amount of risk with any company. For example, if your company makes autonomous cars, there is a high risk that your vehicles could injure or kill a person, creating legal issues that could lead to significant financial liabilities. Also, the company could run out of money before developing the perfect system that works in all conditions; there are “n” number of such endemic risks associated with each company and each sector outside of systemic/market risks which influence all companies. A VC will assess the risk of the investment and decide if it is worth pursuing.
startup planning with pins on board
  1. Use of Funds – Having a detailed plan for the use of funds is crucial before starting the fund-raising process. Your proforma should provide as much detail as possible and describe where and when the money will be spent. Providing investors with a proforma of financial projections with a detailed use of funds and their outcomes is part of the due diligence process.
  2. Prior investments, a clean-cap table – Your capitalization table shows how your company is capitalized, who the owners of the company are, and where money has come from in the past.  Investors want to see a cap table that is relatively clean. A cap table that carries a fair amount of debt and has convertible debt and options makes the cap table more opaque; before raising institutional capital, ensure all your convertible notes and SAFEs are converted to equity.

Spending time up front to learn as much as you can about the investment process is well worth it for your best chance at securing funds. The difference is clear to the investor, who is far more likely to work with you if the above points are well addressed. Good luck in your ventures and be sure to reach out to Stout Street Capital if you believe your business is a great fit for our portfolio.


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