Venture Capital investments are a vital component of today’s businesses and innovative startups. However, obtaining a VC investment is an involved task as several companies compete for the limited funds. Here is a preview of what VC companies look at before finalizing ideas and approving them for investment. Gaining an insight into this would provide you an edge over other businesses and could help you be VC-ready.
- What is a Venture Capital Firm?
- An insight into the mind of VC firms
- What do venture capital firms look for in their potential investments?
- Summary
Cultivating an idea for a captivating and lucrative business venture is foundational and where it all begins. With the creative minds sitting and brewing up various plans given the vast world of knowledge that they have at their disposal, ideas flow at a great speed.
Bringing these ideas to fruition, however, is where the real challenge is. One of the reasons for this is because most business ideas need capital investment to make it work – or at least kickstart the project.
The main elements for any new business can be wrapped into four elements:
- Time
- Effort
- Ideation
- Capital
For a full-fledged and successful business, a compromise in any of these aspects can lead to collapse or less than optimal success pathways. Time, effort, and ideas can be controlled by the founders and management on the way to developing their business ideas. Capital is where venture capital firms step into the picture.
What is a Venture Capital firm?
Venture capital or VC firms are companies that aid in the financing of startups and new business avenues. These companies are typically made up of investors who believe in supporting and sprouting younger and fresher ideas and bringing them into the world. Naturally, venture investors would also look at their success and hence a return on their investment.
So, not only do they take an effort in building the businesses of the newer and promising start-ups, but they also look to hold stakes and make profits with the growth of these companies. In other words, venture capital firms aim to provide capital to new businesses and ideas that demonstrate a higher potential for profit and growth in exchange for an equity stake.
An insight into the mind of VC firms
The minds of people inside a VC firm are always churning looking for the perfect opportunities and prospects in the world of business. Venture capital firms and venture capital investors are deep into the arena of calculated risks and gambles as they aim to invest in a business venture or a few who do not have any solid/concrete data to provide any factual support. Therefore, most often than not, we see a VC firm reject ideas as they might not be convinced by reasons such as
- The idea
- The team
- The overall margin, and capability for long-term profit
- Not being the right fit for matching ideologies, etc.
To be able to pitch and woo a VC firm is the first task. Venture investors are tough to break. It comes as a part of their job roles. If they started believing and investing in every idea they came across, it would be tough for them to survive. Therefore, these venture capital firms partake in a rigorous screening process before being potential investors in start-up business prospects.
What do venture capital firms look for in their potential investments?
Various aspects influence venture capital choices, such as the team, the wireframe, the competitive landscape, and the portfolio terms. Here are the top attributes (tangible and intangible), you must possess to attract the right investment from Venture capitalists.
- Leadership Quality
The ability to lead and recruit talent is one of the most important aspects that VCs look for in a start-up or business. The best thing about finding people with strong leadership skills is that you can hire them down the line as you build your company. Venture capital firms want to invest in safe bets, which means that organizations that may face leadership challenges in the future will not receive funding from venture capitalists.
● A Good Team
Yes, the business idea is important. But an idea is only as good as the people behind the execution. For a VC firm, this is one of the key criteria that they consider. This is because they do not have solid data and numbers to back up their claims as a startup; however, they can gain an insight into the potential success of how their VC fund will be used by knowing about the grit, mindset, and determination of the people running the business.
Experience in the right domain, number of employees, unique aspects of each employee, etc are things that might come in handy while looking for venture investors. VC firms typically look for the following qualities in your team:
- Teamwork: The team must have strong cooperation and understanding. They must understand that no matter how smart they are individual, they will never be as bright as the whole group.
- Passion: The team must also have a strong drive to see their project through to completion, even if it means putting in a lot of effort and time.
- Motivation: To ensure their success, the team must be driven by the earnings they can gain from it.
- Execution Skills: The team should be skilled at executing their business plan seamlessly, right from building a product to marketing.
- Goal-oriented: The team must set goals to actualize the desired results. This can be done through brainstorming and goal setting or just focusing on one goal at a time.
● Strong Financial Position
The financial health of the business is another crucial factor that VCs look for. They’ll want to know if your company can survive financially throughout its growth.
Thanks to their network, venture capitalists can investigate a company before they invest in it thoroughly. This gives them insight into the financial position of your business, and it will allow them to determine whether you are in a position to manage their investment.
Not only do they want strong financial proof, but they also want proof that you can grow fast enough.
● Market Size
It’s no secret that venture capital firms are investing for the long term. Typically, VC firms will invest in a company for a period of 5-10 years. So, it’s an important metric when they look at how big the market is and how much it is expected to grow in the next few years.
Venture capitalists expect business plans to include detailed market size—the bigger the market, the higher the potential for significant returns.
For example, assume your products are aimed at farmers in the United States. According to research, there are approximately 2 million farmers in the United States. Your Market Size would be much over $2 billion if your product sold for $1,000 each in a year.
● Business Plan
Before you can get funding from a VC firm, you must have a solid plan to determine if your startup is worthy. A business plan should contain:
- key performance indicators (KPIs),
- goals,
- milestones,
- budget,
- and resources for reaching those goals.
Venture capital firms look for plans which can generate revenue, cut costs, and increase profits. A plan can be in the form of a P&L / Income and cash flow statement or a simple business model sheet.
It would help if you showed them that you have a solid plan and Management in place and understand the potential risks involved.
● Innovative Product
The most successful venture capital firms are on the lookout for the next Apple or Google. They want something that will cause a market disruption so that they may profit handsomely when it takes off.
They’ll want to see a compelling business case to justify their investment. The product or service must be strong enough to appeal to people’s needs and maintain its attractiveness over time. This will help you raise more money.
- Incredible ROI
The best VC firms are looking for great returns. They want to know if the company is going to be able to provide them with a healthy return on their investment. According to UpCousel, the majority of venture capitalists or venture capital firms expect to get at least a 25% return on their investment. If there is potential for a higher return, then they will obviously consider investing in that company. Venture Capitalists typically assume that 1 in 10 of their investments will hit a home run, i.e. provide handsome oversized returns. You must convince them that you are that 1 in 10!
There must be proof that the company can grow fast enough and has the potential to provide investors with a good ROI.
● Early Traction
It is natural to hold on to the VC fund until the firm is sure of having invested in a company that can show profits. When a business venture is launched, VC firms keep a lookout for the traction that it is gaining in terms of the product, the idea, service, the customers, etc.
In case a company can gain the required attention from its target audience, the company receives the proof it is looking for and VC funds will automatically flow in.
Examples of traction could be:
- Successful creation of a beta product
- Early customers or brand-name customers
- Partnerships or associations
- Feedback from customers/clients/users, etc
- Uniqueness of product, service, or sector
● Growth Potential
VC firms will check for growth prospects when deciding whether or not to invest in a firm. They want to put their money into businesses that can grow at a rapid pace.
It’s not enough to declare you’ll have exponential growth once a venture capital firm invests in you; you need to back it up with figures and data that demonstrate this potential.
If there is a lot of evidence that the company will grow exponentially, VC firms are more willing to invest in your business.
- Capital Requirements
Not all start-ups need large amounts of capital from VC firms. The amount of money that is required can vary depending on what you want your company to achieve.
The amount of funding, a business needs, depends on your start-up, how much money you want to bring in, and how quickly you want to turn a profit. Venture capitalists use this information to determine whether they are willing to invest in your company.
- Production Cost/Value
Venture capital companies will be interested in how much it will cost to get your product or service off the ground and into production when you describe your strategy to them. They’ll want to see how long it will take for you to start seeing returns on their investment and how big those returns are projected to be.
- Appropriate CBR (Cash Burn Rate)
VCs do not typically want to throw their money into companies that cannot offer a healthy return on investment. If the CBR (the rate at which you use up cash reserves) holds steady, then the investor will receive a reasonable ROI. However, if the CBR goes above this affordable range, then the investor runs the risk of losing more than they can make back on their investment.
Therefore, it’s important to understand how much you need to make things happen for your business and generate your own revenue.
● Risk Factors
While it is important to look at all things good, one cannot undermine the weightage of the risk factors that might be associated with business ideas.
A VC firm must be particularly careful of the potential threats to the growth of the business they are looking to provide venture finance for. Investors in startup business ventures need to be wary of the obstacles that might come their way to be able to plan effectively for them.
Risks and obstacles concerning technology, partners, funds, partnerships, legal aspects, product liabilities, patenting, etc must be considered.
To get funding for your startup, you must be able to show venture capital investors that all the risks have been accounted for and plans have been devised to mitigate the losses if any. These factors would work tremendously in building confidence and faith in the venture.
Summary
A venture capital firm needs to be careful, precise, and thorough before investing in a startup. No research can be enough in a scenario, and even then, unexpected issues can cause the money to not be used up to the fullest potential at times. Taking calculated risks can never be easy no matter how much one is prepared for it.
Finalizing and settling down on one in several business ideas is a tedious task. The zeal to invest in opportunities that would potentially be lucrative and would allow them room to grow is what venture capital firms look for. They would not shy away from believing in companies that seem promising and steadfast in their ideas. So, show them evidence that you have the potential.