Every successful business gets that way by understanding its customers’ needs and wants. But understanding what investors want is often a mystery to these same companies.
On a broad level, it’s pretty easy to figure out what investors are looking for: a company that is going to make them a lot of money. The mystery is in how we determine whether a startup has that potential or not.
As an institutional Venture Capitalist, I am always looking for a startup that could reach $100 million in revenues and that has the potential to get to $1 billion in revenues. I have an idea in my head for what that could look like. I’m sure other investors have different ideas, but they are likely all variations on the same things. That’s why if you’re looking to impress investors you only need ask yourself the following three questions:
1. Is the market big enough to support our product or service?
The market size is very important. It pretty much tells you the limit to growth for a particular company. A quick and dirty way to determine this is to take your average selling price and multiply it by the number of targets in the target market segment. Usually companies don’t think this through very well. It’s important, for instance, to get accurate data on the market and realistically look at whether their offering is aimed at that entire market or just a sub-segment. Then you need to determine what portion of the market you are likely to appeal to. There isn’t a right answer here, but in general the more I can imagine how a company can get big, the better.
2. Is our competitive advantage strong and durable?
This is another area in which startups usually miss the mark. That’s understandable because when you’re starting a company it can be hard to take a step back and look at what’s unique about your company or offering and how valuable your differences are to your target customers vs. the value of the differences that your competitors have. It is also difficult to see the newer competitors in a market, particularly small competitors in large, global markets.
When asking this question, you also need to look at what Warren Buffett calls “moats” and how long those will hold in the market. In some cases, the advantage may be the product itself because it’s so simple to use and elegant that it sells itself. But no one has a competitive advantage forever, so the thing to look at is how long it will take another company to catch up with you.
3. Does our economic model work?
This can get lost in these days of sky-high valuations for unprofitable companies, but eventually investors want to see that there are strong economics underpinning your company. In particular, for SaaS companies, we want to know how long it takes to pay back the cost of acquiring new customers. Once you get those customers, we want to know how long you hang on to them and their revenue streams. For instance, when my firm invested in ExactTarget in 2004, the time to pay back a customer acquisition was a year and when you got a dollar from a customer on day one, it would grow about 6 percent a year. That’s very good. On the other hand, if you have high churn, then it’s hard to build your company. Said differently: The more cash you can get out of each customer, the better, and the less it costs you to acquire each customer, the better!
Those are the basics of what investors are looking for. If you have good answers for these questions that means you can grow a large sustainable business that someone will want to buy.
Of course, investors are people too. Everyone has different tastes so don’t feel too bad if a VC snubs you. They might be looking for chocolate ice cream and you’re serving vanilla. In other words, you should try to understand what investors want, but also take into account that they have personal biases and “tastes” that are beyond your control. If you’ve answered these questions satisfactorily, then you’ve done your part.
You can learn more about OpenView’s investment strategy here.