Identifying genuine entrepreneurial talent is a rare and considerable skill. VCs need to be able to spot revolutionary ideas and founders to find startups that can generate the desired revenue for them. In capital markets, it is a rule of thumb that 80% of profits are generated by 20% of the investments. This means that capital market businesses, including VC firms, are heavily dependent on high-performing assets for generating revenue. Star performers can also help VCs scale up by giving them the financial security to foray into new market sectors.
But how do you find the right startups for your portfolio? One of the key problems VCs face while scouting startups is being able to differentiate between the ones with genuine promise for growth and the ones that are just looking to raise funds to sustain operations. While the latter might prove to be safer investments, they often end up becoming stagnant portfolio assets with a stable but low ROI. Having too many of these startups in your investment portfolio can hinder innovation and growth. While there is no standard checklist that can help VCs identify promising startups, there are a few things you should actively seek while scouting startups.
Tips for finding the right startups for your portfolio
Scouting and investing in promising startups require VCs to undertake extensive high-quality lead generation processes. These processes are supported by trustworthy referral networks and an overall strong social capital that can be leveraged to find and convince the right entrepreneurs to join your portfolio. Here are a few things you should keep in mind while setting up your scouting processes.
- Determine what kind of startups you want to invest in
Most startups fail in their nascent stages because of one key mistake: They are unable to identify a market niche they’d like to occupy. This makes them lose the sense of direction early on in the process of building a business. Without a concrete goal and target consumer base, startups are often forced to run haphazard operations in search of revenue generation opportunities. Similarly, without a set goal and investment philosophy, investors can end up investing in startups that are promising on their own but end up affecting the overall health of their investment portfolio. It is always wise to identify a particular category of startups and a market sector where you’d like to invest. Once you’ve made these decisions, you can generate a long-term plan which includes scaling up your portfolio beyond seed-stage startups.
The kind of startups you should invest in also depends on the size of resources that are currently available to you. For instance, if you do not have a good scouting department in place yet, it wouldn’t be wise to invest in seed-stage startups with no existing investors. On the other hand, if you have a great scouting team at your disposal or have close business ties with a trusted accelerator, it might make more sense for you to actively look for seed-stage startups.
- Make an investment thesis
An investment thesis can be considered a concrete checklist that you use to filter through all your incoming leads. Good VC deals are hard to come by, which makes it all the more important for firms to avoid losing good leads amid the noise present in their deal pipeline. Having an investment thesis allows VCs to quickly sort through leads using set parameters that define the kind of startups they are interested in. They can also use an automated deal management platform to perform extensive parameter-based filtering on all incoming lead data.
A standard investment thesis contains:
- The specific type of company (B2B, B2C, or other size and operation-based distinction) you're looking to invest in.
- Target market sector.
- Funding stage (seed stage, Series A, Series B, etc) of the startup.
- Target consumer demographic.
- Founder demographic (for instance, some VCs opt to only invest in women or minority-led startups).
- Avoid investing in entrepreneurs who are too product focused.
While an entrepreneur must know everything about the product or service their company has developed, focusing too much on the offering itself might prove to be an operational red flag down the road. Every product, no matter how good, needs to be marketed, packaged, and made available to consumers who then weigh it against hundreds of other market options. In today's cut-throat market environment, relying solely on product quality can only get a business so far. Entrepreneurs whose pitches are predominantly product-based need to be vetted further about their organizational structure, customer acquisition strategies, and overall understanding of the needs and wants of their target consumer demographics. Further, their production and fulfillment processes should be examined for viability and scalability. Entrepreneurs who have a concrete business blueprint in place are much more likely to be the star performers in your portfolios. These entrepreneurs spend time conducting market research to understand different market dynamics and come up with a stable business plan that can help guide their operations for the foreseeable future.
Moreover, such entrepreneurs know what they want out of their relationships with your firm and are willing to invest time and effort in the right direction. For instance, a product-focused entrepreneur would require you to spend considerable time and effort working with them to find the right distribution channels and target consumer demographics. A business-focused entrepreneur, on the other hand, would already know that they want to leverage your firm’s retail distribution connections, for instance, to be able to ship to supermarkets and convenience stores across the country.
- Stress on having a replicable customer acquisition model
It is essential to pay special attention to the proposed customer acquisition model of a business since individual customers are often the predominant source of revenue for nascent-stage businesses. Not having a stable or predictable customer acquisition model can leave a startup vulnerable to the market risks that come with unpredictable models like guerilla marketing and internet virality. Predictable models, on the other hand, allow startups to grow at a healthy pace and scale up without much risk.
Predictable customer acquisition models can include:
- Advertising (both traditional and digital)
- Marketing campaigns
- Cold contacting
- Word-of-mouth publicity for small, community-based businesses.
Reliable customer acquisition strategies pay off in the long run by allowing
businesses to grow organically and garner a loyal consumer base. When a startup charts out an exact customer acquisition plan, they reduce the time and effort it would take VCs to help them develop customer acquisition processes. Once a customer acquisition blueprint is agreed upon, the startup can divert its time and energy into running and scaling up business operations to meet customer demand and dynamically grow with the market.
Developing a gut feeling for finding the right startups
Research conducted by the London School of Economics shows that gut feeling is integral to decision-making when it comes to early-stage investors. While it is always wise to rely on data and prediction models, they sometimes may not suffice to help VCs gain enough insight to decide whether or not to invest in a particular startup. In such cases, a strong gut instinct can guide you toward the right decision. This feeling can be a result of the chemistry between the founder and you or a few positive signs (like confidence in one’s product offering and long-term thinking) that suggest that a startup can prove to be a promising asset for your firm. Relying on gut feeling can be especially helpful in situations where formal analysis proves to be inadequate.
VC firms that don’t organize all of their incoming lead data risk losing good deals to desk clutter. Zapflow is a specially curated, purpose-built deal management platform that can help you avoid this.
With Zapflow, you can automate the collection and organization of incoming lead data using custom parameters. Our platform also allows you to reach out to founders and communicate with them at the click of a button. We eliminate the hassle of having to sort through long email threads to find relevant points and maintain timely communication with every startup. Zapflow isn’t just an average CRM but a comprehensive productivity enhancing software that can help VC firms switch to better deal management processes.
