If you understand how venture capital firms work, it’ll be pretty easy to know what a venture capital group invests in.
Every company starts with an idea, but when it comes to writing checks, venture capital groups tend to look for ideas that have already turned into operating companies.
Venture capital groups are not just broad market investors that put their money wherever there is a potential cash upside. They specifically look for high risk, high growth industries and opportunities where there is a lot of M&A and IPO activity. They need their investments to become liquid in a short period of time, so companies that are just profitable aren’t good enough. They need to be purchased or taken public for them to matter to a venture capital group.
Every company starts with an idea, but when it comes to writing checks, venture capital groups tend to look for ideas that have already turned into operating companies. The early stages of ideas that are just on the back of a napkin tend to be the domain of angel investors. Once the company has gotten some traction and begun to grow, then it becomes the domain of a venture capital group.
Unlike an angel investor, a venture capital group can only invest in deals that have a huge potential upside that will likely lead to an acquisition or IPO.
In order to do this, venture capital groups must target companies going after extremely big markets that have plenty of room for these types of outcomes.
What’s considered a “big market” by venture capital standards? The most consistent answer would be a market that’s big enough to support a company to go public. Short of being acquired, a company going public is the only outcome that will provide the liquidity that a venture capital group needs to get its return on investment.
Not every industry can generate the types of returns venture capital companies need. You may be running the most impressive landscaping business in your city, but unless that industry is churning out public companies, you’re probably not a likely fit for a venture capital group’s money.
We’ve mentioned the most popular venture industries like technology and healthcare, but those aren’t the only industries venture capitalists will look at. They are most concerned with rapid growth and big sales, which sometimes come from other industries, like retail. Starbucks may have only been a coffee shop at first, but they showed that there was a growth path that could give them a public market-type opportunity.
Venture capital groups tend to concentrate on specific markets where the partners have significant domain expertise. That’s your opportunity to connect at a very personal level with the firm and get them excited about your deal.
Assuming your company fits into the spectrum of investments the venture capital group makes (big markets, hot industries), the next thing an investor will look for is momentum and traction.
It’s all well and good to have a novel new idea, but it’s something else entirely to show that the company itself is taking off. Twitter is a clever idea, but Twitter quickly getting to 100,000 users practically overnight is something that will make every venture capital group lean in and take notice of.
Even bad ideas (let’s not mention any names) can attract the attention of venture capital groups if there is enough early momentum with the company to warrant investment. No one really knows for sure which companies are going to become the next big hit, so investing on momentum is at least an early indicator that a company might have struck gold.
A popular phrase among venture capitalists is “I don’t bet on the horse, I bet on the jockey.” Don’t worry, in this case they aren’t calling you the horse!
The entrepreneur’s track record is incredibly important in evaluating a venture capital group’s decision to invest. Demonstrating your past achievements is a fantastic way to give a venture firm confidence that you’ll be successful in the future. In many ways it mirrors the way employers look at your resume in order to see if you are qualified for a job.
That’s often why you’ll see venture capital groups give checks to companies they would never normally invest in – they believe so strongly in the entrepreneur.
And that’s the key – the venture capital group strongly believing in you. If they like you and the idea is so-so, there may be a deal. But if they like the idea and think you’re not someone they would want to back personally, the deal is almost certainly dead.