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VCs Reveal Their Top Criteria for Funding a Startup

Venture capitalists invest in early-stage, innovative companies in exchange for equity, hoping to hit it big if the startup succeeds. With so many startups seeking funding, VCs are very selective, looking for entrepreneurs and ideas that have the best chance of scaling into a profitable business.

The Team

The number one thing VCs look for is an excellent founding team, according to over 75% of investors on this Quora thread. As VC Mark Suster explains, “I would rather fund an A+ team with a B idea than a B team with an A+ idea.” VCs want to see that the founders have the skills, experience, drive and chemistry to overcome inevitable challenges and grow the company. Important qualities include:

  • Technical and domain expertise. The team should have strong experience in the industry they are disrupting as well as the technical skills to build the product.
  • Leadership ability. There should be one or two strong leaders that can effectively build and manage a team.
  • Commitment and drive. The founders should demonstrate the passion, perseverance and work ethic needed to succeed.
  • Coachability. The team must be open to feedback, pivot when necessary and learn quickly from mistakes.

Without an all-star team that covers these areas, VCs will pass on funding a startup no matter how intriguing the idea.

Market Opportunity

The next major factor VCs consider is market opportunity, according to over 70% of investors in this survey. The startup must be targeting a large addressable market with major growth potential in the coming years. As VC Bessemer specifies, the opportunity should be at least $1 billion in annual revenue. Investors also want to see that the market has a clear need for the startup’s solution and that there are no major barriers preventing adoption. Startups can demonstrate a promising market opportunity by:

  • Researching market size and growth trends using reputable sources. For example, citing projections that the US fitness app industry will reach $120 billion by 2027.
  • Validating demand through customer discovery interviews, waitlists, letters of intent or early traction. For example, having 10,000 signups for the beta version.
  • Benchmarking the success of comparable companies in adjacent markets. For example, pointing to the rise of Duolingo demonstrating demand for education apps.

Without demonstrating a sizable, growing market desperate for their offering, startups will struggle to attract VC backing no matter how strong their team.

Product Solution

While team and market are most important, over 50% of VCs in this survey also want to understand the startup’s product solution. They look for innovative technology, services or business models that creatively address a market need as well as a clear path to scaling the solution. As VC First Round advises, startups should communicate details like:

  • The problem they are solving specifically for customers.
  • The solution and how it works at a high level.
  • What makes it unique from alternatives.
  • Product roadmap and key milestones for scaling growth.

Being able to articulate their novel solution and how it delivers value better than competitors helps assure VCs that the startup can win market share. It also demonstrates that the team understands their customers and market dynamics.

Traction

While traction is not strictly required, over 40% of VCs in this survey want to see some proof of concept and market acceptance. Traction can involve:

  • Number of users, signups or waitlist demand
  • Revenue and growth
  • Partnerships, channel distribution or affiliate networks
  • Customer testimonials, interviews and case studies

As VC Mark Suster explains, “traction proves that there are real customers wanting to buy your product.” Even modest traction signals that the startup is executing well and demonstrating customer demand. With strong traction, other evaluation criteria become less important.

Financials and Metrics

Later stage VCs will dive more into financials, looking for a viable path to profitability. Key metrics they assess include:

  • Customer Acquisition Costs: How much it costs to acquire customers based on sales and marketing spend. Lower is better.
  • Lifetime Value: Projected total revenue per customer. Higher is better.
  • Burn Rate: Monthly spend rate. The slower the burn, the longer runway they have.
  • Margins: Gross margins demonstrate efficiency; net margins demonstrate profitability.
  • Return on Investment: Performance metrics like month-over-month growth prove scalability.

Strong financials and operating metrics give investors confidence in the underlying economics. It shows that the startup can eventually become profitable while scaling.

Exit Strategy

VCs invest not just for revenue and dividends but for the eventual exit opportunity. As VC Sequoia summarizes, they assess, “How and when can we get our money back plus a return?” Common exit strategies include:

  • Acquisition: Exit by selling to a larger company in the industry
  • IPO: Initial public offering provides liquidity for early investors
  • Secondary Sale: Selling shares to another investor provides partial exit

Being able to articulate the long-term vision for an acquisition, IPO or secondary sale gives investors more confidence in their potential returns. They want to see realistic options for a profitable, timely exit within 5-7 years.

By evaluating teams, markets, products and financials, VCs determine the startups most likely to exit with large returns on their investment. Funding startups is high-risk, so they are very selective, rejecting over 95% of startups. Meeting the top criteria separates the startups bound for success.

Key Takeaways

  • VCs prioritize funding exemplary teams over ideas alone. Founders must demonstrate expertise, leadership, commitment and coachability.
  • Large addressable markets with massive growth potential are essential. Startups must prove market demand for their solution.
  • While secondary, the innovation and viability of the product, business model and roadmap affects funding.
  • Traction like customer growth and revenue offer proof-of-concept and market acceptance.
  • Later stage VCs examine operating metrics and financials for the path to profitability.
  • All VCs look to exit investments through an acquisition, IPO or secondary sale with sizable returns.

Carefully targeting these criteria will help startups attract the VC funding essential for scaling their business. With the right combination of team, market and product, funding and success await.

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