From startup podcasts to the constant Silicon Valley buzz and shows like Shark Tank, it seems that almost everyone has the entrepreneur fever. The idea of creating a multi-million or even billion-dollar company has turned from a nearly implausible, unreachable dream to an actual possibility. Visionary tech companies, such as Facebook, Shopify, and Shutterstock, have proven that success is not a dying anomaly. Rather, technology has created a digital world of infinite possibility.
There is a widespread belief among founders that venture capital is the make or break for startup companies, and there is truth to this theory. While some companies have achieved success through pavement pounding and sweat equity, VC is the common denominator of the most successful tech startup companies, making it crucial to figure out what angel investors are looking for. Consequently, the question that investors hear most is “how do I get a VC to back my startup?”
It is a daunting task to narrow down what VCs are looking for because data may simply not exist during early stages, making determinations more reliant on qualitative over quantitative factors. During the infancy of a startup, the company may be little more than a set of PowerPoint slides, hope, and a prayer. Financial metrics and raw data may not exist, making it impossible to predict an investor’s ROI. This begs the question: “If the data is not there, what can I do to land a VC investor?” Luckily, VCs are entrepreneurial valuation wizards and have developed methodology to evaluate investment prospects.
The following is a bit of insight into what VCs consider when evaluating an early-stage tech company.
Your mere existence may be the key to striking a lucrative VC deal. During early-stage investing, people become the most pertinent qualitative factor that VCs consider. When a startup is nothing more than a small group of individuals – possibly even a single individual – with an idea, much of the focus turns to the team. Ideas are not proprietary, meaning that it is possible for other individuals to emerge and attempt to start the same business. In these situations, a mad race to the finish line ensues and victory is likely to hinge on the quality of the team. VCs will scour background information, looking for hints that demonstrate an increased likelihood that a new idea can be effectively executed by a team. Their decision can determine the ultimate fate of the project. The opportunity cost of investing in a single team is infinite; a decision to move forward means that a VC cannot choose another team even if they are better equipped to accomplish the goal. Given the gravity of making the right investment decision, thorough investigation is necessary and a founder may bolster the odds of success by highlighting attributes that demonstrate a proven track record or an increased ability to succeed.
VCs want to know that a genuine need exists for the proposed product. After all, without demand, a product is destined to fail. VCs utilize a proverbial “what came first – the chicken or the egg?” analysis to determine if they are dealing with a product-first or company-first startup. In a company-first approach, a founder decides to form a company first and then thinks of products that may be good to build it around. On the other hand, in a product-first company, the founder experiences or identifies a problem and develops a product to solve the issue. Subsequently, a business is formed around the product. VCs often find the organic evolution of a product-first company very attractive, giving preference to this model. The reasoning being that if a product was developed to solve a problem, it is likely that a host of potential customers have experienced the same issue and that a genuine need exists.
Marc Andreessen coined the term product/market fit which refers to the degree to which a product satisfies a very strong consumer demand. A high degree of product-market fit means that an item is so attractive to marketplace consumers that they automatically recognize the problem that it was intended to solve and are compelled to purchase the product. A product-first model raises the possibility of a strong fit and high demand, making it even more appealing to investors.
You may have heard a VC ask: “what’s your unfair advantage?” VCs place a significant emphasis on the unique characteristics that founders bring to the table. They want to know that you have something that others do not. Perhaps, a founder may have a very specific educational background that plays perfectly into the proposed product. Alternatively, they may have had an experience that exposed them to a problem, providing unique insight into a creative solution. Take for example, Airbnb. A group of roommates, struggling to make ends meet, noticed that local hotels booked up during major events, creating a shortage of availability and driving up prices. They had the brilliant idea to rent out a place to sleep in their apartment – helping travelers save money while concurrently paying their rent. Thus, their concept was born.
In some cases, a founder who seems like a foreigner within the industry, may be just what a VC is looking for. Familiarity often can have the unintended effect of pigeonholing a founder’s thought process, resulting in creative bias. Having an outsider perspective gives rise to inventive solutions that may not exist had someone in the field formulated them. For example, Southwest Airlines was co-founded by an attorney named Herb Kelleher in the 1960s. In an NPR interview in 2016, he was asked why a lawyer was a good fit for founding an airline. He quipped: “I knew nothing about airlines, which I think made me eminently qualified to start one, because what we tried to do at Southwest was get away from the traditional way that airlines had done business.” Thus, his differences gave him an unfair edge that led to Southwest’s success. As entrepreneurs take on well-developed industries, an unconstrained perspective may be the plus that appeal to VCs – their unfair advantage.