Venture capitalists or “VCs” are always on the lookout for the next big thing. They keep their finger on the pulse of the business sector, watching for the latest trends, startups, and experiments that offer that 10X return with minimal comparative risks.

Being a VC takes experience, knowledge, and of course, cash. Even when you have all of these things, it can be difficult to decide where to invest your assets at any given moment. In 2022, there were so many startups and so much investment money floating around, it was easy to suffer from analysis paralysis. In 2023, the situation is reversed, and inflation-fearing investors are backing companies with more care.

Regardless of the economic climate, it’s important for VCs to consider the right factors when choosing what fledgling companies they’re going to make an investment in. Here is a list of things, both internal and external, that you should be looking at when you’re investing in a project.

Internal factors to consider in a startup

Let’s start with an introspective perspective. What are some of the internal elements that a VC should analyze when looking at a startup?

1. Consider C-suite competencies

Leadership is one of the first units of a company that locks into place early on in its life. No matter how large an org chart gets over the course of a company’s growth cycle, the C-suite will always be limited to a specific and important group of individuals.

Before you invest in a company, consider what personnel they already have in place to guide their enterprise through its early days. Along with key positions, like a CEO and CFO, look for the right traits in each executive.

The AESC (Association of Executive Search & Leadership Consultants) recently identified “new skills & capabilities for leadership roles” as the primary factor driving the need for top talent. The organization broke down these skills and capabilities further into six key core competencies that all leaders should possess, including:

• Adaptability
• Agility
• Innovation
• Communication
• Collaboration
• Customer centricity

Along with looking for these core traits, you should also consider the coachability of each team you want to invest in within the context of how hands-on or hands-off an investor you want to be.

2. Look for lean teams

When you invest in a younger company, especially in the early stages, it’s all about leadership. The core team within each startup is responsible for finding the best product-market fit and identifying a profitable path to growth.

With so much resting on the skills and competencies of this initial group, this naturally raises the question: What should you look for in a team?

Performance analytics company, Two Story, considers “lean teams” an ideal approach for startup teams. The brand’s Head of Performance Science and Growth, Michael Mueller, encourages early-stage startups to resist the vanity metrics associated with growing headcount and instead, build and scale their business with a lean team.

Lean teams consider strategic measurement a business imperative. They understand their KPIs, particularly the leading indicators that drive impact for the business. Look for companies that resist growth for growth’s sake and only expand their team by design and with carefully crafted roles and objective criteria.

3. Identify unique features and benefits

Every company is only as good as the value that it offers to its customers. Before you invest in a brand, evaluate its offerings and its USPs. What are the key features of its products or services? How do these benefit the customer? Do they meet real pain points? What is it that gives a brand a competitive edge?

Along with a general analysis, go to the facts. Look for proof of concept. Does the product or service a startup is offering actually work? Where’s the data showing that it does what is promised on the label or sales page? If a project is worth investing in, the answers to these questions should be clear and satisfactory before you put a penny into their coffers.

4. Review for clean finances

Financially speaking, as a VC, you want to see clean accounting activity before you make an investment. That doesn’t mean a company has to be profitable. On the contrary, they’re looking for funding to help them become so. However, a well-run startup should have a clear path to financial viability in place before they ask investors to help them.

What does a clean balance sheet look like for an investor? On the one hand, a small number of high-profile accredited investors is always encouraging. On the other hand, a large number of smaller donations or large stakes owned by friends and family members is a bad sign.

In addition, look for plenty of capital and a solid cash burn rate (how fast is the startup going through its cash?). Ensure that the company has a clear roadmap for how to convert customers to increase (or in some cases begin generating) revenue before that capital runs out. Other startup metrics to look for include:

• Customer acquisition costs: What does it cost to acquire a new customer?
• Monthly recurring revenue: How much money does a startup generate in a given month?
• Weekly revenue growth: Is revenue growing not just occasionally but on a weekly basis?
• Customer lifetime value: What is the entire value of a customer (proven or at least estimated) over the course of their patronage of a brand?
• Churn rate: How quickly does a startup’s current customer base erode?

A new company’s financial condition is never predictable. Even so, it should be clean enough to reassure you that they’ll use your funding wisely and maximize your chances of a solid ROI.

External factors to consider with a startup

Along with the company itself, you want to consider the environment within which a new business will operate. Here are a few factors to keep in mind.

5. Size up market potential

Customer centricity is a major factor for modern businesses. Everything from customer service to growth marketing requires a continual focus on the customer. As a VC, one way to gauge the viability of an investment option is to do your own customer analysis.

What kind of market does a startup serve? Is it tending to a basic need, such as food or clothing, or are its offerings inessential, such as entertainment or luxury items? Is a brand’s target market niche or broad? Does it consist of a large demographic of consumers or a few high-profile customers?

If you’re looking for a baseline market value for any investment, veteran entrepreneur Kathleen Utecht recommends that startups target a market with at least $1 billion in value if they want to attract VCs. To reverse engineer the advice, if you’re a VC, don’t shop below that billion-plus price tag.

6. Consider the competition

Along with end users, analyze the competition that a company faces. A startup should already have conducted its own competitor analysis, and as a potential investor, it’s always worth reviewing those findings.

Before making an investment as a VC, you should go further than information filtered through another brand, as well. Do your own competitor research. Compare other companies’ products and services to the brand you want to invest in. What makes your potential investment stand apart? What are competitors doing right that the startup should emulate? Do they have plans to or are they willing to consider doing so?

Contrasting investment opportunities to market comparables is a great way to gauge if an investment has real potential. If there isn’t something special to help a new brand stand out (not just to you but to their target market) think twice before investing.

7. Assess every possible risk

It doesn’t matter if you’re funding a strong idea backed by a stellar team with an immaculate track record …or a hyper-risky experiment with huge boom-or-bust potential. You should always do your homework when it comes to risk.

As a VC, your official function is to assess liabilities and decide how to risk your own capital based on the potential business-building actions of others. Once you’ve looked at the internal operations of a new brand and considered the market conditions that surround it, balance risk versus reward and use that to gauge whether it’s worth investing or looking for something else.

Investing as a venture capitalist

It’s estimated that 96% of businesses fail within a decade. Venture capitalists may generate massive returns at times, but they also face steep risks with each company that they back. As a VC, make sure you’re taking everything into consideration, regardless of the type of investment. Whether you’re investing in a cutting-edge crypto company, a small-town retailer, or anything in between, be sure to review everything involved with the investment.

Whatever the situation, look for the signs that a company is set up to operate at peak efficiency in a fertile economic environment. When those stars align, invest with confidence, knowing that you’ve maximized your chances for the best returns.

Featured Image Credit: Lukas; Pexels: Thank You!