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.
1. Risk
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
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
6. Growth
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.