I recently attended a VC panel discussion, along with tech entrepreneurs who had gathered at the Impact HUB in Seattle to hear from three prominent local investors on what they look for before funding a startup. The event was part of Seattle Startup Week, and the panel speakers included Chris DeVore (General Partner of Founders Co-op), Gary Rubens (an angel investor and founder of Start it Labs), and Greg Gottesman (Managing Director of Madrona Venture Group).
The discussion gave me validation that seeking an equity investment, via venture capital or angel investors, leaves many emerging tech companies unfunded—despite growing revenues and a promising trajectory.
Below is a summary of the panel discussion, with six questions venture capitalists consider before they invest.
Q1: Is it a big idea for a big market?
VCs and angel investors want a big payback (usually 10X over 5-7 years) so they look for a big idea that can serve a big market. If your idea seems “too obvious” today, or your market space is already filled with many competitors, they will probably pass. The assumption being that your company is not going to generate the kind of returns they expect.
Q2: Is this the right type of company?
All VCs have preferred industries to invest in, depending on their backgrounds. So when searching for VCs, be sure to research the companies they have backed in the past. A particular VC may say they fund tech companies, but fund only mobile app companies in practice If your company doesn’t match their investment portfolio, don’t waste your time.
Q3: Do I know you?
Most VCs get hundreds of emails every day from entrepreneurs or investment bankers pitching them on business ideas. That’s why a warm introduction is really important, if you want to get in front of them. If you are not part of the in-crowd, you will need to invest time in networking to get an introduction.
Q4: Is the pitch clear and realistic?
VC investors don’t have the time to do a lot of research on your business idea, so you need to clearly articulate the concept, market, and plan of attack in your pitch. A repeatable, short soundbite will gain their interest, but to keep it you need real stories showing you can attract customers and ship products. If you are early-stage, make sure to have preliminary customer data and a long-term fundraising strategy. Avoid hypothetical scenarios and focus on true client stories and a product demo.
Q5: What is your customer acquisition cost?
This is something VCs really focus on. Customer acquisition can be expensive and entrepreneurs need to be able to show that the lifetime value of their customers is greater than the cost to acquire them. As a benchmark, a 2-3x return is a great metric. Figuring out this number may be tough if you’re pre-revenue and don’t have any customers, but in the discussion Greg from Madrona Venture offered some creative ways to test the market. For example, you can drive paid traffic (SEM) to a specific landing page, and analyze the demand for certain keywords, and you will be able to see how well your product can potentially convert.
Regardless of the stage of your startup, be prepared to answer this question and show how you will scale your business based on customer acquisition costs.
Q6: Am I a partner or a cash cow?
Don’t expect VCs to write a check after the first half-hour meeting. Courting an investor can take months. During this time, they expect you to reel them in by building your case. VCs want to be a partner in the business, not a bank that just provides a line of credit. Because it’s a long-term partnership they’re after, all panel speakers expressed how important it is for entrepreneurs to show their credibility and trustworthiness during the fundraising process. Sometimes entrepreneurs exaggerate or lie in order to secure funding and that’s the biggest turn off for VCs.
I left the panel discussion feeling a lot of empathy for the entrepreneurs. Having the conviction to start your own business is hard enough, but securing funding to execute your idea is even harder. In this era of big data and mobile technology, raising money has not changed. It’s still about who you know and how well you can give a presentation. As Greg from Madrona Venture group said multiple times: “I am constantly looking for ways to say no, in a nice way.”
For early-stage entrepreneurs, the options are limited, and the inability to get funding can ultimately lead to the collapse of a dynamic startup.