The thoughts and views of an investor are usually a bit different than those of the entrepreneur. For obvious reasons, investors that place their money in startups take on an enormous amount of risk. For every 10 startups an investor backs, he can expect that 6 of them will fail, and won’t return any amount of the investment. Companies 7, 8, and 9 will fair well enough to return about the amount of the investment. This means that, in order for the investor’s time and money to be worthwhile, startup #10 will need to produce such a large return that it makes up for the losses from startups 1 through 9—meaning the investor hopes to make at least 10-times his investment from a single startup! For that reason, investors can’t afford to take chances on companies that don’t at least have the chance of delivering that 10x return. Although the risks of betting on a startup are pretty well understood, here’s a few ideas on what investors see when they look at a company and how you can present your business in a way that will turn heads.
Understanding, in great detail, the opportunity that you and your company plan to address is the first step in understanding the language of investors. Make no mistake, the dollar-amount of the opportunity is very important—I’ve heard from several VC’s that, as a rule of thumb, they generally seek companies that are taking on a total addressable market of at least $100,000,000. However, it’s even more important to understand the singular customer in that market. This is the piece that is usually referred to as “validation” or “traction”: How well do you really know that customer, be it an individual or a company? Do you truly have the opportunity to solve a real issue they face? Are they actually willing to pay you to solve that problem? And, finally, how many more individuals/companies have the same problem and would also be willing to pay? It’s not always the most intuitive notion that great products don’t necessarily translate to great opportunities — it’s the entrepreneur’s job to understand what the market’s pain is worth in dollars and cents, and then deliver evidence of that opportunity to the investor.
What Will It Take To Address That Opportunity?
If costs outweigh the revenues of solving a particular problem, the business model is a bad one. Virtually everyone understands that simple idea. The problem lies in trying to predict all of the costs that will ultimately go into delivering a product. Especially if your company is pre-operational, your business model will largely be based upon assumptions. Similar to your opportunities, investors will understand the validity of your “what it will take” assumptions—including R&D, your go-to-market strategy, key resources and partnerships that will need to be established, and so on. And in the realm of “what it will take”, dollar amounts and timing are key. When a VC firm raises a new investment fund, the fund is intended to mature in about 10 years, give or take. During the first 5 years, the firm will search for and invest in promising startups (see “The Opportunity” above). However, this means that their money must be returned within the second half of the fund’s life—meaning, the startup must be able to address its targeted opportunity and reach a liquidity event in that time (no pressure!).
The other piece to this is deeply understanding what it is you need from the investor and why. When will capital expenditures occur during your startup’s rise to full-scale operations? How many months of working capital will you need funding for before the company generates positive cash flow? And, based on the company’s opportunity, how much of your precious company are you willing to give up for that funding?
Above all else, they want to know that the founders standing in front of them are the right team for the job. In this day and age, when investors play a much more hands-on role than they used to, it’s also becoming more important that the “right team” also be one that constantly seeks advice and guidance. Chris Sacca, managing partner of Lowercase Capital and renowned venture investor, notes that one similarity among the most successful entrepreneurs is that they’re always “learning, they’re modeling, they’re constantly researching, they’re gathering data” (hence, everything written above about deeply understanding your business model and its surrounding market). A coherent, proactive, clever, and coachable team will always prosper over a grade “B” team that merely a great product.
Written by: Alex de la Fuente