12 Things Investors Look for in an Investment Opportunity
Being funded by a VC fund has been glamorized in the past 10 years—and it’s no wonder why. Venture capitalists not only provide funding for young and innovative businesses, but also bring a partnership with seasoned professionals and experts with a proven ability to develop and grow a business.
Because venture capital investments tend to be high-risk, with around 65% of VC-backed businesses failing to return their capital, VCs tend to be very selective about where they place their money. With so many companies seeking VC investment, competition for VC funds can be fierce.
What Investors Look for in an Investment Opportunity
So what do venture capitalists look for in a business? While essential, a “good idea” is not enough. A number of additional factors weigh into venture capital decisions, including the team, the proof of concept, the size of the market, and the terms of the investment.
1. Leadership Ability
One of the first people the venture capitalists will come in contact with is the Founder/CEO. What is his or her presence? Is the person inspiring and a great communicator? Do they seem fully committed? Are they willing to listen and take advice? Do they seem calm and competent under pressure? Do they seem like they would be able to problem-solve and make adjustments should the business hit roadblocks? Are they passionate and knowledgeable about their product/service and industry? These indicators often signal to VCs that the Founder has the potential to succeed. If a Founder feels they are lacking in this regard, adding a strong CEO can beneficial.
2. A Strong Team
In a recent Angel Investing Podcast, host and angel investor Tatyana Gray interviewed Sam Bernards, a renowned Utah venture capitalist and partner at Peak Ventures. In this interview, Bernards explained that the team is a top factor venture capitalists look for in an investment. “It’s the team that means everything,” says Bernard, stating that 80% of the decision is anchored in how they feel about the team. The bottom line is: VCs invest in people, not just businesses.
Venture capitalists want to see a team that is “all in” from the beginning (not waiting in the wings for funding to arrive before they jump on board). The idea is that if the team is passionate about their product or service and can get through the “bootstraps” stage of growth, then they have the determination to overcome any hurdles they will face in the growth process. VCs also want to see the team shares the Founder’s vision and offers the relevant skills and experience to face future challenges the business will face as it expands. Smart founders are very strategic as they build their core team, making it a source of value that VCs find attractive.
3. A Clean Cap Table
As a general rule, when venture capitalists look at a company, they tend to prefer to see a limited number of investors and they like to see accredited investors (over $1 million of assets not including their home or making a high income multiple years in a row). This means a VC will want to see the capitalization table (list of shareholders, how much of the company they own, and the amount they have invested). Early-stage businesses often require multiple rounds of investment and the cooperation of existing investors. Carrying a large number of small investors—especially family—can be a real challenge, making it hard for smaller investors to keep up with larger ones in later rounds. A “messy” cap table is a turn-off and increases the risk of conflict in the future. Most entrepreneurs walk a fine line to secure much-needed capital early on without adding baggage to their cap table.
4. Innovative Product
Venture capitalists don’t want to see a “me too” or “also-ran;” they want to see a business that either provides a compelling reason for people to change from their current habits, or see something that is truly unique. For this reason, venture capitalists want to see a product that has strong differentiators. They’ll want to see that people don’t have a reason to buy someone else’s product or service instead. If people are already using a similar product or service, why will they want to shift to your product instead?
5. Proof of Concept aka “Traction”
Even though venture capitalists are typically investing in startups or young companies, they still want to see proof that the business is a viable one. This means moving beyond just having a product idea to having proof that someone will pay for it (outside of family and friends). They want to see traction with your core market. This should be a broad segment and intentional, otherwise the VCs will be skeptical.
6. Broad SOM (Serviceable Obtainable Market)
If your product or service is for a very niche market, then chances are a VC fund won’t be very interested. They want to see a large market and see that people are spending (big) bucks in that market. In an article by Forbes, Kathleen Utecht, seasoned entrepreneur, investor, and current Entrepreneur in Residence at Comcast Ventures, Utecht suggests that to attract VCs your market needs to be at least $1 billion.
7. Conversion proof (and conversion process isn’t too complicated)
Venture capitalists want to see that you can move prospects to the point of conversion. They want to know what the different customer segments are and how you can get to them. They also want to see that there aren’t too many barriers in the buying process and that there is a relatively uncomplicated process for converting clients.
8. Reasonable Cash Burn Rate
Chances are, a venture capital fund is going to take a look at your cash burn. How much do you currently have and how quickly will it run out? They call this your “runway.” Your gross burn rate is the amount of operating costs incurred as expenses every month. If your company is currently earning revenues, then your burn rate will be your revenues minus operating costs and COGS. If you take your money in the bank and divide it by your monthly burn rate, then you’ll get a good idea of your “runway,” or how long you have until you’ve burned through your current cash.
9. A Detailed Plan for How the Capital Will Be Put to Work
This—hopefully—goes without saying, but a venture capitalist won’t want to invest in your business without knowing what, exactly, the money is going to fund. This is where a financial forecast can be incredibly helpful. A financial forecast will detail out where the money will go and when, and will use existing trends and educated predictions to show how this is expected to impact revenues, operating costs, cash flow, and the bottom line. Read more about financial forecasts in this article.
10. Favorable Terms or Downside Protection
In a study published by the University of Chicago Booth School of Business surveying 885 institutional venture capitalists, the VCs rated the most important factors in deal structure and how flexible/inflexible they were on each feature. In this survey, the most common deal structure features included pro-rata rights, participation rights, and redemption rights. VCs also tended to be less flexible in pro-rata rights, liquidation preference, anti-dilution protection, valuation, board control, and vesting.
11. 10x Potential
Since venture capitalists are investing in companies that are higher risk, they’re usually looking for 10X exit multiples. This is because half of their investments are likely to be worth zero in five years, and others may return no more than their original investment. In order to provide a reasonable ROI to their LPs across their portfolio of investments, they need to look for businesses that will make up for the investments that don’t return as well (or at all).
When you’re proving this 10x, make sure it’s realistic. Know exactly how you’re going to make those numbers happen (and that they’re comparable with industry standards and similar organizations).
12. Investment Thesis Fit
VCs are looking for companies that fit their investment philosophy and complement their portfolio and brand. This isn’t because they are snooty or overly-selective; it’s actually a benefit to the companies they back. By choosing investments that fit their investment philosophy, they are able to concentrate their mentorship in industries in which they have the most experience. This means they’re looking for a business to which they can best add strategic value.
How Can We Help?
Are you in the process of raising capital or in strategizing for a transaction or exit in the future? Preferred CFO can help. Our CFOs are experts in raising capital and can help with providing the essential financial tools needed to present to investors, can help with networking, completing due diligence, and negotiating contracts. Find out more about our services by contacting Preferred CFO today.
About the Author
Troy Skabelund has over 20 years experience as a CFO and Systems Expert for organizations of all sizes and industries, including 12 years at the Walt Disney Company. He specializes in analyzing and designing financial systems with experience in both proprietary and 3rd party solutions.
You may also be interested in…
Does My Business Need a Financial Advisor?
The wise business owner will “know what they don’t know,” and will seek the appropriate experts such as financial advisors to fill those gaps.
3 Reasons you Need a Financial Forecast
If Your Company Doesn't Have a Financial Forecast, You're Wasting Time and Money Every company has goals. Where do you want your organization to be 5 years from now? 10 years? Most even have a general idea of the benchmarks you need to hit to get there—"By increasing...
Determining the Payback Period of a Business Investment
Whether implementing a new software system, adding office space, acquiring another company, or any other substantial investment, companies want to know how long it will take to recoup the money they spend on major purchases. The way to determine this is by calculating...
10 Steps to Prepare for Raising Capital
Finding funding for your business is a process that takes a lot of time and effort, especially during the startup phase. Many entrepreneurs fail in their first attempts at fundraising because they are poorly prepared. Others get themselves into trouble by choosing the...
How Can a Fractional CFO Help You Save Money?
In these days of economic challenges and changes, many companies struggle with uncertainty about the future, seeking tools and resources to best position their businesses for financial success. Often it can be beneficial to bring in a financial advisor who has...
What is a Capitalization Table and Why Does it Matter?
Capitalization tables, commonly called “cap tables,” are highly useful spreadsheets maintained by companies that have multiple owners or investors. Cap tables are especially important for private companies at startup and in the early stages of the enterprise. They...
Top Benefits of Financial Staff Augmentation
Many companies experience times when they find their accounting departments short on staff or short on expertise. Sometimes emergencies and financial needs arise that are beyond the capability of their financial personnel to address. This is particularly true in times...
Qualities of an Effective Profit & Loss Report
A Profit and Loss (P&L) Report, also called a Profit and Loss Statement, is a key financial document that details a company’s income and expenses over a specific period of time. This time period is typically a month, a quarter or a year. Depending on company needs...
What Is a Quality of Earnings Report?
When a business sale, acquisition, or major investment is contemplated, one important step in the due diligence process is the generation of a Quality of Earnings report, sometimes abbreviated as QOE. Even though a company may have strong financial statements, those...
What Is the Purpose of Accrual Accounting?
What Is the Purpose of Accrual Accounting? There are two methods of accounting: cash and accrual. In cash accounting, transactions are recorded when payment occurs. In the accrual method, revenues and expenses are matched and recorded at the time the good is delivered...
3 Things to Know Before Choosing a Supplier
Choosing the right supplier for your business can be complicated, especially if a large portion of your product comes from a single company. For many companies, supplies are secondary only to labor in their expenses. But choosing the right supplier has even more...
How Does a CFO Influence Strategic Decisions?
In every company, there are important decisions to be made on a daily basis. Some decisions are mundane and have only short-term consequences. Others are strategic and can affect the company’s performance and profits for years. Too often, these critical decisions are...