Over the past 6 months I have been spending more time meeting many first time founders in New York City and elsewhere. One question has arisen over and over again. What are the most important things a venture capitalist wants to know about my start up in order to invest? I will attempt to answer that question in this post. ((Any errors in appropriately citing my sources are entirely mine. Let me know what you object to, and how I might fix the problem. Any data in this post is only as reliable as the sources from which I obtained them.))
To set the context, I am assuming that the potential investor and the entrepreneur are meeting one another for the first time, and that the startup is an early stage startup raising a seed or series A round of capital. There are still numerous questions to be answered, but the entrepreneur has made some progress and is well beyond just having an idea. There’s a product that is in a really early iteration and has had some user testing, but is still far from “perfect”. The startup has already raised some capital from friends and family, and subsequently from angel investors.
Some of my comments are directed towards startups building products for enterprises, but the same logic applies to startups building products for individual consumers.
First, as the potential investor, I want to understand the market in which you think your startup will exist. ((In this blog post from July 2007 Marc Andreessen argues that the market is the only thing that matters: http://pmarchive.com/guide_to_startups_part4.html)) I want to know as much about that market as possible. How many potential customers are there? How much did those customers pay in the past year for solutions to the problem you are solving? If this is a small but growing market, at what rate is that growth occurring? How do we know that? If you are trying to convince me that you will somehow “grow the market”, how will that happen? How big is the market today? I would much rather bet on an entrepreneur building a product for a big market. The bigger the market the better. What is the current market structure? Who are the biggest incumbents in the market? How might they respond? What barriers to entry do you have to overcome? How difficult is it going to be for you to reach potential customers? ((In this blog post from December 2013 Rob Go describes why the choice of market is important: http://blogs.hbr.org/2013/12/great-entrepreneurs-pick-great-markets/))
I want to understand the market because it is the most important factor in determining the success or failure of your startup. A great market is one in which customers will find you if your product works. They might complain that the product could be better and they might ask for more features, but if it works they will find you and they will buy your product. In a bad market your product is irrelevant. If you are selling to an industry with very thin profit margins, there may simply not be enough money available for additional expenditures on a new product. Also, it is very hard to displace a product that your prospective customers have learned to use and around which they have built their business processes.
Closely related to my questions about the market, I want to understand the problem that you are solving for that market. Too often I meet founders who are unable to succinctly and clearly describe the problem they are solving. In a typical week I speak with many founders about their startups. The startups I most easily remember are those that make it easy for me to understand the problem they are solving. It is important that I have a firm grasp of the problem the entrepreneur is solving. Why? My understanding of the problem will direct how I perform my independent research. It will also ensure that I study the information and data that I find on my own from a perspective that is congruent with the point of view of the entrepreneur.
Second, I want to know if the founder or founding team has an ability to learn. I am certain that the founder will encounter many unfamiliar questions in the future if the entrepreneur is building something truly unique and solving a problem that has not yet been solved by someone else. It is important that the founder is someone who can gather unfamiliar information, process it, interpret it and then make decisions about strategic and tactical choices. A founder who lacks the ability to process large amounts of unfamiliar information quickly but thoroughly is at an extreme disadvantage. Market structure changes. Regulations change. Consumer tastes and preferences evolve in ways that might escape notice till it is too late and business has deteriorated. Technology changes constantly. The economy shifts between upswings and downturns. Rivals and competitors enter the scene without warning. All this generates volumes of information and data. I much prefer to back founders and entrepreneurs who I believe possess an inherent ability to learn. It is equally important, that they can build teams around them of people who have this same quality. It is the only way that their startup will move from the early stages of its lifecycle and into the growth phase. ((In this blog post from January 2014 Brad Feld reflects on his strong preference for CEOs who are learning machines: http://www.feld.com/wp/archives/2014/01/invest-ceos-learning-machines.html))
You will often hear venture capitalists say that they consider things in this order; market, product, team, and deal. Their analysis of the market and the product belong in the same category as the first factor in my preceding discussion – market. The question is this; is this a great market, and will someone pay to use this product in that market? Their analysis of the team falls under the second factor – is this a team that can learn what it needs to learn in order to succeed?
Every other question is simply an attempt to fill in the details.