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Venture-Backable is (not) a grey area

As a VC firm investing in Black-led tech startups, we meet a lot of founders and have sat through countless pitch deck reviews and conversations. Though we have had the most stimulating conversations and engaged with some of the most ingenious minds in the industry, we have not funded all of them. Why did we turn some down and decide to invest in others? What’s the distinction? After all, some of the ideas that were pitched to us were great and driven by passionate founders. But did that make them a viable candidate for raising venture capital?


Our perspective is, no.


What we have come to realize is that there's a lot of grey area around what is considered VC-backable. We're writing this blog to help founders evaluate and self-introspect to determine if venture capital is the best source of financing for them.


A good place to start is by understanding the goals of a VC fund:


Stated plainly, the goal of a VC firm is to make OUTSIZED returns on the capital it invests. Outsized is written in capital letters here for a reason. They are not aiming for 1-2X returns. We are talking about business models with the potential to generate 10X returns (this is the benchmark for early-stage capital) and alter the state of an industry in a market worth billions. And for this, they have to make high-risk, high-reward investments.


With the above understanding in mind, startup founders need to ask themselves if they show the followings signs which suggest that they are VC-backable:


THE SIZE OF THE OPPORTUNITY


To be considered VC-backable it is crucial that an entrepreneur can prove that their market is big enough for their company to potentially achieve a unicorn status and that it represents an opportunity for outsized financial returns.


What does this mean?


The questions we are looking to answer here are:


  • What is the total addressable market (TAM), or the size of the opportunity your company is going after?

  • Is the market large enough to build a $1 billion business out of it?

  • Is there room for growth or has the market for my product plateaued?


EXISTING PLAYERS AND YOUR PLACE AMONGST THEM


In addition to proving that they are addressing a critical problem with a solution that has the potential to generate over $100M in annual revenue, startup founders need to show how they are positioning themselves among established players and that there is enough scope for penetration left for the company to reach an attractive value.


To ascertain this, ask yourself the following questions:


  • Is the market need addressed and if so, is my product vastly superior (or disruptive) from a customer perspective, compared to what the competition currently has to offer?

  • Do you have a real (not theoretical) ability to disrupt all pole position players? How defensible is my business?


TRACTION AND GROWTH POTENTIAL


An important metric examined by potential investors and which founders should prove is traction; i.e results, momentum. The indicators to look at when measuring traction may vary greatly depending on the stage and type of business. To determine whether they have traction early-stage startups seeking seed funding can think through the following questions, as an example:

  • Do I have a validated product? (i.e. With a potential or an actual customer base that indicates a clear demand)

  • Do I have a tangible indication of revenue generation potential (early sales, corporate partnerships, etc.)?


FINANCIAL AND STRATEGIC SCALABILITY


Scalability: the ability for a venture to drastically increase sales and reach - is a factor that VCs evaluate in a potential investment opportunity. A scalable business model can meet increased demand at the same or preferably at an increased profitability.


Check if you measure up on the following aspects:

  • Will your cost grow linearly while the revenue grows exponentially?

  • Have your users become power users and are ready to pay more for the same product/service?

  • Is your business model easily replicable in different markets?


TEAM: DEEP PASSION & BORDERLINE OBSESSION


VCs invest first in the founders and then in their business idea. We would much rather invest in an A-level team with a B-level idea than a B-level team with an A-level idea. An A-level team speaks to intent to execute, a clear understanding of the competitive landscape, and traits like tenacity and passion. We get excited meeting founding teams that are slightly obsessed with the problem they are trying to solve and when this obsession is backed by merit.


Here's how VCs assess founding teams:

  • Does the team have a clear understanding of the market, the target persona, and the revenue opportunity?

  • Does the founding team have a complementary skill set, relevant experience, and connections to capture a large, shiny opportunity?

  • Is there a willingness to take feedback and the ability to course correct, pivot, and adapt quickly for business growth?


DO YOU HAVE WHAT IT TAKES?


If you have answers to the above questions and have a startup with a strong foundation of team, market, scale, vision, and traction, then you have the attributes required for VC funding. Of course, the above are broad considerations and every early-stage VC firm will have their own variation of these criteria to gauge if they want to back an opportunity. However, we feel this is a good starting point for companies to self-assess before pitching to VCs.

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