What VCs Look for in a Startup Investment

As the founder of Pegasus Tech Ventures — a successful venture capital firm in Silicon Valley — perhaps the most common question I get is what VCs look for in a startup investment. Founders typically wonder what my team’s top priorities are: management experience, technology innovation, and financial projections. I always consider several important factors when evaluating whether to make a startup investment. Let’s look at a few critical aspects.

Strong Management Team

A startup needs to be led by a smart, creative, and visionary management team. I like to understand whether their backgrounds are diverse, which typically leads to better decision-making. McKinsey & Company reports that companies in the top quartile for gender diversity on executive teams were 25 per cent more likely to have above-average profitability than companies in the fourth quartile — up from 21 per cent in 2017 and 15 per cent in 2014. The management team should have strong goal alignment and a proven ability to make the difficult decisions they will inevitably face.

Addressable Market Size

Startups should target a large addressable market that can generate US$1+ billion in revenue. This helps ensure large returns for investors. A larger market size makes a trade sale more likely, making a given startup more exciting for VCs interested in exit opportunities. Ideally, I would like to see a startup capable of growing sales to hundreds of millions of dollars. It also helps when a company is registered in a startup-friendly region such as the U.S., U.K., or Singapore.

Great Product or Service with a Competitive Edge

A startup should solve real, burning problems for customers, and the company should have a sustainable competitive edge. I look for products or services that customers simply can’t live without. They should be better or cheaper than anything in the marketplace. Startups looking for investment should generate sales and profits before competitors emerge, giving them an edge on customer loyalty. Harvard reports that loyalty leaders — companies at the top of their industries in Net Promoter Scores or satisfaction rankings for three+ years — grow revenues 2.5 times as fast as their industry peers and deliver 2–5 times the shareholder returns over ten years.

A Clean Cap Table

It’s ideal for startups to have a limited number of investors, likely accredited investors. A startup’s capitalization table should be clean and show a list of shareholders, how much outside investors own, and the amount these investors have invested. Remember that early-stage businesses often require multiple rounds of investment with the cooperation of existing investors. It’s challenging for a startup to carry many small investors, especially family, which makes it hard for smaller investors to keep up with larger ones. A messy cap table is a turn-off for VCs and increases the risk of conflict.

Solid Track Record

I always look for startups with significant revenue traction and already loyal customers. High customer satisfaction and positive experiences mean customers are likelier to stick around. It’s important to understand what customers like about a startup’s product or service, what they think of the brand, and whether they are willing to buy more or pay a higher price. If a startup has strong traction with its core customer market, ideally across a broad international market, it is more likely to grow and succeed.

Solid Fundraising & Execution Plan

It’s typically best if startups rely on multiple investors for fundraising — including angels and VCs — and they have a solid plan about how much capital to raise and from whom. Raising money from corporate partners — who offer unique insights and connections — can be a key element of startup success.

Aside from raising money, startups must have a clear plan about how raised capital will be put to work — including a projection of the cash-burn rate. How much capital does a startup have, and how quickly will it run out? How much runway is left? VCs are impressed with startups having both conservative and realistic spending plans.

Exit Potential & Investment Thesis Fit

I like to see startups with clear plans to run and grow the business, including a vision about potential exit paths. Research data backing up these plans will help potential investors have more confidence in the startup. Finally, having an investment thesis fit means that startups should fit a given VC’s investment philosophy and complement their portfolio. This way, VCs can concentrate their mentorship in certain industries in which they have experience. As a VC, I look for startups where my team can add strategic value and offer meaningful advice to the startup.

While finding the right fit between a startup and investors is not necessarily easy, it’s worth the time and effort for both parties. Like any business partnership, it’s imperative that each partner understands the other well and has confidence in their abilities and plans. This helps the startup succeed, and the investors receive a positive financial return.