When my colleagues and I meet with entrepreneurs to discuss potential investments, we often ask ourselves this question: Can we imagine a movie about how the company is going to develop over time?
Other questions soon follow. Who are the characters? Are they compelling? Does the plot make sense? And, of course, we want to know how the movie ends. Is it with a great big business delivering a highly differentiated product to a huge market, or with a small business stalling in a saturated one?
Frankly, that last question is the most important one for expansion-stage VCs to answer.
After all, we are trying to help scale profitable businesses. Naturally, we must be able to envision the companies we partner with growing into big businesses with clear exit potential. If we can’t see that, and don’t believe the companies have the potential to deliver great returns, then we can’t justify putting our money, and our investors’ money, behind them.
As we play the movie in our head, there are several factors we consider that help us determine whether or not to move forward with an entrepreneur. Every investor wants a great movie, but every investor’s movie is created by different factors. I typically rely on these seven:
How many customers does the company currently have and how many others like it exist? If the market is large enough to support rapid growth, I’ll take the next step. If it isn’t, I may end the conversation right there.
How unique is the product? Are there competing solutions with similar features? If an investor sees a small market with a bunch of similar companies fighting for those customers, he or she will likely tune you out. If he or she sees a big market and a differentiated solution, that equals excitement about partnering with your business. If you can’t clearly describe the competitors in your market and their advantages and disadvantages to your target customers, you probably can’t articulate your unique advantage. Understanding and communicating about your competitors, relative to your company, is key!
Team (Ability to Execute)
Does the company have a strong management team? The CEO role is hugely important, but how about the team members responsible for designing, building, evolving, and distributing the product? Venture backers are looking for both experience and raw horsepower in different relative levels that depend on the age of the team members and the needs of the company.
Has the business made money from its products yet? If it’s not generating revenue, how does it plan to? And how long will it take the company to be profitable or attractive to other investors? For expansion-stage venture capitalists, no revenue is almost always an immediate deal breaker. If your business is generating revenue, venture backers will also want to see that your economic model supports rapid growth without consuming excess capital, and that it has the potential to become a large, valuable company.
Can the entrepreneur articulate where he or she wants the business to go? Does this person understand the market and the customers? Does the long-term plan make sense for an investor? Lack of vision or an inability to communicate long-term strategy will make it really difficult for the investor to play the movie in his or her head!
What are the company’s long-term exit plans? Are there strategic acquirers that would be interested in the company if it’s successful, or is an initial public offering a reasonable possibility? The more exit options there are, the easier it is for investors to know how the movie ends. If you can’t articulate your exit strategy or don’t have one, investors will be less interested in your business.
Every investor needs to do deals where the trade-off between risk and return is appropriate for their particular investment style. Investors tend to run a number of different analyses to figure this out. For example, does the company’s revenue history and market size align with the deal size it’s seeking? Ultimately, most investors will laugh entrepreneurs out of the room if they come in seeking $100 million at a $1 billion valuation for a business that hasn’t yet generated a dollar. Businesses like Instagram and Twitter are the exception, not the rule, when it comes to venture capital financing.
Ultimately, gauging some of those criteria requires intuition, while others will largely speak for themselves. But, by the end of a conversation, I want to see that an entrepreneur can clearly and compellingly address all of them, and deliver data or anecdotal information that supports their claims. This allows me to run the movie and get a good grasp on the range of potential endings.
Why the Past is Relevant to the Future
Making investment decisions will never be a perfect science. I’ve made investments in companies that didn’t work out, and I’ve turned companies away that eventually evolved into big businesses.
Sometimes, the best indicator of future success is previous results. If, as an entrepreneur, you can show venture investors that you’ve had success, developed a clear plan for the future, and identified a market large enough to support growth, the likelihood is that investors will listen. If, on the other hand, you have no real plan for the capital you receive, and your vision is built on false promises or unproven potential, you’ll likely walk away empty handed.