What VC firms look out for in funding startups

The success story of many startups in Nigeria over the years cannot be complete without the funding and coaching from venture capital (VC) firms.

Companies like Flutterwave and Opay, which have contributed majorly to the development of the country’s economy during their early stage, have relied heavily on VC investments to stand.

VC is a form of private equity and a type of financing that investors provide to startup companies and small businesses they consider have the potential for long-term growth. It generally comes from well-off investors, investment banks, and any other financial institutions.

According to a recent report by Africa Private Equity and Venture Capital Association, Nigeria outperformed four other countries that made the top list to account for 22 percent of the 853 investment deals worth about $6.5 billion on the continent.

“Africa’s largest economy and most populous country maintained its status as the most funded country in 2022, while Egypt (15 percent) rose in rank to second place, eclipsing South Africa, which drew 14 percent of Africa’s VC deal volume last year,” the report said.

VC has risen to become a most viable source of raising money for companies with limited operating history, mostly when they lack access to capital markets, bank loans, or other debt instruments. In many cases, the venture capitalist is involved in this funding and coaching process for future returns.

As a risk investment, the venture capitalists (VCs) take a series of decisions to nurture the startups.

VCs take investment decisions for startups by evaluating several factors, including the potential of the startup’s business model, market opportunity, and the founding team’s experience and capabilities. Here are some of the key factors that VCs typically consider when making investment decisions:

Business model: They evaluate the viability and scalability of the startup’s business model. They consider whether the business has a clear value proposition, sustainable competitive advantage, and a plan for generating revenue.

Opeyemi AwoyemI, managing partner at FastForward Venture Capital, said every investor wants to work with startups that are financially feasible.

“Every investor has an investor backing them up; so before making any investment decision, they ensure that the startups portfolio meets the target,” he said. “The key is to be exceedingly precise, clear and transparent about your startup’s strategy and current indicators when presenting it to an investor.”

Market opportunity: VCs assess the size of the market opportunity for the startup’s product or service. They look at the potential customer base, growth prospects, and competition in the market.

“The market is full of competition, and investors are keen on startups that are solving exceptional problems in the space they occupy,” Adewale Yusuf, co-founder of TalentQl, said.

Founding team: A survey conducted by the National Bureau of Economic Research showed that 95 percent of VC firms agree that the management team of a startup is an important factor in making decisions about investment opportunities.

VCs evaluate the experience, skills, and track record of the founding team. They consider whether the team has the necessary expertise to execute on the business plan and whether they have a history of building successful companies.

“The team building a startup is a crucial indicator to every investor, as they prefer startups with a founding team rather than a sole founder,” Awoyemi said.

“It’s best for founders to have relevant experience and come from a thriving industry if they want their chances to be backed by VCs to be good. Investors want to make sure that the team is qualified to lead the startup to success.” he added.

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“Investors are skeptical about single founder, as the risk involved can kill the startups if not properly managed,” Paula Gould, co-founder WomenTechIceland, said,

Financials: VCs review the financials of the startup, including revenue, expenses, and projections. They assess the financial health of the company and its ability to generate profits.

The internal rate of return is a metric that helps to estimate the profitability of a potential investment. As an alternative, VCs often turn to the metric known as cash-on-cash return to calculate possible returns from an investment. After all, investors expect to profit from the deal.

Traction: According to Ifeoluwa Dare-Johnson, CEO of Healthtracker, startups should focus on traction to stay alive, and a lot of investors are more interested in the startups margin, revenues, and growth.

“For early stage startups, focusing on growth without burning your entire runway secures a higher chance of being invested in,” she said.

Nevertheless, VCs consider the startup’s traction, which includes customer adoption, user engagement, and revenue growth. They look at the milestones achieved by the startup and how well it has executed on its business plan.