Is your startup ready for VC funds? How VCs decide if your startup gets the cheque

How early-stage investors evaluate your startup to determine its "investability"

Venture capital (VC) funding is a crucial milestone for many early-stage startups, providing the financial boost needed to scale operations and reach new heights. For most first-time founders, raising funds may be the hardest thing they'll have to do aside from running their startups. Many claim that raising funds is a full-time job as it requires a lot of time, networking, and energy. For some, this process takes between a week and sometimes six months, depending on how lucky they are. Lack of funding is the top reason many early-stage startups die within their first three (3) years.

Attracting VC investment requires startups to meticulously align with the criteria investors consider when evaluating the potential for success and return on investment. In the past week, I spoke with some investors in Africa, from analysts to principals, to fully understand the key factors that shape their confidence in early-stage startups, providing insights into what founders need to focus on to make their venture attractive for VC funding. Priorities vary from fund to fund depending on their thesis, sector, investing stage, fund size, local or foreign, and portfolio mix, among others. Here are a few things that are common to all investors when making decisions about your startup:

• Team: If anyone will give you money, they’d want to be sure that you are the right team to build the vision and that you have all it takes to execute correctly and adequately. They’d want to be sure you have the right experience or whether you have worked in the industry. Since investors care about returns, founding previous startups or even exits is a great booster and gives comfort that you understand the right priority. Since VCs are also in a trade to compete for the best idea or business, that signals to LPs that they can identify and back the crème de la crème. Socially proofing your thought leadership or industry popularity may just be a bonus. Startups with more than one founder are typically a marriage because of their long-term nature, so there must be good chemistry among the founders with the right motivations in terms of equity owned among the founders. If the CEO has 95% while other key founder(s) have single digits, the power dynamics are skewed and may impact the motivation of the others to dedicate enough time for the success of the startup. To get funded,
• Emphasise not just experience but also the team's diversity of skills and backgrounds.
• Highlight industry expertise, thought leadership, and any previous successful exits.
• Discuss the power dynamics, equity distribution, and cultural aspects that contribute to a well-functioning team.
• Showcase the presence of advisors and the corporate governance structure in place.
• Investors focus on the people behind the ideas, looking for passion, drive, and unwavering belief in the vision.
• Emphasise complementary skills within the team and the ability to collaboratively tackle challenges.

So remember that gender balance, power play, the share of equity between founders, industry expertise, culture, passion, education & qualifications, the number of founders and advisors, corporate governance structure and policies, and the skill gap within the team are super important criteria used by VCs.

2. Traction & Proof Points: The only way to prove that the world needs your solution and you have struck something worth backing is through the traction and demand you’ve generated organically. This means people are willing to pay for your solution because it solves a pain point.

• Explore how paying customers, testimonials, and social proofs validate the market need for your product.
• Discuss the minimum viable product (MVP) and pilot customers, emphasising progress and user feedback.
• Demonstrate customer loyalty, repeat purchases, and low churn rates to showcase sustained interest.
• Concrete evidence of the concept's viability is paramount.
• Showcase paying customers, successful pilot programmes, and a Minimum Viable Product (MVP) to validate market interest.

3. Market Analysis: The total population of a country or market you are in isn’t your total addressable market; demand is backed by the ability to pay, so your TAM is the total number of people that are impacted by the problem you are solving and can pay for your solution to solve that problem. SAM (serviceable available market) is the percentage of the TAM you can reach, whether as a result of your technology, product scope, pricing, etc., while SOM (serviceable obtainable market) is the percentage of the SAM that you can reasonably capture considering your other competitors, existing traditional solutions, the maturity of the market, and the adaptability level. You need to drill down on how big the market is, how many people can afford to pay, what can be captured, what has been captured, and if this market is large enough for your startup to reach its desired valuation, which will equally give VCs their desired exit or growth potential.

• Evaluate the total addressable market (TAM) and serviceable attainable market (SOM).
• Discuss the market's maturity, adaptability, and ability to pay.
• Analyse the potential for growth, exit, and scalability within the identified market.
• Assess the market's maturity and readiness for innovation.

4. Scalability and Business Model: Every business must have products, but not every product or idea should be a business. As a founder, you need to ask yourself: if your business is highly scalable, if it is very defensible, what are the gross margins, what are the biggest cost drivers, what is the potential for economies of scale, if the business model is sustainable, if the business is focused enough, or if you have too many products solving too many problems? Too many products/revenue streams and a lack of focus are red flags. For growth potential, how many people currently need the solution, how often do they need the solution, how are they currently solving the problem, and why will they want to jump on the new solution?

• Highlight scalability, defensibility, and sustainability in your business model.
• Address how your solution can grow without compromising quality or its unique advantages over competitors.
• Assess the scalability and defensibility of the business model.
• Explore gross margins, cost drivers, and potential economies of scale.
• Emphasise focus by addressing the importance of a streamlined business model and the target audience's pressing needs.

5. Competition vs Defensibility: Since business is a race and a winner is crowned with the most value in the market, investors are often interested in what successful DNA you have built into your business that is enough to defend it and contribute to its winning. These include your patents, competitor analysis, first move advantage, the problem being solved, demand generated and supply/demand gap, niche, moat, USP, and trade secrets, among others.

• Highlight any patents, first-mover advantages, or unique selling propositions (USPs) that set the startup apart.
• Conduct a comprehensive competitor analysis and showcase the problem-solving aspect of the product.
• Discuss the existence of a moat, demand-supply gaps, and the startup's niche in the market.

6. Financial Forecast: The true picture of your business is captured in its financials. Your financials also form the basis for evaluating the potential return and ability to create liquidity for investors. Hence, they check if your business has positive unit economics with (LTV/CAC) lifetime value/customer acquisition cost above 5, CAC payback of fewer than 12 months, a clear path to monetization and good gross margin, low operational costs, low capital costs, cost economies of scale, good pricing, a positive path to EBITDA, a positive path to cash flow, and realistic assumptions in your forecasts.

• Demonstrate positive unit economics, with a focus on customer acquisition cost (CAC) payback and lifetime value (LTV).
• Provide a clear path to monetization, showcasing realistic financial assumptions.
• Discuss the potential for cost economies of scale, good pricing strategies, and a roadmap to profitability.

7. The Deal: “A business may be good, but the deal may not,” says one of the veterans I spoke to. Investors always consider the valuation & equity on offer, how messy the cap table is (this is expected since many founders are often quick to give out equity for small cash during their survival stage—largely pre-seed), overdiluted founders—giving out too many shares at a very early stage, founders or key men holding very small shares, diluting more than 20% in one single round at an early stage. This helps the investors understand the complexities surrounding the business before investing, while deal terms such as standard rights and protections, the amount being raised, and the use of funds vis-à-vis growth help them see how they function within the business post-investment. It is also important to check if the round & the number of runways it covers will be enough to carry the team to the next proof point to avoid premature dilution. To pass this:

• Address the valuation and equity on offer, ensuring that the cap table remains clean.
• Highlight the balance between funding requirements and the growth stage, avoiding over-dilution of founder shares.
• Emphasise standard rights and protections for investors.

8. Exit Strategy: The goal of an investor is not just to find good businesses but ones that can create good liquidity events enough to return their funds or meet their LP goals. The business must have a clear and realistic exit strategy that is linked to its everyday business KPIs, financial projections, and growth goals. Projected ROI with at least a 5x multiple on investment, ability to execute strategy, exit liquidity, & frequency within the market are also metrics considered by investors to evaluate the possible value to be earned on their investment. As the business grows, the metric for its valuation changes as investors start considering its fundamentals; hence, the projection and strategy must align with this. Founders are expected to:

• Demonstrate the ability to execute the exit strategy and discuss exit liquidity within the market.
• Define a clear exit strategy, whether through acquisition, IPO, or alternative paths.
• Project a return on investment (ROI) that aligns with investor expectations and a realistic exit timeline.

Conclusion

VCs are not in the business of charity or enriching founders, as they have a burden to return 3x of their total funds to LPs and still expect to enjoy good carry on their funds; hence, the investment process is only in favour of founders and startups that can clearly show that they can help VCs achieve their own goal while impacting their immediate world. Successfully navigating the VC landscape requires startups to align with investor expectations across various dimensions. By focusing on building a strong team, showcasing traction and proof points, thoroughly analysing the market, emphasising scalability, and addressing financial forecasts, startups can enhance their appeal to early-stage investors. Remember, while these factors provide a framework, individual investors may prioritise differently, so adapting to specific investor preferences is key. Ultimately, a well-rounded approach that considers all these factors positions a startup for success in attracting VC funds and achieving its growth objectives.