Whether you're looking to raise capital or not, understanding how this special breed of investor thinks can improve how you run your business.
Recently I asked Sam Ifergan, a venture capitalist who invests in tech companies, fresh off his $75-million exit of Visualsonics, to detail what goes on inside his head when he is asked to invest in a business. You may not have any plans to raise money for your business but understanding how these consummate capitalists think can sharpen your entrepreneurial skills. Here are six thoughts he offered up:
1. "Why you?"
The first thing Ifergan tries to understand is whether you are uniquely qualified.
"If you're a teller at the bank and you're pitching me on starting a new bank, we're not going to have a very long conversation," he says. "I'm looking for people with deep expertise and experience in their field."
By contrast, Ifergan explained what got him interested in Visualsonics, a technology company that improves the resolution of the typical ultrasound machine. With Visualsonics' technology, rather than grainy images that can (usually) reveal a baby's gender, highly detailed pictures can uncover abnormal patterns of blood flow in the brain.
When Stuart Foster, co-founder of Visualsonics, pitched Ifergan on creating a business that would improve the clarity of ultrasound images, he was interested because Foster had dedicated his life to imaging technology: he has a Ph.D. in the field, pioneered high frequency ultrasound, is a professor at the University of Toronto and teaches at Sunnybrook Hospital.
"Foster is the world's leading expert on the subject. I'm going to listen to a guy like that," says Ifergan.
2. "Should your concept really be its own product?"
Next, Ifergan tries to understand if your idea is really a good product or if it's simply a new feature for an existing product.
Ifergan was recently pitched by a start-up that claims to have developed some technology that helps e-mails move more quickly through corporate networks.
"I didn't spend much time with the guy," Ifergan said. "If he truly has a subtle improvement on e-mail routing, he should go license it to [Blackberry maker] Research in Motion or Cisco. It's a feature on an existing product, not a company."
In contrast, in the case of Visualsonics, Ifergan saw that an entirely new company was needed to go after new markets for imaging technology with a product line of different ultrasound machines.
3. "How much will it cost to get someone to buy your product?"
Third, Ifergan tries to understand the demand for your product and how much it will cost to reach the market.
For example, one company that pitched Ifergan wanted to take U.S.-based teaching materials, translate them into Mandarin and sell them in China. With a billion Chinese people eager to join the middle class, Ifergan was interested enough to write up a term sheet for the company.
However, during due diligence, Ifergan discovered the distribution for educational materials in China is heavily fragmented. There are thousands upon thousands of small retailers, none of whom have enough coverage to reach a meaningful portion of the market. Ifergan walked away from the deal, reasoning that, while some Chinese people may be willing to buy the product, the cost of getting it to them would be prohibitive.
4. "Can I protect your idea?"
Once he likes your business idea and believes in you as an entrepreneur, Ifergan wants to know how easily a competitor can copy your idea.
Most VCs like to invest in technology businesses that have some intellectual property that cannot be easily replicated. It's why Ifergan does not invest in retail concepts: "Retail businesses rarely have IP (intellectual property), so if something works, it's copied by competitors in six months."
By contrast, Ifergan became interested in a company called Tri-Link that was an early leader in developing the technology that allows phone calls to be made over an Internet connection. The founding team of 30 engineers had spent a year and a half creating the technology. Ifergan reasoned it would be difficult for a competitor to catch up on so much research and development, so he invested in Tri-Link and eventually orchestrated a successful sale of the business.
5. "How much money do I need to invest before your company will be worth more than it is today?"
Ifergan avoids investing in companies that have business plans featuring internal engineering milestones such as creating a beta version of a new product by a specific date.
Instead, Ifergan looks for "value creation milestones" in a business plan relating to external achievements that increase the value of the company (e.g., revenue, profitability or number of customers).
For example, with Tri-Link, Ifergan invested only after it was agreed that the company's goal was not an engineering milestone but to get 12 enterprise companies to use its product. Ifergan reasoned that once a dozen big companies were using Tri-Link's product, it would become a more valuable company.
6. "Can I fill the holes on your management team?"
Clearly, a business needs good leaders. As such, if you are located in a city where the talent pool is shallow, Ifergan won't invest.
He learned this one the hard way by investing in a media company based in Columbus, Ohio. Ifergan took the company public but was never able to get the right talent to move to Columbus, and the business languished.
By contrast, Ifergan found Toronto to be a great place to recruit the Visualsonics management team, given the region's extensive network of hospitals, universities and technology infrastructure.
While every venture capitalist no doubt has their own set of investment criteria, I have found most have Ifergan's focus on scalability. You may not need or even want venture capital, but running your business to their high standard can help you think through big decisions, investments and new ideas.