Venture capitalists or “VCs” are always looking for the next big thing. They keep a finger on the pulse of business, watch the latest trends, Startupand experiments that offer that 10x return with minimal comparative risks.
Being a VC requires experience, knowledge and of course money. Even if you have all of these things, at some point it can be difficult to decide where to invest your assets. In 2022 there were so many startups and there is so much investment money floating around, it was easy to suffer from analysis paralysis. In 2023, the situation is reversed and inflation-fearing investors are more cautious behind companies.
Regardless of the economic climate, it is important for VCs to consider the right factors when choosing the young companies to invest in. Here’s a list of things, both internal and external, to look at when investing in a project.
Let’s start with an introspective perspective. What are some of the internal elements a VC should analyze when looking at a startup?
Table of Contents
1. Consider C-suite competencies
Leadership is one of the first parts of a company that establishes itself early in life. No matter how large an org chart becomes over the course of a company’s growth cycle, the C-suite will always be limited to a specific and important group of individuals.
Before investing in a company, consider what staff they already employ to get their business through its early days. Work with key positions, such as a CEO and CFO, to find the right traits in each leader.
The AESC (Association of Executive Search & Leadership Consultants) recently identified “new skills and capabilities for leadership roles” as the key factor driving the need for top talent. The organization has further categorized these skills and capabilities into six core competencies which all leaders should possess, including:
- Adaptability
- Maneuverability
- Innovation
- Communication
- Cooperation
- Customer focus
In addition to looking for these core traits, you should also consider the coachability of any team you want to invest in, within the context of how hands-on or hands-off an investor you want to be.
2. Look for streamlined teams
When you invest in a younger company, especially in the early stages, it’s all about leadership. The core team within each startup is responsible for finding the best product-market fit and identifying a profitable path to growth.
Now that so much rests on the skills and competences of this first group, this naturally raises the question: What should you look for in a team?
Performance analytics firm Two Story is considering”slim teamsan ideal approach for startup teams. The brand’s head of Performance Science and Growth, Michael Mueller, encourages early-stage startups to resist the vanity metrics that come with a growing workforce and instead build their business build and scale with a lean team.
Lean teams view strategic measurement as a business requirement. They understand their KPIs, especially the leading indicators that drive impact for the business. Look for companies that resist growth for growth’s sake and grow their team only by design and with carefully crafted roles and objective criteria.
3. Identify unique features and benefits
Any company is only as good as the value it provides to its customers. Before investing in a brand, evaluate the offer and its USPs. What are the main features of its products or services? What benefits do they offer the customer? Do they encounter real pain points? What gives a brand a competitive advantage?
Go to the facts along with a general analysis. Look for proof of concept. Does the product or service offered by a startup really work? Where is the data showing that it does what is promised on the label or sales page? If a project is worth investing in, the answers to these questions should be clear and satisfying before you put a dime into their coffers.
4. Review for clean finances
Financially, as a VC, you want to see clean accounting before making an investment. That does not mean that a company has to be profitable. Rather, they are looking for funding to help them become this. However, a well-run startup should have a clear path to financial viability before asking investors for help.
What does a clean balance sheet look like for an investor? On the one hand, a small number of high-profile ones recognized investors is always encouraging. On the other hand, a large number of smaller donations or large interests from friends and relatives is a bad sign.
In addition, look for sufficient capital and a solid cash burn rate (how quickly does the startup run out of money?). Make sure the company has a clear roadmap for converting customers to increase (or, in some cases, start generating) revenue before that capital runs out. Other boot stats to search include:
- Customer acquisition costs: What does it cost to acquire a new customer?
- Monthly recurring income: How much money does a startup generate in a given month?
- Weekly sales growth: Does the turnover not only grow occasionally but weekly?
- Customer lifetime value: What is the total value of a customer (proven or at least estimated) during his patronage of a brand?
- Expiration rate: How quickly does a startup’s current customer base wear out?
The financial condition of a new company is never predictable. Still, it should be clean enough to reassure you that they will use your funding wisely and maximize your chances of a solid ROI.
Together with the company itself, you want to think about the environment in which a new company will operate. Here are a few factors to keep in mind.
5. Estimate the market potential
Customer focus is an important factor for modern companies. Everything from customer service to growth marketing requires a continuous focus on the customer. One way to gauge the viability of an investment option as a VC is to conduct your own customer analysis.
What kind of market does a startup serve? Does it meet a basic need, such as food or clothing, or are the offerings non-essential, such as entertainment or luxury items? Is a brand’s target market niche or broad? Is it made up of a large consumer demographic or a few high-profile customers?
If you’re looking for base market value for an investment, veteran businessroundups.org Kathleen Utecht recommends startups turn to a market worth at least $1 billion if they want to attract VCs. To reverse engineer the advice, if you’re a VC, don’t shop under that $1 billion price tag.
6. Consider the competition
Together with end users, analyze the competition a company faces. A startup should have already done their own competitive analysis, and as a potential investor it’s always worth checking out those findings.
Before making an investment as a VC, you should go beyond information that has also been filtered by another brand. Do your own competitive research. Compare the products and services of other companies with the brand you want to invest in. What differentiates your potential investment? What are competitors doing right that the startup should emulate? Do they have plans or are they willing to consider this?
Comparing investment opportunities with market comparisons is a great way to gauge whether an investment has real potential. If there isn’t something special to help a new brand stand out (not just to you but to their target audience), think twice before investing.
7. Assess every possible risk
It doesn’t matter if you’re funding a strong idea backed by a great team with an impeccable track record… or a hyper-risky experiment with huge boom-or-bust potential. You should always do your homework when it comes to risk.
As a VC, your official function is to assess liabilities and decide how to risk your own capital based on the potential business-building actions of others. Once you’ve looked at the inner workings of a new brand and considered the market conditions surrounding it, strike a balance between risk and reward and use that to gauge whether it’s worth investing or looking for something otherwise.
That is estimated 96% of companies go bankrupt within a decade. Venture capitalists can sometimes generate huge returns, but they also take great risks with every company they support. As a VC, make sure you take everything into account, regardless of the type of investment. Whether you invest in an advanced crypto companya small town retailer or anything in between, make sure you go over everything related to the investment.
Whatever the situation, look for the signs that a company is set up to operate at maximum efficiency in a fertile economic environment. If those stars align, invest with confidence, knowing that you’ve maximized your chances of the best return.
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