Hindsight is 20/20 — once a company has succeeded its success almost seems pre-ordained. But when it is just starting that is hardly the case, in fact, chances are if you poll even experts the consensus will be the company will fail. Divining whether a particular idea will actually beat the odds is essentially why venture capital exists. This post presents the core framework by which VCs make decisions and identify a winner — like Microsoft pictured above. Frameworks are not exhaustive and there are always exceptions, consider this a practical guide for creating your 12-15 slides that will serve as your pitch deck.
The team is always the most important, especially at the early stage when there are few proof points. What experience does the team have in the problem they are solving? Have they been in a startup before and if so, what roles did they play? How did the founders come together? What are some of skills gaps currently? What’s the team’s hiring strategy? These are just some of the questions a VC is asking, ultimately looking to understand why this particular team could succeed. Aside from the questions stated openly, investors are also assessing how they would work with the entrepreneur and perhaps other investors already on board. Entrepreneurs may say getting rid of a VC from your cap table is really hard, good VCs are likewise cautious on signing up with an entrepreneur they don’t know well, which is why a structured diligence process is key. Practical lesson: beware of VCs who sign up too quickly, chances are they are also going to be quick in dropping off the radar.
VCs will tell you that an A team with a B idea is preferable to a B team with an A idea because the former will eventually pivot, whereas the latter will always be limited by their skills. That said, nothing better than investing in an A team with an A idea and key to that is market. If a market is wide open (“blue ocean”) then why aren’t there other players? If a market is saturated (“ red ocean”) then why will this company specifically succeed? Why is now the right timing? Tops-down market size represented by acronyms like TAM and is interesting but what is most relevant is actually a bottoms-up analysis of what a company can achieve, say number of customers times price each customer is willing to pay. Practical lesson: beware of VCs who just take your market numbers as gospel, the best ones will factor in their model ie do their own homework.
3) Product / Technology
A minority of teams with just a powerpoint do get funded, usually on the basis of their previous track record. But institutional investors largely are looking to come into the seed ie when there is a prototype, or in the series A ie when there is a product-market fit. For products with significant hardware there may be more questions around manufacturing (BOM) and distribution. For products with significant software there may be more questions around engagement and churn. For any product in general the investor is looking to understand how you acquire customers (CAC) and how much value they would bring over time (LTV). Practical lesson: beware of an investor who can’t converse at the same level as you when it comes to the product / technology, if they don’t have the expertise they should be willing to learn enough lest they be deadweight on your cap table when it really matters.
As a general rule the more data you have the more informed conversations you can have with investors, partners and the overall market. This applies even to pre-seed and seed companies, which may not have commercial deployments but often have results from pilots or experiments. Consumer startups will often measure traction with daily (DAU) or monthly (MAU) activity. Enterprise will often look deeper into sales cycle and revenue per year (ARR) or over the lifetime of a contract. Practical lesson: surely give credit to a VC’s overall experience but beware of those who tell you their opinion is right or yours is without hard facts about your very specific case.
5) Financials / Business Model
Often the least developed area in an early-stage startup but still important to VCs because it reveals how an entrepreneur is thinking about the problem right now. The earlier a company and the further ahead you are looking, the lower credit investors will give to the projection. In fact most VCs will disregard financial estimates beyond two-three years, after all startups definitionally are a specific type of company built for exponential change. What all entrepreneurs can and often don’t highlight is burn rate and cash on hand. Very often startups will already have a cap table and option pool for employees (ESOP) which are additional factors seasoned investors will want to look through. Practical lesson: beware of an investor who gets enamored by your vision and doesn’t at least ask you about the nitty-gritty details of how you manage the company.
6) Competitive Landscape
VCs see many pitch decks, in fact 10 new companies per week is probably an underestimate. In many of these decks entrepreneurs mention themselves as the first to market, which may be true but then the competitive landscape is how to break status quo. Another common feature of pitch decks is entrepreneurs fall under the temptation of showing how their company is better than the competition on several dimensions. What really matters is having an edge in something very critical — one strong point of differentiation is often better than five weak ones. Finally, think of entrepreneurs as focused on depth and VCs as focused on breadth ie a good investor should tell you things you don’t know. Practical lesson: beware of an investor who doesn’t tell you about at least one other competitor.
7) Fundraising / Use Of Funds
Often an area completely missing from pitch decks which arguably matters as much as the other areas other than Team. How much have you already raised? From whom? Why did you pick these investors? What is the plan moving forward? The common advice is to raise a bit more than what you need (so you have reserves for a rainy day) and earlier than when you really need it (so you have a stronger negotiation position). And if you can raise money when you absolutely don’t need it chances are you should take it but continue running the keep efficiently. Essentially it’s about how an entrepreneur is building the ship, what speed it will sail, and what is being done to prevent it from sinking. Practical lesson: beware of a VC who gives you too good of terms, that may be a sign they are viewing your startups with rosy lenses and are unprepared for the risk.