This is a question that always comes up when you start your company, how do the VC's pick the companies they invest in and so how can I get them to invest in my company. I hope this answer below, given by Brad Feld from "Ask the VC", will help a little....
Question: When a VC evaluates startups to invest in what are the key qualities and what emphasis do you place on it? Is management as high as 50% or more?
Every young venture capitalist learns several cliches about how important either (a) the team is or (b) the idea is. Unfortunately for the young venture capitalist, these cliches are directly contractor as some wise old VCs are believers that it’s all about the team and others are believers that it’s all about the idea. Such are the paradoxes of life.
Looking back on the investments that I’ve done, it’s clear that a combination of team and idea is key. If the team is weak, that’s a non-starter. If the idea is weak, that’s a non-starter. So – it ends up being a classic 2 x 2 matrix: strong team + strong idea is good; weak team + weak idea is bad; and strong team + weak idea or weak team + strong idea is – well – questionable at best.
The big challenge is determining whether a team or an idea is a strong one. Just because someone has had success doesn’t mean they are good (since I’m feeling cliche-ish tonight “better lucky than good” comes to mind.) The converse is also true – I’ve met plenty of great entrepreneurs with a failure or two under their belt.
The same goes for the idea. Those online pet food stores seemed like a great idea at the time in 1999. And – in the same time frame – “yet another search engine” didn’t seem like such a great idea to lots of other folks (YASE = Google.) Of course, there’s always a lot more to the story – but on the surface it’s not an easy evaluation, which of course is the point.
So – the answer to your question will vary by investor. There are several distinct philosophies as well as numerous investors who probably don’t have a clear set of rules (e.g. I can’t tell you the number of times I’ve heard something like “I always invest in people, but the idea here is so great that we can fix the team later.”) Whenever in doubt, remember the answer is 42.
Also for those who need the meat and two veg on the matter, try Venture Capital and the Finance of Innovation by Andrew Metrick,
Part 1 is titled VC Basics and covers the VC Industry, VC Players, VC Returns, The Cost of Venture Capital, The Best VCs, and VC around the world. It’s a solid introduction to how the VC industry works.
Part 2 is titled Total Valuation. This part has a bunch of juicy meat in it that is relevant to all entrepreneurs raising venture capital (as well as any new venture capitalist.) It delves deep into the financial structuring of deals in sections titled The Analysis of VC Investments, Term Sheets, Preferred Stock, The VC Method, Discounted-Cash-Flow Analysis of Growth Companies, and Comparables Analysis. The examples are extensive, build on themselves, and create a solid foundation for anyone that wants to understand the economics of venture capital.
Part 3 – titled Partial Valuation – is the section where it becomes apparent that Metrick is a professor at a business school. While intellectually (and mathematically) interesting, most of this section is a departure from the practical reality of how most VCs think about deals.
Part 4 – titled The Finance of Innovation – is all business school stuff. R&D Finance, Monte Carlo Simulation, Real Options, Binomal Trees, Game Theory, and R&D Valuation.
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