Author: Sunitha Viswanathan, Investment Associate, Unitus Seed Fund
Why do most entrepreneurs sweat at the thought of pitching to a Venture Capitalist? Why do founders go through a gruelling amount of time to get their pitch deck in place? Why do they make those midnight calls to friends, family and neighbour’s cousin’s aunt to get that one introduction to a VC? Conventional wisdom suggests one is better off building a business at one’s own pace without bothering with VCs and their preferences. However, with several startups aiming for market leadership and the mantra being “grow big, go fast” one eventually knocks the doors of VCs to grab their eyeballs and eventually those big $.
Given that most VCs finance only one or two ventures out of 100 business plans they see, you would be wasting your time if you do not understand their investment criterion. Every VC fund has a different requirement – one may only look at IoT(Internet of Things) start-ups, whereas another may be only interested in enterprise solutions and add to the mix, the latest flavour of the season and you have an even narrower preference. However, VCs tend to be consistent with common threads they are looking for across all startups irrespective of the sector. This is no Ten Commandments but speak to any VC and they will invariably rattle out most of these items as part of their mental checklist.
1. Team: Even if this sounds like beating the same drum, no other factor influences the judgement of a VC than the quality of your team. Let me take a sample team for an educational tech start-up to highlight the importance of a team. 2 member team – X& Y; X previously worked with an education product company heading sales efforts in South India, Y was part of the core tech development team at a large mobile ecommerce company. X& Y had worked together in a start-up when they decided to start shop independently. This would catch the interest of any VC and would get that coveted first meeting. What aspects of the team make it interesting for an investor?
A. Complimentary Skills – X brings on board sales and Biz Dev skills which compliments Y’s technology skills which are critical in an edtech start-up. In the early stages, when resources are few, most of the ground work needs to be done by the founders and overlapping skills of founders does not solve this issue. As start-ups grow, one needs a founding team with the ability to spearhead different verticals.
B. Prior Experience– It always helps if founders have worked in the same space previously. This reduces the learning curve and accelerates the pace of growth. Y does not come from the education space, but his technical skills are an asset for a start-up looking at delivery content on mobile.
C. Founders’ chemistry: Founders need not be drinking buddies, but it always works in their favour if they have worked together previously. Investors are looking for teams that can weather the storm ( and there will be many !) together, without getting into a blame game. Can they identify solutions to overcome roadblocks and execute decisively?
2. Market Size: Every investor is chasing for that Unicorn that can get them 10x returns. A targetable addressable market (TAM) that is estimated at $10 M will barely be able to achieve this compared to a TAM of $10 B. No matter how many paying customers you might have already signed up, if you cannot show a TAM that is interesting enough for a VC, it is unlikely you will hear back from them.
3. Traction: It will be unreasonable to assume that VCs will fall over themselves to fund ideas that you have conceived. Unless you have had a blockbuster exit previously or been a successful serial entrepreneur, the reality is paper ideas do not get funded. If anything, the amount of traction that VCs expect has only increased. It helps them reduce their risk, validate your model and gauge the potential of success the start-up could achieve. Some of the metrics critical to demonstrate traction: No of paying customers, M-o-M double digit growth numbers, customer acquisition cost.
4. Secret Sauce: Investors are looking for start-ups with a defensible IP/ patent that can give them an unfair advantage over competitors. This differentiation acts as a barrier to entry for other players and gives you time before someone else with a large treasure chest makes an entry. A lot of businesses are ending up being execution heavy (Intra city logistics market, Food Tech space etc.), in which case the mantle again falls on the team’s capability to execute fast to capture customer loyalty and market share.
5. Unit Economics: Not all businesses are cut for only large volumes and no path to profitability. On a unit level are you making profits by delivering a service or product? Investors appreciate that corporate overheads make your business overall non profitable and are willing to invest for that, but if the fundamental unit is loss making, the gates to unrestricted funding will need to open and this might shut out most investors. Justify your unit economics with future growth plan and how it can be improved over time.
One may say there are also other things that need to be given importance – exit potential, partnerships established, use of funds etc. Most of these get covered under one or more of the items listed above
With over $2.4 B invested in 2015 till date, up three times the figure for the same period in 2014, entrepreneurs have not had a better time to raise money from VCs. High caliber teams working on sound ideas catering to large markets with the ability to disrupt status quo will continue to be in the reckoning with VCs irrespective of whether you make those midnight calls or not.
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