The average VC fund will see hundreds of business plans per year, and will fund 3 to 5 - translating to much less than 1% of the companies that seek their financial backing. Every entrepreneur would love to know the magic recipe to be among these chosen few, and through there's lots of great fundraising advice out there, few patters are consistent across all companies.
In fact, being at the right place at the right time, market trends that heat up bids in certain industries, and team composition are considered some of the biggest influencers. So, really, what affects a venture investor's decision to back your company?
Pulling from research and our own experience, here are the questions we ask of investors and ourselves before we sit down for any meeting. Here's hoping it makes your own funding journey easier.
Before You Start: Match Your Investor to Your Business
I see too many entrepreneurs trying to get the interest of funds that are investing either later or earlier than the stage of their enterprise is in. If you are seeking seed funding, don’t talk to people who are doing late stages and vice versa. Before you get started, research your target investors to know what stages of companies they're funding, and the total amount of venture capital they plan to deploy up front, and during scale up.
This second factor, the total amount of capital, is important considering the amount of money needed to get your company to a point where it is self-sustaining. Depending of your market and product, this is going to vary from millions of dollars to hundreds of millions of dollars.
In other words, your initial need may be $2M to get you off the ground but, in the end, later stage financing will require over $100M. Understand that some VCs will simply cap the total amount of capital that will be raised (from them and others) into a venture and will walk away if your project’s capital requirement exceed that cap. According to Chamath Palihapitiya of Social+Capital, it's funds with strong follow-on investments that have the best rates of company success - so bet on those who will bet on you long term.
Your Leading Equation: Nail Your Product-Market Formula
What is your product? Is there a market for it? This is probably the most difficult question you'll be asked, because there is one element of the question that is missing: the temporal nature of markets. It used to be that what we call smartphones was a small market reserved to professionals. Look at it today. Obviously, as the smartphone market develops, it attracts new entrants and new innovation.
Are you introducing a new product into an existing market? Are you trying to create a new market with a new product? Are you trying to create an entirely new business model in an existing market? Make that very obvious to the people you are seeking financial backing.
When you think of your startup evolving, think of these three variables simultaneously:
The maturity of the market - from very structured to non-existent.
The innovativeness of the product - from bleeding edge to no innovative at all.
Your business model - from traditional to completely “disruptive”.
Where in that space are you positioned? As an entrepreneur, you must be aware that depending of where in that space you want to operate your new venture, the associated risk, and the reward, is vastly different. And so is the amount of time and the amount of financing that will be required.
VCs are extremely aware of the space I have described. They live it, day in and day out. As a founder seeking financing, you must show that you understand that model and you are ready to navigate its treacherous paths.
Your Best Assets: Your Team
In most cases, the only tangible “assets” a new venture possesses is its founding team. The product does not or barely exists. It has not been sold to anybody. As a matter of fact, customers do not even know that, one day, they will be asked to consider purchasing such products. There is no cash. No buildings. Nothing. Just a couple of founders, their ideas and their enthusiasm.
With that in mind, is it surprising that VCs spend so much time understanding who the founders really are? Are the founders committed? Honest? Have the right values? Seem to work well together? Are complementary? If there is only one founder, who can be associated to her or him to make the team stronger? Are they capable of attracting and retaining top talents? What is their strengths and weaknesses? These are but a few of the questions that will be asked. And the answer to these questions weighs a great deal on the ultimate decision.
Your Best Virtue: Your Unconditional Belief
The belief of the founders in the product(s) and their project is the sole source of energy at the onset of a venture. That belief must be such that the team will overcome the many obstacles they are sure to find in their way, and the many setbacks they will experience. Founders who do not have an unquestionable belief in what they do fail 100% of the time.
A VC evaluating an investment opportunity will want to test your belief in your product and mission to its very limit. Yes, they will ask if you have invested your own money in the venture. To the extent they are going to fund the project with substantial amounts of money, they want to know that you have, as an entrepreneur, at least as much, if not more, at stake than they will.
All they want to assert is that the entrepreneurs are not simply going to give up when the goings get tough (and, of course, there is 100% probability that it will happen).
Your Vision: Sharing the Plan
Let us established something right off the bat: a plan is not a prediction of the future, and nobody is going to take your financial projections at face value, even if you think you have been as conservative as you think you can be.
As a Chairman of a VC fund, I used to cut in half and move out by 12 months any forecast that I looked at. Why? Because it gave me an idea of the real amount of cash that was going to be required to get to a sustainable company.
What VCs want to see is that you have an understanding of the dynamics of your market, an understanding of how to bring a viable product to market, an understanding of how you are going to price this product and distribute it. In other words, do you understand the mechanics of your nascent business? Do you understand your competition?
In a startup the number of things you do not know or, are unable to precisely forecast, far outnumbers the things you may be sure of. Better be upfront with the unknown and the wild guesses. VCs will want to see that you have built an as complete as possible universe of the hypothesis and have tested them, even if the result does not provide any definitive answer.
Most importantly, when making your investment pitch, make the plan you're offering is lined up with the round of your fundraising, or as Marco Zappacosta of Thumbtack advises, pitch for the round you're raising, not the one before it.
Your Secret Weapon: Salesmanship
A lot of building a new company involves selling. Selling the idea to family, friends and/or angels. Selling the concept to the team you are building. And selling your business plan to VCs. Successful sales people appeals to both reason and emotions. The founding team of a startup must have (collectively or individually) a healthy dose of salesmanship to succeed in getting VC backing.
How can you be believed to recruit top talent (a sales job), or sell your product to your first customers if you cannot sell your idea and yourself first?
VCs will want to understand how much salesmanship inhabit the team. And if they cannot find any, it does not necessarily mean they will not invest but they will seek to fill that hole as soon as they invest.
Your Opponent: Gut Feeling
Some years ago, IBM conducted a study to understand how internal decisions were made in its various business units, divisions, etc. If you do not know already, IBM is famous for having very structured processes up and down the ladder.
At the end of each survey form, there was one question asked to every participating manager: “What was the most important factor that influenced your decision?” In 90% of the cases, the answer was “Gut feeling”. So here is the master of structured planning discovering that, in the end, its internal decision process is mainly driven by a completely subjective appreciation of each decision point.
It happens to all of us. It happens to VCs too. After all the market studies, the business plan eviscerating, the experts’ advices, the valuation tables, the checking of intellectual property, the team evaluation, every investment manager is going to be left with a very simple question: yes or no? And that is, in 90% of the time (like at IBM) a question of gut feeling. “Does it feel right?”
I often say to entrepreneurs that, when they look at business plans, VCs, try first to find a reason to say “no”. When you fund less than 1% of the plans you look over, you cannot spend a lot of time studying each one in details. So you will try to find things that trigger rejection very quickly. It is brutal but understandable. The few plans that are retained will go through a meticulous evaluation and the founders will get drilled as if they had just landed on Parris Island. But don’t be fooled, in the end, the main driver of the decision will be “gut feeling”. It will provide solace to some and despair others. But that’s the way it works.