The interaction between entrepreneurs and venture capitalists can be evaluated through these three points to determine if there is a chance of being invested by institutional investors. Additionally, venture capital partners can quickly filter projects using these indicators.
These three points, as I understand them, are “Team,” “Market,” and “Business Model.” Here, I will share with you my understanding of why these three points may lead venture capitalists to not invest in your project.
🤑 The market is too small
This is one of the indicators that many venture capital partners frequently use to filter projects: Is the market big enough?
The size of the market is directly proportional to the potential business scale you can achieve, and your business scale is directly proportional to the value of your company. In other words, only with a sufficiently large market can your company become one with high market value. But how high does this “high market value” need to be?
Since each investor operates at different stages, their risk tolerance and expected returns vary. Some pre-IPO investors may be satisfied with a two-fold return, but early-stage investors may require returns of ten times or more. Only then can it be considered a good return for their overall fund.
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We can calculate the possible value of this “high market value” from your valuation and what achievements you need to accomplish.
Let’s assume you are a startup seeking funding, and you expect a valuation of USD 10M. Suppose an investor also invests in you at this price. Without considering subsequent share dilution from future financing and other factors, this initial investor is looking for a ten-fold return. In other words, they hope that when they exit, the company’s value will be at least USD 100M. That could be the figure representing the “high market value.”
When estimating a company’s value in the public market, it is usually done based on a multiple of its revenue or profits. For example, if we use a multiple of two times revenue to calculate the company’s value, it means your company needs to achieve an annual revenue of approximately USD 50M.
This is the performance you need to achieve. Finally, you can use this figure to ask yourself if the market you have chosen can enable you to reach USD 50M in one year. It’s also a method to evaluate market size.
👥 Insufficient Team Quality
The team, market, and business model are the three crucial factors in investment decisions, with different weights at different stages. Among them, the team is the most important factor.
First, let’s take a look at the three types of Fit that you must know during the entrepreneurial process to understand the concept of Founder-Market Fit. The other two Fits are the commonly known Product-Market Fit (PMF) and another one I personally value, which is Founder-Investor Fit.
Having Founder-Market Fit is extremely important. It involves whether the founders have worked in this industry, the extent of their knowledge of key companies and figures in the industry, the strength of their connections, whether they have patents, and if they have previously founded companies in similar fields, among other factors.
These are all excellent questions that can provide you with more points to observe and determine if this team can succeed in this market. If the founder’s family is already involved in this business, and they have been exposed to it from an early age, it could be a natural Founder-Market Fit.
In my own experience, when evaluating a team, I used to start with Founder-Market Fit. I still remember during my graduate studies, while conducting case analyses with my professor, we were shown a business plan for a startup in the toy industry. That textbook taught us step by step how to write a Business Plan (BP), and the toy startup was one of the examples.
Regarding the team section in that business plan, I only recall it mentioned that the founder had held a senior position in a toy company in the past, indicating he had Founder-Market Fit. Of course, from a textbook perspective, such description seems a bit rigid, as it implies that having previous experience in the industry automatically makes the team good.
Perhaps, from a teaching standpoint, it was only meant to emphasize the importance of assessing the team’s familiarity with the market. However, to make a more detailed assessment, practical experience in the field is necessary to develop the ability to evaluate teams.
As a result, I later started considering the 3H elements (Hustler, Hacker, and Hipster) as essential factors when evaluating a team. I broadened my evaluation of teams and now consider them from various perspectives.
Read more about “3H Personality Theory: Hustler, Hacker, and Hipster for Founding Startups“
However, I have since developed a different perspective on Founder-Market Fit. When it comes to digital software startups using new tools to disrupt a particular industry, these entrepreneurs often don’t come from the industry itself.
Instead, they bring a fresh perspective and advantages that can lead to innovation. In some cases, there may be one entrepreneur with industry experience among several others who come from different industries, and their clash of perspectives generates new elements. This is my recent view on Founder-Market Fit.
🔍 Unreasonable Business Plan
In the past, my teachers often said that a business plan (BP) serves as a medium of communication between entrepreneurs and investors. Through this BP, they can convey what they want to do, why they want to do it, why they are the right ones for the job, their achievements thus far, and how much money they need for future endeavors.
Therefore, I believe that the reasonableness of the BP also reflects on the evaluation of the team. If the BP contradicts itself (e.g., positioning as a boutique but choosing night markets as the distribution channel) or if the entrepreneur hasn’t thought through their objectives clearly, such as how much they need and what they will do with the funds, it shows whether they are a well-planned entrepreneur with a sense of numbers.
Is your financial forecast just a stack of numbers in Excel without practical market data and experiential support? For example, does the growth in performance solely come from increasing the number of salespeople? It’s not as simple as continuously adding numbers. Are talented individuals readily available, or do they need training and development? There are investments required for a business to mature, and it’s not something that happens by merely tweaking an Excel sheet.
This is one way to observe a team by examining their BP. If the BP is unreasonable, investors will deduce that the team is unreliable, thereby decreasing the chances of securing funding.
Let’s hope that through these practices, we can make our business plans more reasonable and increase the likelihood of finding good investors.