At the risk of sounding a bit obvious, a startup’s ultimate success often lies at the feet of the founder or founding team. If these leaders start with a bold vision and build a rock-solid business plan to help turn that vision into reality, they stand a chance of ending up among the relatively small percentage of startups that grow into sustainable businesses.
But founders don’t necessarily have to go it alone. An entire industry of investors exists to help early-stage startups get off the ground and grow into valuable companies over time. These investors may even provide support that goes beyond pure funding, such as industry-specific advice and expertise. Finding the right investors can make all the difference for your company’s future, and it’s much easier to find the right investors if you know what those investors want. So, what do investors look for in a startup?
The short answer is not very surprising: Investors typically want to see a compelling product, a large market opportunity, and a business plan that makes sense. Many early-stage angel investors and venture capitalists also look for a founder or leadership team they can believe in, since much of the success at that stage is purely theoretical. In this article, we’ll review a few more characteristics investors look for in startups and discuss how you can put your best foot forward when pitching to potential investors.
Before answering the question of what investors look for in startups, it probably makes sense to answer a more fundamental question: Who are these investors, anyway?
There are a few types of investors or investor groups you may encounter when raising funds for an early-stage company. A significant number of them are private equity firms or private equity investors, meaning they invest their own money into private companies. Different private equity investors may appear at different funding rounds, but in early funding rounds (i.e. seed funding and the Series A round), you may encounter angel investors and venture capitalists. Let’s take a closer look at what these terms actually mean.
Angel investors (sometimes called seed investors) are typically some of the earliest outside players to invest money in a startup. As such, they occupy an important role in the startup funding ecosystem. These angel investors are typically high-net-worth individuals. They may come from a business background or they may simply be very rich; in any case, they tend to invest their own money into startups and founders they believe in.
Venture capital (VC, for short) is a type of private equity that specializes in funding startups. Many venture capitalist investors or venture capital firms focus specifically on startups that offer a ton of growth potential (and thus, a ton of potential return on investment). A typical VC firm raises a pool of money from a group of limited partners and invests that money in various early-stage companies on the partners’ behalf.
Because so few startups actually succeed—only 1 in 12, according to a recent report from the policy advisory and research organization Startup Genome—venture capitalists tend to have a healthy appetite for risk. And many venture capital firms focus their investment portfolios on particular industries in which they are experts or have a lot of experience, which helps them make better investments as well as provide crucial, industry-specific support to the companies they invest in.
While VC firms tend to ask for a relatively larger ownership stake in the business than angel investors, they also tend to want founders to stick around and keep their skin in the game. For this reason, they may acquiesce to founders and key members maintaining the largest equity stake in the company.
Which type of investors your company attracts will likely depend on factors such as how much money you’ve raised to date, how much you need or hope to raise in a funding round, and the current health and viability of your business. Venture capital firms tend to arrive later and invest larger amounts than angel investors, though this may not always be the case.
Other funding options exist, too. Some early-stage startups successfully use crowdfunding to raise funds; this can be especially effective if they manufacture consumer products that can get a large group of people excited. Debt financing in the form of small-business loans and other debt instruments can also help a startup raise money without giving up equity, though this may come with other risks to consider.
Now that we’ve identified some of the major players who invest in startups, let’s discuss some of the factors and characteristics these investors typically look for when deciding which companies to invest in.
These characteristics are by no means exhaustive, and certain investors may put a lot more weight on one and a lot less weight on another. But if you want to understand the key traits investors look for in startups, this list is a great place to start.
Many early-stage startup investors aren’t just investing in startups. They’re investing in people. A startup in its earliest stages likely doesn’t have a robust track record of success, but its founder or founding team may inspire a high degree of confidence that success is soon to come. If you have a clear vision for a business and (if possible) the requisite industry experience on your leadership team, you could be in better shape when pitching investors.
But that’s not necessarily enough for all investors. Some may want to see that you’ve invested your own personal capital or bootstrapped enough pre-seed funding to get your idea off the ground. In other words, they may want to see some demonstration that you’ve invested your own hard-earned money in bringing your business to life. Startup investors tend to like when founders show commitment to the cause. This is why a venture capital firm may agree to only take a minority stake of equity and leave the largest share to the founder or founding team as an incentive to keep growing the business.
Think about how you invest your money. You probably wouldn’t pour it into a stock or an investment vehicle you haven’t done your proper research on. Startup investors are similarly discerning in the types of companies they invest in, and many tend to stick to a relatively narrow industry or industry subset in which they feel most comfortable. As an added bonus, investors with expertise in a particular industry can lend helpful support and context to founders navigating that industry for the first time.
Research and due diligence are especially important responsibilities for venture capital firms, which spend a ton of time and resources on both. Many VC firms hire individuals or whole teams of individuals specifically for the task of evaluating prospective investments. These folks may look into everything from a company’s market potential to its founders’ track record before arriving at a recommendation to walk or to consider an investment.
Another thing they look at, perhaps unsurprisingly, is the company’s business plan.
Investors want to know the financials of the companies they invest in. A strong business plan shows that you’ve put the work into understanding and analyzing not only your target market, but how your company will successfully produce, market, and sell its products or services in that market. Some of the key elements of a business plan may include:
If you happen to be the founder of an international startup, your business plan and pitch deck may also include a plan for international expansion and managing your balance sheet against currency fluctuations. Learn more about Levro’s enterprise-level currency management tools, which can help you manage your treasury operations without hidden fees or costly delays.
Many early-stage startups may not have a long track record of success. But what they could (and likely should) have is a proof of concept that demonstrates how they will market and ultimately sell a particular product or service to customers.
Again, this proof of concept does not necessarily have to already be profitable or fully fleshed out. But it should demonstrate—via customer research, case studies, marketing experiments, or some other means—that there is a viable market willing to pay a certain price for the company’s products or services.
Speaking of viable markets, many potential startup investors evaluate the market opportunity as a critical criterion for investment. Conventional thinking goes that the larger the market size (as measured by the existing revenue opportunity for the company’s products or services), the more enticing the business.
This is a bit of an oversimplification, though. After all, some of the most successful companies in the world created new markets that didn’t previously exist, or changed existing markets in such a way that they were greatly expanded. For a recent example of this, we can turn to certain early blockchain and cryptocurrency companies, which initially seemed to be addressing a smallish market but have since helped to expand that market to a greater number of institutional and retail customers.
Investors don’t like it when the companies they invest in set their money on fire. In other words, they want some certainty that their money will be used in the most effective way for growing and evolving the business. When pitching your company to investors in a financing round, you should be clear about how much money you want to raise. This money should naturally be tied to a specific plan or specific business objectives. For example, investor money could be used to:
Whatever the case, be sure you know why you’re raising money and how you specifically intend to deploy it. This isn’t just good for gaining investors’ confidence; it’s also good for your business.
At the end of the day, investors are in this to make a profit. And in order to do so, they can’t hold an ownership stake in your company forever. Investors and founders should work together on developing an exit strategy that ensures the investor can exit with a significant profit, should the company continue to experience growth and success.
How this exit happens depends on a number of circumstances, including at which funding round the investor entered and what the company’s timeline may look like for a potential IPO, sale, or acquisition.
If you’ve checked off all of the above characteristics, congratulations! It’s very likely that your company has a strong profile for potential investment, and you can feel more confident going into pitch meetings with prospective investors.
But that’s not all you need to worry about. You also need to carefully think through your company’s cap table and investment structure, because this can have significant ramifications on issues that affect your business decisions—not to mention your own equity stake as a founder.
If you’re an early-stage startup and aren’t yet ready for a proper valuation, you may not be able to offer equity to potential angel investors. Instead, you may need to offer a convertible security such as a SAFE or a convertible note. Though these securities differ in terms of how they work, they’re called “convertible” because they may convert into a certain amount of equity later down the line. Understanding how these and other equity types work is crucial before entering a funding round.
It’s also important to understand the types of rights and privileges an investor’s potential ownership stake may grant them. For these types of conversations, a lawyer or legal representative can be an invaluable asset and help ensure that you don’t give away rights or privileges that you aren’t comfortable relinquishing.
And that’s really what it’s all about, isn’t it? All too often, founders narrowly focus on how to attract investors without thinking hard about what investors should be doing to attract them. A relationship with an investor can be a years-long affair that involves a lot of facetime and accountability, so you should feel comfortable with the folks you plan to bring on board. If you prioritize investors who empower you to do what you do best, you’ll likely position yourself for greater success.
Here at Levro, we’re all about helping international startups achieve great things. We make it easy for global startups to manage their complex financial picture, with custom solutions for everything from bulk payments to treasury operations. And if your business achieves funding that allows it to expand to new markets, we’ve got you covered with support for more than 30 different currencies and more than 80 countries.