VC firms often face the dilemma of coming across promising deals with two or more startups competing in the same industry. This is especially the case when a particular market is growing fast and there are multiple startups with similar goals and plans, all lined up one after another.
For VC firms, it makes little sense to invest in conflicting startups, so how can they choose between competitors? In this article, we outline a few criteria that can make the process of choosing one startup over another easier and more streamlined. From running adequate due diligence to having clarity on your vision as a firm, here are 7 things to look out for in startups when making your decision.
Source : https://news.crunchbase.com/venture/global-vc-funding-monthly-recap-november-2022/
Understanding of the product
The product lies at the heart of the deal. When you are in talks with two competitors operating within the same space, the most crucial differentiator is the product that each company is selling.
Founders need to have their basics sorted, including their key drivers and a clear vision of the impact they expect to make in the market with their product. Most importantly, it should be clear what exactly the problem is that they are trying to solve. One way VC firms can dig deeper into the founder’s understanding of market needs is to ask them how they can be sure they are addressing an issue that is important for customers. Startups that have managed to run cohort analyses, for instance, stand on stronger footing when defending the need for their products in the market.
Be on the lookout for founders who can communicate their ideas clearly and convincingly. This is an indication of how well they know their own ideas and plans. Only when founders demonstrate an adequate understanding of their target audience can they begin to think about why and how their product is the one you should fund. A surface-level understanding can only get startups so far, making those companies a less suitable choice to receive VC funding.
Ability to prioritize
Founders tend to be a passionate bunch. It is expected that they demonstrate a lasting commitment to their ideas. However, they are often led astray by this very enthusiasm and conclude that their product needs to solve multiple different problems that a customer has. This leads to their overpromising and trying to add multiple features to a product or service.
Although this excitement is admirable in some sense, such an approach indicates that the founders are not able to prioritize the customer’s needs and focus on the single biggest problem that they need to provide a solution to. Such an approach can also lead to otherwise avoidable issues during the development stages. Additionally, if the product is lacking a singular driving factor, it will be difficult to pitch it to customers.
Clarity on the product includes the ability to prioritize issues that need to be addressed and features that need to be included. When choosing between two startups pitching you similar products, keep an eye out for founders who can keep their focus narrow and know what they are going to build first before they expand. At the same time, having an idea of how they will expand and continue to develop the product is also important to consider.
Competitive advantage
While any startup’s competitive advantage is instrumental in setting it apart and determining its success, it becomes all the more salient when there is fierce competition in the market. As a VC firm, seeking out the unique selling point of either the startup’s founders or their products is going to be crucial if you want to make an informed decision about which of the two competing companies to fund.
For any idea or product to succeed and last in the market, it needs to contain an element that immediately differentiates it from the rest of the market. This edge must not only be strong enough to strike down any existing competition but also to help the product remain one step ahead of future competitors. There is thus a time-based aspect that founders must take into account when developing their ideas. For instance, products that incorporate a significant technological advantage are better placed at limiting competition because their innovations are difficult to copy. Conversely, some ideas may only have the potential to be product features and not full-blown products in themselves.
It is a good idea to grill founders on their product and the edge it has over other offerings in the same space. That way you will be able to determine whether or not they have done enough market research before developing their product.
Firms must also look beyond the product and its founders to other aspects such as the business model for any signs of a competitive advantage that puts one startup over another. Let us look at some of these aspects in detail.
Business model
Once it is clear that the founders know what they are talking about when it comes to the product, shift your focus to the business model they have come up with. Knowing which needs of the customers need to be met is only the first step. Knowing how exactly a product will achieve its promises is equally important.
Compare the business models of competing business ideas on metrics such as scalability to determine which startup shows greater potential. The business model presented may need further tweaking, but it can be quite telling of the amount of thought and effort that has been put into it. It also gives a fair idea of whether the startup is headed in the right direction, and what kind of support the VC firm will need to offer on top of monetary contributions.
The marketing and sales strategy must not be underestimated at this stage, as it plays a pivotal role in helping the startup stand out in the industry. An organic strategy, for instance, is essential for any business to succeed. Press the founders on their ideas for such a strategy as it is instrumental in establishing the product in the market and connecting with customers. This will ultimately determine the returns it can lead to.
Existing limitations and anticipated risks
No startup or founder is infallible, and venture capital is a matter of taking calculated risks. Be alert when talking to founders and have a mental model of the kinds of risks you are willing to take and what is off-limits for your firm and its investing strategy.
Founders may have varying strengths and weaknesses, but those that are most likely to shoulder responsibility every step of the way and enter into problem-solving mode when the need arises are the deals worth investing in. Because risks and challenges are inevitable, you want to support somebody who will meet those challenges and lead their team to success despite obstacles. While optimism is essential, keep an eye out for founders who acknowledge and foresee the kinds of challenges that await them.
The team
Founders are at the center of a startup, but they are also part of a larger team that is intent on realizing a particular vision. Zero in on the qualities of a startup founder as much as possible to see if they align with what you are looking for as a VC firm. While you will be supporting a team, you are essentially putting your faith in a founder and backing them when you close the deal. There is no recipe for the perfect founder, but they must be able to defend themselves and their choices. The founder must feel strongly about the project and also believe that they are the best person to make it happen.
That being said, founders must also demonstrate an understanding of what makes the right team to develop and deliver their product. They can either already have a team in place or be clear about the kind of talent they need to attract to bring their vision to life.
It is all about the right fit
Finally, VC firms have to exercise flexibility when meeting with founders. While you will go in with an idea of what you are looking to invest in and have clarity on your vision as a firm, keep an open mind and have honest conversations with the founders.
Long-term successful deals ultimately boil down to being the ‘right fit’. Being flexible and managing your expectations as a firm can go a long way in helping you find the right startups to invest in. The effect of this becomes even more pronounced when you are faced with choosing between two competitors. The more open and honest your conversations are, the more likely it is that you will gravitate towards a founder or startup that is most in alignment with what the firm is looking for and willing to invest in.
Use a CRM to manage deal flow
Tracking and effectively managing your deals saves you the time and energy that can go into making decisions about the startups you want to invest in as a VC firm. This is especially true when you have to choose between two competing startups. Using a deal flow management solution such as Zapflow is a great way to stay on top of every single deal that comes your way.
Get ahead of the curve by booking a demo with Zapflow today!
