Would Amazon, Apple, Microsoft, and Starbucks have seen the light of day without the backing of a farsighted venture capitalist? Probably not! That’s how crucial venture capital funding can be to the success of innovative business ideas. In this scenario, where the success of a startup hinges around finding the right venture capitalist firm, how can entrepreneurs influence a VC funding decision?
In our recent study “How Do Venture Capitalists Make Decisions?” published by the National Bureau of Economic Research, we tried to answer that question by seeking the views of 885 venture capital professionals at 681 firms. Their answers gave us a fascinating insight into the lesser-known factors that drive investment decisions.
VC Funding Is All About The “People!”
The average investor evaluates 200 companies and invests in just four every year. Each deal takes an average of 83 days that includes 118 hours of due diligence. So, after such intense scrutiny, what finally tilts the scales in favour of the chosen four? The answer it turns out is the people behind the idea—the management team.
In fact, at least 96% of VCs surveyed said that startup management teams had been crucial to their success. They even rated this over other factors such as business model, technology, market, and industry.
However, when identifying the people that they will invest in, it is not just an entrepreneur’s ability and experience, but their passion for an idea that is a clincher. Nothing works like the sight of entrepreneurs working full-time on a business and committing their own money to an idea. That influences a VC’s investment decisions more than product or technology.
Understanding Product And Industry Can Be A Game Changer
Yet, while the founding team’s abilities and experience score over the product itself, its industry and product understanding could finally prove to be a deal maker. Take the case of Dropbox. Among the VCs evaluating Dropbobox was an investor who believed that file sharing was going to be the next thing, and had even spent meeting several other teams who were trying to build companies around the same idea. However, what moved the needle in favour of Dropbox, was the team’s complete understanding of the file-sharing concept.
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They had clearly thought ahead, and were even prepared to overcome related challenges and explore the opportunities offered by this technology. Once the investor saw this, Dropbox was clearly the best investment choice.
While at twenty-four, Drew Houston, the founder of Dropbox, had more experienced technologists than him in the room, what investors were most impressed with was Drew’s understanding of technology, and they put their faith in him. The rest, of course, is history.
The Best Ideas To Get VC Funding Will Face Scrutiny
All venture capitalists exert effort and expend resources on deal sourcing, deal selection, and the provision of post-investment value added services. However, VCs typically rate deal selection as the most important of the three. This was confirmed in our study. Here, while all processes were considered to be important, close to half of the VCs interviewed ranked deal selection as the most important determinant of success and real value creator.
Consequently, it is the deal selection process that dominates the effort expended by VCs, and all shortlisted ideas most undergo a rigorous selection and due diligence process. So entrepreneurs with the best ideas must be prepared to answer tough questions.
Networking Does Matter
How far your idea will go ultimately depends on your circle of influence. Most VCs still rely heavily on professional and personal networks to find investment worthy start-ups.
In our study, at least 30% of VCs sourced deals from their private network. Next came references by private investors and recommendations by a VC firm’s existing portfolio of companies.
Different VC Funding Strokes For Different Folks
Finally, it is also true that one size does not fit all. And while we highlight certain general trends, clear variations based on location, industry, and stage of investment also emerge. This was observed even among our more homogenous sample of 885 venture capitalists.
For instance, information technology investors were more interested in an entrepreneur’s management team, but on the other hand, health sector investors were more focussed on products and market forces. Similarly, California investors were more likely to back less experienced entrepreneurs, as the Silicon Valley ecosystem has traditionally supported such founders with advice, help, and mentoring.
In the startup ecosystem, there has been a longstanding debate on the horse (technology) versus the jockey (people) when it comes to VC funding. The question—which comes first comes first when VCs make an investment decision? Clearly, individual variances aside, the jockey currently scores overwhelmingly over the horse!