An average venture capitalist meets approximately two new companies per day, 250 days per year. That’s 500 potential investments every year. Plus, VCs also receive thousands of cold emails, unsolicited pitch decks, even the occasional pitch in an elevator. From all those opportunities, they somehow have to determine which might turn big paybacks on investment in the future, i.e., their exit. Yes, even before they invest, they are considering your future value when they sell their stake.
While choosing the best start-ups is, in fact, difficult, it’s not quite as difficult as most entrepreneurs might assume. Why? Because VCs aren’t choosing their investments from the full pool of every start-up they meet. Instead, because of the sheer volume of start-ups they encounter, VCs develop advanced pattern recognition, shortcuts that help them quickly recognize those that do not fit or have limited chance of being successful. This then allows them to immediately disqualify as many as 95% of start-ups within minutes. Yes, within minutes. A VC will probably take about 2-3 minutes to review your pitchdeck.
To help you become one of the 5% who ARE considered and avoid being among the 95% of companies getting disqualified within minutes, here is some insight to three common filters VCs use when evaluating start-ups:
Filter No 1: Doesn’t match their investment thesis
VCs receive hundreds of emails from entrepreneurs looking for capital, they need a way to trim that down into a manageable collection of companies they can meet for in-person pitches. Those pitches, by the way, are part of the aforementioned pool of roughly 500 pitches they hear each year.
The first shortcut VC’s use to filter all those entrepreneurs is blunt but effective: the investment thesis.
Every investor has a different investment thesis, and they all incorporate some combination of the following elements.
- Type of company (e.g., B2B, B2C)
- Target market/industry
- Stage of company (e.g., idea, seed, growth, etc.)
- Company location
- Founder demographics
If your company doesn’t fit an investor’s investment thesis, don’t bother reaching out. To be clear, some investors will happily talk with founders they know they can’t/won’t invest in, so you might still get a meeting, but you’ll never raise capital. Since your goal is, presumably, to raise capital, why waste your (or their) time?
Filter No 2: Entrepreneur is too product-focused
Once a venture capitalist does agree to hear your pitch, one thing they will listen for to determine whether you’re worth investing in is what you focus on. If your pitch focuses mainly on your product — what it does, how it works, how it was built, planned features for the future, etc. — the VC will likely decide not to invest. Why?
That’s because VCs don’t invest in products or tech. They can’t. They have to invest in businesses because businesses are what generate returns on their investments.
VCs may not actually tell you they don’t want to hear about your product. Instead, when you pitch to a VC, they may ask questions about how it works. They might even start brainstorming additional functionality with you, and that’s going to make you excited. You’re going to think the VC “gets” what you’re building and why you’re building it, and you’ll assume their understanding of your product will lead to an investment. But that’s not what’s actually happening.
Instead, you are burning through the hour you and that VC were scheduled to spend together (because that’s how long a typical pitch meeting gets scheduled for), and the VC may not want to be rude by ending the meeting early. Even though the VC has already disqualified you, the easiest way to complete the meeting is to keep discussing your product, so that’s what the VC does. Don’t fall into the trap. Talk about your business and how it makes (or will make) money.
Filter No 3: No replicable customer acquisition model
VCs love it when they come across a more business-focused rather than product-focused entrepreneur. These are the entrepreneurs who are pitching companies with customer acquisition models that can be evaluated for their growth potential.
Evaluating a company’s growth potential also happens to provide the third pattern matching filter VCs use to determine whether or not a company is investible.
Customer acquisition models are either predictably scalable with additional capital, or they’re not. A predictably scalable company, in case you aren’t familiar with the term, is a company that knows every X dollar it spends will produce Y revenues.
As the main purpose of venture capital is to provide money, VCs look for investments that are predictably scalable. They want clear examples of how a start-up currently uses money to acquire customers so they can understand how additional money will lead to, you guessed it, more customers.
Examples of predictably scalable customer acquisition strategies are:
- Scaling supply to an existing, nascent customer base
- Paid advertising
- Cold and warm calling
- Cold and warm emailing
- Channel marketing/development
- Content marketing
- Customer/user testimonials, references and advocacy (a.k.a. word of mouth)
Example of customer acquisition strategies that aren’t predictably scalable include things like:
- Guerrilla marketing
- Growth hacking
When a start-up demonstrates its customer acquisition strategies are scalable in a controlled and predictable fashion, they become more investible. From there, investing is a numbers game based on how much value the investment is likely to generate for the company and the level of ownership the VC can get in return.
Remember the maths: from the thousands of companies a VC encounters each year, roughly 95% get disqualified using the above filters. In addition, other, less common issues knock out a few more companies, leaving VCs with somewhere around 25 or 30 viable investments per year.
That might not seem like a lot to choose from, but most VC firms won’t invest in more than a handful of deals each year (often it’s only one or two), so choosing the right deals out of 30 viable potential investments still isn’t a perfect science. But it’s a lot easier than trying to choose from thousands.
So, knowing this, your goal, as an entrepreneur trying to raise venture capital, is to avoid being filtered too soon.
You want to reach that Top 30 of companies a VC sees each year. Being in that Top 30 doesn’t guarantee you’ll raise capital, but it’s a great sign you’re on the path toward building a successful start-up.