When venture capitalists are deciding whether to fund a fledgling company, they must consider a number of factors to determine if the investment is wise. Entrepreneurs should have polished and convincing pitches to catch the attention of venture capitalists, but these short speeches likely won’t address all of the questions that potential investors need answered before they can make a decision.
Below is an overview of the types of questions that potential investors should ask before agreeing to support a startup.
As investors look at potential investments, they judge the amount of risk involved with the prospect. Investing in startups involves a great deal of risk, and venture capitalists need to ensure that the entrepreneurs they back have taken steps to minimize risk by having a plan for compliance with applicable legal and regulatory issues. Entrepreneurs should also understand product liability issues. All business plans necessarily involve risk, but this fact does not mean that risks cannot be mitigated through research and by bringing knowledgeable expects to the table.
2. Customer Acquisition
New customer acquisition is one of the primary means of generating profit. Companies should have a good plan for acquiring customers that will evolve over time to tap into new markets. Venture capitalists should ask about the type of marketing the company is currently engaged in, and how this might change to bring in new customers as the brand grows. Social media and PR strategies are particularly important. When entrepreneurs don’t have a clear sense of how their company will approach these issues, they may struggle to find customers—no matter how incredible their product or service is. Entrepreneurs should also have a sound estimate of the likely cost per acquisition, along with the research or data to support these figures.
3. The Competition
Every business will struggle with competitors. If no competitors are immediately apparent, the company should have a strategy for identifying competitors in the future and maintaining an edge in the market. Often, competitive advantage is a result of execution and marketing, so entrepreneurs should demonstrate an understanding that a great product isn’t the only requirement for success. Potential investors should ask for specific details about beating out the competition and how the product or service will be presented in a meaningful way that secures a significant market share. Venture capitalists need to ensure the entrepreneurs they support have conducted thorough market research and have a clear sense of where competition could arise in the future. Many potential investors ask about specific competitors to verify that an entrepreneur knows exactly what he or she is up against.
4. Intellectual Property
It is becoming increasingly important to ensure that a new company has a strategy for intellectual property protection. Investors should ask about current and pending patents, as well as copyrights, trademarks, trade secrets, and even domain names. Entrepreneurs should have a clear sense of how to keep their ideas protected and demonstrate that all necessary steps have been taken. In addition, an entrepreneur should be able to show that his or her company is not infringing on the rights of any other entity.
5. The Team
Many venture capitalists are motivated to invest in a company because of its leadership team, rather than its product. For this reason, it is critical that potential investors get to know a startup’s leadership team. The company founders should have clear reasons for any hires they’ve made, and it should be clear that the team can handle the next steps in the company’s growth plan. Investors also need to ask about how the team will expand in the future. Typically, startups first hire individuals who can wear many hats, but their strategies often change as they build specialized divisions within the company, or when they hit roadblocks that the existing team cannot overcome.
Many entrepreneurs struggle to clearly outline how they will grow their company beyond what it has already achieved. Venture capital is typically used to fund growth, so it’s absolutely essential for investors to ask about the company’s growth plan. Unless the company can grow successfully, the investment will not have a significant return. The growth plan should address many of the issues listed above, such as the expansion of the central team as the company expands, marketing strategies to reach new customers, and ideas for meeting the challenges of competitors.
7. The Return
Investors need to have conversations about the return on investment. There are many ways to structure a venture capital investment, so it is critical to have a conversation about what each side wants and is willing to do. If the investor is adamant about stock or convertible notes, this should start the conversation. Questions about ROI should also address the issue of profitability, or projections of profitability if the company has not yet reached this point. These sorts of questions are a great means of testing an entrepreneur’s financial savvy and judging how realistic his or her expectations are.