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Sep 22, 20203 min read

Venture Capital: key criteria for the investment selection process

Updated: Sep 24, 2020


1. Market size and anticipated growth of market/opportunity (timing)


If you want to be rich you need to be at where the money is. So finding a demanding market that can generate $1 billion or more in revenues is advantageous - need information regarding their:

  • competitors

  • entry barriers

  • the potential to exploit substantial niches

  • product life cycles

  • distribution channels.

However, we don't want to enter into a game that the rules are already known i.e. red ocean, with crowded market space and cutthroat competition.

Also, being in blue ocean (creating new market space) is a gamble. It's an all or nothing game - it can be a jackpot if you know what you are doing and consumers are ready for your product, but if not, then that's a no no.

So, just like with everything else in life, timing is also a crucial factor when it comes to investments. Who would have known that we needed Airbnb (shared economy), Tesla (self-driving cars), Netflix (OTT), Amazon (e-commerce and Cloud).



2. Expertise of founder & the team (people)


Just like wework or Theranos, if a business is driven by enticing founders with wrong mindset then it is bound to be doomed. So, if a business is ran by a founder with a healthy mindset and someone who:

  • believes in their product

  • commits to deliver and show by actions/execution

  • is driven, determined and passionate

then it is ought to be successful. Just like the famous quote, "If there is a will there is a way".

Also, just like hiring an employee, investment is also an act of believing in that person. The gain is made on the risk of trusting the person to deliver what they say they are going to deliver.


But execution can be done if people try. However, experience and expertise can not be replaced. Hence, when selecting a business to invest in, you need to consider the expertise and experience of the founder - you may not be the expert in the field, but the founder has to know what they are doing.


Additionally, the team also needs to believe in the product and the CEO. As you climb up the ladder it is your duty to hire best talent and choose the best people in the field, in order to maximise their expertise and create synergy. These are some of the factors that could be questioned when screening their team:

  • The team's ability to achieve business strategy/plan

  • the teams skills & backgrounds

  • the ability to articulate and express their ideas

  • the founding teams' composition and strengths.


Alibaba didn't just become Alibaba one day. So you want to look at the overall people.



3. Realistic business idea (product)


You have the opportunity and the people, but there is a big missing puzzle. You first need to have a great business idea/product/service with a competitive advantage that is long lasting. The business model will be moulded and expanded as the time goes (based on the demand from customers - e.g. Youtube, Disney) but the fundamental has to be set in the beginning.


A few of the areas to note are:

  • Product differentiation

  • process differentiation

  • price point differentiation

  • niche differentiation

  • how well does the start-up fit with the VC's underlying philosophy

  • has the start-up backed demonstrated progression with solid metrics and data.


Number is more honest than words so we would want to set some deadline for the business idea. We would want the business to have some progress within 12–18 months and sales cycle no longer than 60 days.



4. Assessment of Risks


When experts buy shares they do all sorts of company analysis (such as PER, current ratio, etc). However, when it comes to start ups there aren't much data available to analyse. Hence, in order to mitigate the risk as much as possible, minimum of these following technical questions should be raised before investing into any company:

  • Could regulatory or legal issues pop up?

  • Is this the right product for today or 10 years from today?

  • Is there enough money in the fund to fully meet the opportunity?

  • Is there an eventual exit from the investment and a chance to see a return?



5. How the start-up intends to use the funding


You can tell a lot of someone just by seeing how they use their money. If a company is going so well then it wouldn't really need help from any angel investors or venture capitalists. So we would want to ask what the funding is for.



5. Other metrics


The other metrics such as user growth, historical revenue and funding already raised are reasonable factors to consider, but less relevant those above.



References:


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