What Investors Look For In Start-ups.
So you want to get funding?
You have an idea that can change the world, now what? You need to know how to get your idea funded, right?
Well as someone looking for funding myself, I found the venture capital world quite confusing from the outset.
As I was researching, I pieced this post together to outline the key considerations to lookout for when raising capital. While these notes will not guarantee to get your start up funded, it will give you a clearer indication of what investors are looking for.
What is a funding round?
Angel vs Seed?
Seed and angel rounds are the same thing. It is the first stage of the funding ladder. Typically they range anywhere from twenty thousand to two million, but the average lies somewhere around one hundred and fifty thousand. For that you can expect to lose an average of 20% equity, but anywhere between 5 -35% is normal.
If you still don’t get it, this video explains it pretty clearly. (View Notes)
Another thing to remember is that your first round is not typically a VC round, so you’re not going to get a board member at this stage. Often hot start-ups get multiple investors which can help bring collective validation to the product.
The goal of this round, having successfully achieved seed funding, is to assemble a team, achieve product milestones, proof-of-concept, and anything else that will enable a company to attract investors for the next round of financing. Valuations during Seed rounds tend to be driven by subjective factors that need to be assessed before determining the validity of the company.
Company Validity Factors:
1: Team: It is not impossible to be a solo founder, but it is normal that investors look for 2–4 founders because statistically, starts-ups founded by more than 1 person tend to do better.
Investors look for team members with complimentary skillsets, often covering design, tech and business.
It’s expected that the founders will receive an equal distribution of shares, as uneven divides among co-founders can bring detrimental effects to the companies heath later down the line. Despite this, one member will typically take responsibility for the CEO role.
Other areas that VC’s will look at include:
1: Does the founding team have a track record?
2: Do they have a good network?
3: Is the team fast moving?
4: Do they have technical proficiency?
5: Do they compliment the market?
6: Have they worked together before?
7: Are they good communicators?
8: Do they have a reason to tackle this challenge?
The characteristics VC’s look for in founding partners is somewhat lengthy, but these are some of the key attributes: >
2. Market Size / TAM (Total Available Market)
To make an investment worthwhile, the market has to be large enough for substantial growth. If your start-up is tackling a niche, it is unlikely to receive significant investment unless there is a clear route to monetisation that can scale rapidly. This isn’t impossible to accomplish, but it does make the investment less attractive to investors.
3. Product Differentiation
Often entrepreneurs will be attempting to tackle an already pre-existing market with a disruptive new strategy. Make sure you know everything about your competitors and how you intend to differentiate yourself.
4. Sector Volatility
Is the market segment your building your product for particularly volatile? Whilst any angel investment has a degree of risk, it helps if you’re going into a stable market with a clear game plan to be the disrupter, as apposed to going into a market that is anyone’s guess as to who will be the ultimate victor.
If your start-up has a minimal viable product, it will help if it has got some traction already. If you don’t, it’s important to have an idea how you intend to build traction in the early days. Is your product something that people will use every day? Do you have a feature that can create exponential growth? An investor will be looking for around 20% month to month growth, with active users and a high retention.
Does your product make sense from a trend perspective? Often investors will describe trends as ‘tailwinds’. It helps if your idea rides a wave rather than swim upstream among trends in your sector.
7. Intellectual Property
Does your idea or product have any IP that brings value to the deal?
8. Time to Market
Is it the right time to bring your product to market? There are countless cases when start-ups were either too early or two late to a market and missed out on the growth opportunities.
9. Path to Profitability
Investors don’t give away money, they invest it. You need to have a clear game plan for how your product is going to make money and an estimation of the companies’ capital needs, burn rate, and year of profitability. If you’re MVP can provide the cost for user acquisition that is also ideal.
10. Why you?
Does it make sense that you’d be the person to tackle this problem? If so, why is this something that you are passionate about? What is your vision for changing the world? When you go for funding, your committing yourself to a long-term project, you have to have a compelling reason for wanting to tackle the challenge.
Why angels will not fund you:
1: No technical co founder.
2: Non-equal equity split.
3: You don’t want to work full time on the project.
4: Your outsourcing engineering.
Before Contacting a investor— Founder Due Diligence.
1: Who are the investors that invest in our sector?
2: Who has had success in this space?
3: Who is known to be good?
Try and find investors who would be interested in your product by viewing their previous investments. You should be getting to know Investors prior to asking for funding.
How To Contact A Investor
Best: Qualified referral.
Second Best: Website.
Third Best: Twitter & Linkedin.
Always say why you want to connect with the investor. Try and make it relevant to your product.
What not to do:
1: Overplay predictions.
2: Fight during meetings.
3: Think you have an original product and you haven’t done your research.
What you should be showing:
- Investors should learn something new from the founder.
- They want to know how fast you move, and your unique insights.
- Engagement, how you intend to get rapid growth, customer retention, spend per site visit etc.
You’ve Got A Deal
If an investor wants to back you, what should you ask?
Ask to meet 3 or 4 entrepreneurs they’ve backed before so you can ask them…
- When it was tough, were the investors helpful?
- Are they antagonistic at tough times?
I hope this has given you a basic backdrop into some of the points you’ll have to consider when compiling your deck and refining your pitch. If you’re reading this and you think I’ve missed an important point, do get in touch, I appreciate the input.