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6 questions VCs ask themselves before they invest

6 questions VCs ask themselves before they invest

Recently, I 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. This was organized as 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 what they are looking for is a big idea for 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 industry backgrounds. So when searching for VCs, be sure to research the types of companies they have backed in the past. A particular VC may fund tech companies, but when you dig deeper you may find only mobile apps companies in their funding history. If your company doesn’t match the 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. 

Greg Gottesman, Gary Rubens, and Chris Devore on the questions VCs have when evaluating startups

Greg Gottesman, Gary Rubens, and Chris DeVore at Seattle Startup Week.

Image source: Start It Labs

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 when you pitch, you need to clearly articulate the concept, the market, and the plan of attack. A repeatable, short sound bite will gain their interest, but real stories showing you can attract customers and ship products are necessary to make your case. If you are early-stage, make sure to have preliminary customer data and a long-term fundraising strategy. Avoid hypothetical scenarios; 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 costly 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. 

Takeaways 

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. 

If you are in the tech business and have at least $15,000 of monthly revenue, try our alternative revenue-based financing model. It takes 10 minutes to apply, and you will find out if you qualify in 48 hours. We think it’s a more entrepreneur-friendly way to grow your tech business.