How venture capitalists make investment choices

For entrepreneurs who want to raise funds for start-ups, early investors such as angels and venture capitalists are difficult to find. When you find them, it is even harder to get investment funds from them.

But angels and venture capitalists (VC) are taking serious risks. New businesses usually have almost no sales. The founder may only have the weakest real-life management experience, and the business plan may be based on a concept or a simple prototype. There are many reasons why venture capital is tight on investment funds.

Nevertheless, despite the huge risks, venture capital firms will invest millions of dollars in untested small businesses, hoping that they will eventually become the next big business. So, what motivated venture capitalists to pull out their checkbooks?

For mature companies, the process of establishing value and investability is fairly simple. The sales, profits and cash flow generated by established companies can be used to arrive at a fairly reliable measure of value. However, for early-stage venture capital, venture capital must pay more effort to enter the business and opportunities.

Key points

  • Venture capitalists (VCs) are known for betting heavily on new startups, hoping to hit a home run on companies worth $1 billion in the future.
  • Because there are so many investment opportunities and start-ups, venture capital companies usually have a set of standards that they will look for and evaluate before investing.
  • The management team, business ideas and plans, market opportunities and risk judgment all play a role in making this decision for the VC.
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The following are some of the key considerations for venture capital to evaluate potential investments:


Solid management

Quite simply, management is by far the most important factor considered by smart investors. Venture capital first invests in the management team and its ability to execute business plans. They are not looking for “green” managers; they are looking for executives who successfully build their businesses and provide investors with high returns.

Companies seeking venture capital should be able to provide a list of experienced and qualified personnel who will play a central role in the development of the company. Companies that lack talented managers should be willing to hire them from outside. There is an old saying that applies to many venture capital firms-they are more willing to invest in a bad idea led by experienced managers than a great business plan supported by a group of inexperienced managers.


Market size

Proving that the business will target a huge, addressable market opportunity is very important to attract the attention of venture capital investors. For venture capital, “big” usually means a market that can generate $1 billion or more in revenue. In order to obtain the generous returns they expect from their investments, venture capital firms usually want to ensure that their portfolio companies have the opportunity to increase sales worth hundreds of millions of dollars.

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The larger the market size, the greater the possibility of trading and sale, which makes venture capital firms looking for potential ways to withdraw from investment more excited. Ideally, business growth is fast enough for them to occupy the first or second place in the market.

Venture capitalists want the business plan to include a detailed market size analysis. The market size should be presented from “top-down” and “bottom-up”. This means providing third-party estimates in market research reports, as well as feedback from potential customers, indicating that they are willing to buy and pay for the company’s products.


Excellent products with competitive advantages

Investors hope to invest in high-quality products and services with lasting competitive advantages. They look for solutions to real, pressing problems that other companies in the market have never solved before. They look for products and services that customers cannot live without-because it is much better than anything else on the market, or because it is much cheaper than anything else on the market.

Venture capital seeks market competitive advantage. They want their portfolio companies to generate sales and profits before competitors enter the market and reduce profitability. The fewer direct competitors operating in this field, the better.


Risk assessment

The job of venture capital is to take risks. So naturally, they want to know what field they will enter when they take a stake in an early-stage company. When they talk to the founder of the company or read the business plan, venture capitalists want to be fully aware of what the company has done and what needs to be done.

  • Will regulatory or legal issues arise?
  • Is this a product suitable for today or 10 years from now?
  • Is there enough money in the fund to fully satisfy this opportunity?
  • Will you finally withdraw from the investment and have a chance to see a return?
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The way in which venture capital measures, evaluates, and minimizes risk may vary depending on the type of fund and the individual making the investment decision. But in the final analysis, venture capital companies are working hard to reduce risks while getting rich returns from their investments.

Who is a venture capitalist?


Bottom line

The return of an extremely successful, high-return investment may be destroyed by a loss-making investment. Therefore, before investing money in an opportunity, venture capitalists will spend a lot of time reviewing it and looking for key success factors. They want to know whether the management is up to the task, the size of the market opportunity, and whether the product has the ability to make money. In addition, they want to reduce the risk of opportunities.


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