Global
29 April 2019

What Investors Look for in a Startup

Written by Robbie Richards

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90% of startups shut down before they achieve enough growth to be self-sustaining. Why? A recent study of 101 failed startups showed that a whopping 29% simply ran out of cash. The money simply dried up:

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The simple reality is that investors are rejecting a larger number of proposals that come across their desks. They’re investing more money, but they’re investing in fewer deals. They want to be absolutely sure that they’re going to get a solid return on investment:

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And whether you’re seeking investment from an angel investor or applying to an accelerator program, there are certain things they look for.

How Much Funding Do You Need?

You might be tempted to think that your goal should be to get as much funding as possible right off the bat. To raise as much as possible from the very outset. This is a common mistake.

Y-Combinator co-founder Paul Graham puts it like this:

“Venture funding works like gears. A typical startup goes through several rounds of funding, and at each round you want to take just enough money to reach the speed where you can shift into the next gear. Few startups get it quite right. Many are underfunded. A few are overfunded, which is like trying to start driving in third gear.”

In other words, your goal isn’t to gather as much funding as possible at every stage. You want to have funding that is in proportion to your burn rate.

See, here’s the thing:

Funding isn’t a badge of honor. Rather, funding buys you time for survival. The right amount of funding allows you to shift into the next “gear”, as Graham put it. Your goal is to find the right balance between not taking enough funding and giving away too much equity.

What type of funding is right for you?

Let’s look at the different types of investment sources and what they typically provide. The options accompanying each source will dictate the funding vehicle you seek out.

Types of Investment Sources

Personal

Personal investment is, to state the rather obvious, when you invest your own capital and resources in your startup. This shows investors that you’re serious about building your startup and have skin in the game.

Both the company valuation and average funding amount are going to depend on the progress of the startup and the resources of the founders.

Angel Investors

Angel investors are ex-founders (individuals, not VC firms) who use money from their past exits to invest in other startups. Typically, they’re investing in startups that are at the riskiest stages of growth.

The typical company valuation for angel investors is $3 million, and the average funding amount is around $150,000. 

Venture Capital

Venture Capital firms invest in startups that have already demonstrated significant product-market fit and are making serious progress.

  • For Series A funding, company valuation is typically between $15-30 million, and the average funding amount is $10.5 million.
  • For series B funding, the average valuation is between $30-60 million, and the average funding amount is approximately $25 million.
  • For series C and beyond, a company valuation will sit between $100-200 million and the average funding amount will be around $50 million.

By the time a company hits Series B and C, the likelihood of acquisition is high. 

Accelerators

Accelerators offer early-stage startups support, education, partnerships, mentorship, and funding. In exchange for funding and mentorship, accelerators typically take a cut of the equity. The amount taken depends on the accelerator.

For example, TechStars takes up to 10%, AngelPad takes 7%, and Y-Combinator takes 7%.


Note: MassChallenge takes zero equity, but still offers $2m in cash as well as expert mentorship and corporate connections. Learn more about our accelerator programs here.


Crowdfunding

Crowdfunding is when a company seeks the backing of numerous individuals rather than a VC firm, angel investor, or accelerator. In exchange for supporting the company, the backers typically receive some form of reward.

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Equity crowdfunding is similar except the reward is a small portion of equity in the company. In 2018, equity crowdfunding hit a whopping $2.5 billion.

The typical investment amount will vary depending on the company and the project it is trying to launch.

A Quick Word of Caution

When it comes to funding, a lot of startups make the mistake of putting the cart before the horse. They immediately try to get an investor, when in reality this step should come later in the startup journey after you have established product-market fit and landed early adopters.

“Funding is appropriate for products that have some traction in a large market. For the 99 percent of companies that don't fit this bill, external capital can be a recipe for disaster. If you're at the invention stage, just remember that necessity is the mother of invention, not money.” -- Dave Bailey, VC and serial founder

Look for investors only after you’ve validated the MVP and onboarded a pool of paying customers.

8 Things Investors Look For In A Startup

Solid Business Plan

First and foremost, investors want to see a solid, well thought out, convincing and complete business plan. They want to know they you’re not winging it, not overly optimistic, and at least mostly realistic about the future of your business. They want to know that you have both a vision for your business as well as a plan for how to achieve your goals.

In the business plan, they’re going to want to see things such as financial projections, detailed marketing plans, and specifics about your market.

Remember, investors are investing more money in fewer deals. If you want to capture a portion of that money, you need to have a rock-solid business plan.

Product-Market Fit

Investors also want to see that you’re achieving product-market fit. Customers are buying your product. More and more users are signing up every day for your service. You’re forced to hire sales and customer support staff to serve your growing customer base. Reporters are even calling because they want to get the inside scoop on your hot new product or service.

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Essentially, product-market fit is when customers understand and use your product enough to recognize its value. That’s what investors want to see. They want to see that a significant number of people get the value of your product, and want to use it.

Market Size

Investors have funds of various sizes and you need to find investors who match the size of your ambitions. A massive VC firm that needs to generate large returns won’t invest a meager $50,000 in your company. On the flip side, if you’re looking to grow on a large scale, you don’t want to pitch an investor who will only put down $35,000.

If you want to catch the largest investors, then you need to be targeting a large market. Most investors won’t hesitate to pass up an investment that will only top out at a million dollars. However, if you are targeting a billion dollar market, even the most cautious investor will pause and consider your company.

“Market size matters because most investors want to know that you’ve got a big business. Bigger is generally better.” - Dave McClure, 500 Startups

A Minimum Viable Product (MVP)

42% of startups fail because of poor product-market fit. If you want to attract investors, it’s absolutely essential that you have an established MVP that meets the needs of the market. Your product may solve your greatest pain point, but if it doesn’t scratch the itch of the market, you’re going to be out of luck.

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When it comes to creating your MVP, use this simple framework to map out both your customers as well as the pain points you’ll be solving: 

  • What is the overall idea?
  • Who are the customers?
  • Who are the end users?
  • Why would they want it?
  • Why are we building it?

Paul Judge, founder, and CTO  and of Purewire, says, “It’s become so sexy to pitch to investors nowadays that people forget to first go talk to customers. I have people pitch me, and when I ask what customers think about this, they tell me they don’t know. So why are you talking to investors right now?”

Before you pitch investors, ensure that you have an MVP that customers actually want. 

A Differentiator

Are you building the next Facebook? If so, why? We don’t need another Facebook. We need something that’s distinctly different and will give you a competitive edge over the blue behemoth.

Investors want to see that you have some sort of differentiator from your competition. If they aren’t already aware of your competition, they can easily go out and find it. Before they invest in you, they’ll want to see some form of proof that your competition can’t easily beat (or replicate) you.

Strong Leadership

Investors want to see a strong leadership team in place before they give you their hard-won money. Even if you’re not technical, you can typically find a passionate, enthusiastic technical co-founder who can add significant strength to your team.

Instead of using money to find your team, use a platform such as VentureStorm to find your CTO or CEO.

While there is some debate around the numbers, startups usually give co-founders somewhere in the range of 10-35% in equity.

Traction

Investors want to see more than just a great idea. They want more than a great pitch deck or solid business plan. They want to see that you’ve actually got some traction behind your idea.

They hear hundreds of pitches every year, and very few of these pitches get beyond the idea stage. One of the most effective ways to secure funding is to show that you’ve already got significant momentum.

What sorts of traction are investors looking for?

Things like building a product with bootstrapped resources, signing early customers, or hiring strategic talent. These all point to the fact that you’re both passionate and resourceful. That you’re committed to making your idea a reality. The further you can get on your own, without investors, the more likely it is the investors will have faith in you.

An Exit Strategy

Investors want a solid return on their investment, which means you need to have a firm exit strategy in place. Even if they’re willing to be patient and make a long-term investment in your company, they still need to know that at the end of the day, they’re going to be getting a significant return.

Investors will probably want to know both your strategy (acquisition, sale of shares to principals, etc.), as well as your timeframe for the exit. If you can’t provide both, they will probably be hesitant to invest in you.

To provide some additional context, this checklist from funderbeam highlights the type of questions will be asking with regards to an exit strategy:

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3 Startup Verticals Seeing Major Investments

What startup vehicles are hottest right now? Which are attracting the most investments? Here are three to consider.

Blockchain

Cryptocurrency holds significant potential for a large number of industries, including finance, real estate, and politics. And while the Bitcoin crash may have soured many consumers to cryptocurrencies, startups in this arena are still getting significant investments:

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Advanced Manufacturing and Robotics

With the cost of advanced manufacturing and robotics falling dramatically, and labor costs significantly rising, investors are starting to take notice. Relative to labor costs, the average cost of a robot has fallen by more than half, presenting investors with a potentially lucrative investment.

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As more mainstream venture capital investors began to see the potential in applied robotics, investment in advanced manufacturing reached a record $597 million in Q4 2017. Short-term revenue opportunities, unit economics, and recurring revenue are the primary drivers of the increased investment levels.

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AgTech

As the global population continues to expand at a rapid rate, the need for sustainable food growth (such as alternative proteins) increases with it. In light of this, the agriculture technology sector has been generating significant investments.

Pitchbook recently revealed that $1.6 billion has been invested in AgTech globally as of Q3 2018, with the median deal size in the $10 million range.

Conclusion

Ultimately, what investors are looking for in a startup isn’t that complicated. They want to be sure that you have all your ducks in a row. 

Do you have a solid business plan and product-market fit? Do you have an MVP and a plan for standing out from the competition? Do you have a concrete and scalable strategy for acquiring customers? Do you have a defined exit strategy in place that will give investors a sound return on their investment?

Investors are putting more money in fewer deals. If you want to capture a portion of those funds, you need to demonstrate credibility. If you can, your odds of securing funding significantly increase.

Are you looking for capital and mentorship to accelerate the growth of your startup?

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Mission

MassChallenge strengthens the global innovation ecosystem by accelerating high-potential startups across all industries, from anywhere in the world.