How Venture Capitalists Make Startup Investment Decisions

Investment is one of the key resources for startups to grow. India’s startup ecosystem is the fastest growing in the world, and it is now the third largest globally. With high-quality startups emerging across sectors, VC funding in the country is also growing rapidly. According to Bain & Company’s India Venture Capital Report 2022, 2021 marked a milestone for India as VC funding touched $38.5 Bn. 

Startup founders typically start their businesses by bootstrapping and then raising “FFF” capital, primarily from friends and family. Loans are not an option at this stage of the company because loan providers need to look at the company’s hits, which do not exist in a “startup”!

Startups require capital without any kind of security or collateral; investors who provide funds take the same risk as the founders, essentially betting on the company’s future. As a result, the filters for an investment decision rely less on data and more on other factors.

Therefore, understanding what investors look for is critical, especially given that these investors receive thousands of funding applications. Aside from these parameters, each investor will have their own, for example, some will only invest in healthcare, others in agriculture, and many will be sector agnostic.  

Some investors only invest in companies after they reach a certain revenue level, while others may consider pre-revenue companies. So an entrepreneur should conduct some research to determine who might be interested in their proposition.

Founding Team 

The founders of the venture are the most important factor that investors consider when making an investment decision. According to a Harvard Business Review study, 95% of VC firms agreed on this. Venture capitalists invest in the founding team because they will be responsible for the company’s success. 

Founders who understand their domain, customer needs, and how they will access and deliver them. Most importantly, investors evaluate the founders’ leadership abilities and determination. Regardless of the investor, they are looking for founders who are passionate about building their businesses!

These founders should be able to build and retain a complementary team. It is essential, or else the startup will fail to gain traction. It is the team’s responsibility to drive sales, ensure high-quality delivery of the solution/product, collect revenue, and so on.

In fact, capital and team are the two most important aspects of any business. Investors will bring in capital if they see a founder(s) with a team that can execute. 

The Market Size

The industry of a startup and its potential for growth have a significant impact on venture capitalists’ decisions. Businesses that target large addressable markets pique their interest. Large markets are typically driven by solutions that are “necessary to have,” rather than “nice to have.” 

Customers in these markets will be required to purchase the product, and repeat purchase markets are even better! This will propel the company’s growth and create opportunities for exciting returns.

Product Should Have An Edge

One of VCs’ other priorities is to invest in a venture that has a well-differentiated product, as this will give it a competitive advantage in the market. They see products as solutions that help solve real-world problems and meet the needs of customers. 

This is critical for the survival and growth of a startup. Low competition makes it simple for bigger players to drive out the startup.

Risk Assessment 

Every VC understands that investing entails risks. However, all they want is for the risk to be worthwhile.  When venture capitalists make an investment in a company, they want to know what they’re getting themselves into. 

They want a clear picture of what the company has accomplished and what the company’s future plans are. Investors also examine the business model for any potential legal/compliance/governance issues, the product’s future viability, and the rate of return. They evaluate risks so that the returns are high.

Mutually Beneficial Collaboration Is The Way Forward

The investment decision is heavily influenced by the business model, core management, future plans, and market opportunity. Other factors considered include the startups’ operational stage, their products and/or services, and their ability to take the market lead. The bottom line in every aspect that investors evaluate is to ensure that risks are minimised and returns on investments are high. 

The collaboration between investors and entrepreneurs must be mutually beneficial. Both must contribute to the company’s success: founders with money, mentoring, and access to global networks, and investors with money, mentoring, and access to global networks. Together, they will create wealth for both the founders and the investors by building a valuable company.

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