By Rich Abrahams, Chief Investment Officer, Sprout
Venture capital funding can act as rocket fuel for SMEs, providing the funds needed to catapult growth and maximise potential. However, securing VC investment is no easy feat. While global venture funding exceeded $1.1 trillion between 2021 and 2022, the reality is that less than 1% of startups actually receive funding from venture capitalists. Most venture capital investors see upwards of 1,000 investment opportunities every year.
Competition for finance is fierce, and persuading investors to part with their cash can be difficult. Getting the greenlight from VCs requires carefully planning and preparation, with a clear understanding of what investors are looking for. It’s not simply a challenge of getting the right pair of eyes matched with the right business model.
From highlighting a startups value proposition to outlining competitive advantages, target markets and growth potential, there are a range of key criteria that VC investors typically look at. Yet, with so many potential aspects to touch upon, it can be hard to know where to start in conveying the right information, to the right people, in the right way.
From my experience, when evaluating investment opportunities, venture capitalists often focus on what I call the “5Ms” – Management, Market, Machine, Momentum, and Money.
Here, we’ll explore these key criteria, typically used to determine whether a startup has what it takes to build a successful and scalable business, in detail.
#1 – Management
First, the quality and track record of the founding team is critical. Investors want to back proven, successful individuals. They seek founders who are experts in their domain, with the competency and vision to craft and execute the development of a multi-million, or even multi-billion, dollar company. SMEs therefore need to find a way to ensure their expertise shines through in an authentic manner.
Have your management team held previous or current positions for several years or decades? Do they have experience in driving excellence across multiple dimensions of a business? Highlight the complementary skills of your team, emphasising their suitability in executing your specific business plan effectively.
Further, consider bringing experienced businesspeople or mentors on as board members or advisors. Not only will this further provide investors with the confidence that your team will be able to navigate challenges, drive optimal growth and actualise return on investment (ROI), but it will also enhance credibility.
#2 – Market
Regardless of how good an organisation’s talent pool may be, startups are unlikely to receive VC backing if their business isn’t operating in a market with significant potential.
While considering suitability is therefore the first step, those organisations working large or high-growth segments should thereafter highlight key market prospects to potential investors. What makes the market exciting? Is it saturated? Or ripe for disruption? These are the sorts of questions the VCs will be asking, which SMEs need to proactively answer. The bigger and faster growing the market opportunity, the more appealing the investment.
It’s also important to showcase an adept knowledge and understanding of inner-market workings. By demonstrating an ability to anticipate current and future directions, you’ll show that you have a progressive grasp of market dynamics, allowing you to say the right thing – and, perhaps more importantly, avoid saying the wrong thing.
#3 – Machine
A startup’s proprietary technology and intellectual property can give it a differentiated edge. Game-changing tech that solves a real pain point can provide a competitive advantage that is difficult for others to replicate quickly.
Some SMEs may have attractive patented or patentable ideas, while those using cutting-edge technologies can help in drawing in top talent to drive further innovation, creativity, and growth.
Not only do these characteristics act as a signpost for potentially high-growth investment opportunities, but they also signal a recognition of the importance of preparing for tomorrow, ensuring investors will feel more secure that their funds are likely to be futureproofed.
#4 – Momentum
Venture capitalists won’t simply buy into good ideas or people. They will want to see evidence of progress, market validation and product market fit. Rapid growth and traction underscore that a startup’s product or service resonates in the marketplace. Here, the provision of metrics showing strong early adoption and repeat usage can help validate the business model and future potential.
There are a variety of figures that can be used. Some of the most interesting for investors include customer acquisition cost, customer lifetime value, revenue growth rate, gross margin and net revenue retention. Equally, it’s also important to signal where key milestones have previously been achieved with data, evidencing the ability of your company to achieve key targets.
#5 – Money
With capital efficiency having been placed under the microscope given current market conditions, understanding how much has been previously raised, what those funds were used for, and the impact of those investments will be important to investors.
Ultimately, VCs want to know that their cash will be used sensibly. Therefore, both recent examples of sound spending, as well as reasonable, relevant and transparent cost planning for the future, will go a long way in convincing investors to support your ventures. If ROI delivery on previous investments can be demonstrated, then that will also be a vital differentiator.
At the same time, investors will want a good deal. Therefore, ensuring that your valuation is sensible and can be backed up by key data will be vital in ensuring a deal is struck.
Of course, effective money management is just one key piece of the puzzle. For VCs to add a company to their portfolio, they must score highly across each of the 5Ms.