Choosing a Niche

When picking companies to invest in, venture capital firms must be extremely careful in choosing which to fund.  However, the goal of this wariness is not so much to invest in all companies that will give back a significant return.  Instead, these VC firms will look to invest in an array of companies in hopes that just one or potentially two companies will bring a significant return of at least 10 times the amount invested.  VCs know that roughly 50% of the companies won't return any of the invested funds, and the firm therefore need to make up these losses with companies that continue to grow and ideally will eventually have their IPO on a major stock exchange.

So what exactly do these firms look for when deciding which company to invest in?  There are a number of things that companies look for in finding the best companies for their money.  Here are three of the top things that venture capital firms look for when investing their fund:


1. Stage of Company

For VC firms, it is extremely important to look for companies that are in the later stages of development.  Companies that already have at least around one million dollars in annual sales are much more attractive to VCs.  The reasoning behind this is quite simple: the company already has had success selling its product or service and it is more likely that the company will be able to increase sales with more capital.  If the VCs see that the business is scalable and already profitable, the company is extremely likely to receive investment from the firm.

Some potential problems with ruling out companies that are in the seed or early stage is that a lot of companies with great ideas get overlooked.  However, the risk involved in investing in these companies usually outweighs average returns; VCs can't be wasting their time on investigating the possibilities of success with these firms.  Especially because it is nearly impossible to give a company that has no sales a remotely close evaluation.

2. The Product or Service at Hand

VCs like to see that the companies they are funding have innovative products, the kind that change the world.  However, in today's business environment it is extremely difficult to come across a completely novel idea.  VCs aren't necessarily looking for companies to reinvent the wheel, but companies need to go beyond a single competitive advantage in today's market.  Suppose a VC decided to invests in a company that simply makes a product cheaper.  By the time this company breaks through into the market and gains a considerable market share of the industry, the competitors may have already innovated their product to make it cheaper or better, therefore causing a major threat to the firm.

Of course this goes without saying that there needs to be a market for the product created.  If a superior product is created that no one is willing to buy, the company is out of the running.

3. Management

When looking at potential companies to invest in, VCs know that the management team is key to success.  However, this can be extremely difficult to gauge.  Many VCs want to see commitment (mainly time in addition to funds) in their company to know that the management team is committed to the success of the company.  Although this is not a definite sign that the team is completely committed to seeing their company succeed, it is usually the best indicator that VCs can get.

In addition to having the knowledge that a management team is committed, the team must display relevant experience to their respective positions.  99.9% of the time, VCs see a red flag when team members don't have relevant experience to offer the company and position.


In addition to these three points, VCs also intently follow trends to see what industries and ideas are new this year.  If current industries are becoming more popular, obviously a VC is more likely to invest in it given its bright outlook.


My View on Choosing Successful Companies

In choosing companies to invest in, the areas in which I would weight more would be more towards the people behind the business, the management.  Sure there need to be prerequisites that are met: a fantastic product, a desirable stage of the company, a flawless business plan, etc.  But the truly successful companies are born when there exists an entrepreneur with a burning desire to revolutionize their industry.

When one can dig to the core of a founder and discover what is truly driving them, the decision becomes clear.  If those motives are fame, fortune, power, etc., the answer is no.  Because there will be a time when it appears that the company has lost all hope of ever achieving these goals.  However, when a founder is set on making their business succeed because it is their passion in life to do so, the answer is obvious.


Therefore, a founder with a mission to change the world is the icing on the cake when it comes to choosing companies to invest in.  A company that has this along with all the points mentioned above, they are destined for success.