Why Do VCs Invest? The First Rule of Threes
What Do VCs Invest In?
I was asked this question the other day. It was asked in the context of is it “the story” or “the numbers” that matter most. I think the answer to that specific question is both. You need both the story (the vision) and the numbers (the logic) to make your case that you have a company that can radically increase in value with a near term horizon.
I am not, nor have I ever been a Venture Capital investor. However, I have spent decades in leadership positions at companies that have raised hundreds of millions of dollars of VC investment. My answer to the question is my first rule of threes for building successful VC companies. The three things you need to attract VC investment: Market Opportunity, Proprietary Differentiated Technology and the Right Team.
VC Investment wants to see big possibilities, and that means big total accessible market. It is expected that customer acquisition and market penetration may take time, but there needs to be a big enough pond to fish in to make it worth investing in the fancy fishing pole. The market needs to be realistic, likely customers - defined as the potential customers who have a specific problem that your product solves, and have a willingness and ability to pay money to solve that problem. Here you need a little bit of story – the why they would buy – and a lot of numbers – real proof of the number of potential customers.
Proprietary Differentiated Technology
VC investment wants to know that the technology is different and proprietary enough to protect the revenue opportunity from competition, especially during the early days of commercialization. The easiest proof of proprietary approach is a patent or patent application. Other ways to show proprietary technology is to show how knowhow, price advantage, unique business model or a current base of business that gives a first mover advantage that competitors would struggle to overtake.
Proving proprietary advantage is definitely more of a story than numbers. It usually includes a competitive analysis to show why other solutions to the customer problem are not as powerful as your solution. It includes having commercialization strategies and go to market plans that show why you will win.
Whatever the product or plan one of the most critical elements of the VC investment decision is can the team deliver on the promise. Trust that the team has the right skills, experience and drive is critical. It is also a rather subjective evaluation. Trust is easy if the VC knows the players, and/or the leadership team has a track record of entrepreneurial success. Expect that VC investors will do the same due diligence on the leadership team that they do on the product and market.
This bias toward the known and proven is one of the reasons leadership diversity is such a problem for VC investors. People who don’t come out of previous VC companies, and who don’t the traditional image of an entrepreneur, have a much more difficult time winning that trust. Other ways to build trust: having the right specific technical experience, having thought leader experts as references, having advisors and board members with the connections and relationships you do not.
VC Investment is only one way to fundraise for success and it is only appropriate for start-up companies that expect to have a rapid large increase in company value. VCs expect big , rapid returns on their equity investment. Other types of equity investment from angels, family funds, incubators, etc. may be less expensive and more accessible. Debt financing, small business grants, strategics, or just plain bootstrapping are all also on the table.
VC financing gets a lot of press, but it is expensive, difficult to get, and may not be the best choice for your business. If you are looking at VC capital make sure you have both the story and the numbers and hit the big three: a big market opportunity, proprietary differentiated technology, and the right team to deliver the mission.