3 Tried and Tested Tricks Venture Capitalists Use to Identify Successful Start-ups
90% of start-ups fail, statistics show - because of insufficient funds, inexperience, scaling too early etc. But this leaves us with 10% that succeed. So, how do investors single out those that make it big?
Statistics show that venture capitalists are exposed to at least two new business ideas/companies every day, 250 days per year. This massive flux of information makes it very difficult to distinguish start-ups worth investing in from those that don’t.
Experienced venture capitalists use three tried and tested strategies to identify successful businesses likely to turn into multi-billion dollar corporations.
As high-net-worth investors and VCs receive countless emails and presentations from entrepreneurs and business owners seeking investments, they need to apply a strategy to help narrow down the list of potentially successful businesses. So, they choose the straightforward path: the investment thesis, which comprehensively frames the “ideal” company that would fit their portfolio.
Every investor has an investment thesis or theory which combines any of the following elements:
- Type of business (B2B, B2C)
- Target market or industry
- Stage of development the company is at (e.g., concept, seed, growth, or other)
- Company founder stats
As an entrepreneur seeking funds, you will definitely follow the activity of VCs and angel investors to get an idea of what type of start-ups they fund and why. If you’re lucky enough to discover that your company meets at least four out of six items on their investment thesis, it may be worth pitching them, if not… better luck with someone else.
Of course, not all investors are created equal, nor do they share the same vision or business principles. Some may make themselves available for a chat or a more detailed debate - just to get to know you - but is this enough of an assurance that they will contribute the amount of capital you need to kickstart your business? No. So why waste both of your time?
Too much focus on development
Let’s say you caught the eye of an investor. Once they agree to listen to your pitch, the next thing they’ll pay careful attention to is your focus. If your pitch is riddled with technical details about your product - what it does, how it’s built, future iterations, etc., etc., and less or hardly anything about why you built it and where you see your company - not your product - in five-six-ten years, chances are they won’t invest. And the reason is simple: VCs and angel investors don’t invest in products. They can’t.
What VCs and angel investors are likely to resonate with, on the other hand, is the viability of your business idea because that will generate returns on investment and make your product viable. The most likely question you will get from a VC about your product is: “How does it work?” If you’re lucky enough to come across a fellow engineer or developer seasoned in all things tech (supposing your product is technology), the VC might, at best, ask you about additional functionality. Great! But don’t get overexcited about it (if it happens), as questions like this are being asked just to fill up the space of one hour - the standard time a pitch requires. So, you might want to keep your technicalities to a minimum.
The lack of a repeatable customer acquisition model
If a tech or product-driven entrepreneur reaches the heart and deep pockets, what attracts VCs, if anything? That’s simple: Business. Don’t forget VCs are entrepreneurs themselves, and as such, they focus on and are driven by customer acquisition or data that can be interpreted, assessed, optimised, and replicated. This is how the business growth mechanism works.
Assessing a company’s potential to grow is the basis of the third filtering criterion that VCs use to determine whether a company is worth investing in or not - customer acquisition models.
Customer acquisition models can be expectedly scalable with a capital infusion or unpredictably scalable. An expectedly scalable company is one that keeps tabs on every penny being spent to generate X amount of revenue.
As VCs hold the reins of funding, they also wish to generate value, a.k.a. profits, by investing in a start-up. Therefore, they tend to open their pockets to companies emphasising a repeatable or foreseeably scalable customer acquisition model.
Some of the foreseeably scalable customer acquisition strategies include paid advertising, cold calling, emailing, content marketing, attending events/conferences, user advocacy or word-of-mouth marketing. If your business model matches any of these tactics, you’ve already got a step closer to your much-coveted investment.
Unlike these, the unpredictably scalable customer acquisition models include PR and media, guerilla marketing, growth hacking, and lastly, virality. These are less controllable and hence, more difficult to fit into a pattern, which VCs are so very keen on having.
Therefore, once a company proves that its customer acquisition strategies are scalable in a manageable and predictable manner, the company becomes investible. That’s a tough nut to crack…
Statistics show that virtually 95% of start-ups seeking VC funding are disqualified based on the above filtering tactics. Furthermore, several less common issues eliminate start-ups from the race for funding, leaving VCs with a handful of 25 to, say, 30 viable start-up investments per year. To get in the top 25 takes the agility and ability to build a repeatable customer acquisition model and develop an idea likely to attain market validation.