How do VCs decide which startups to invest in?
VCs take different types of risks. More on those types, and flavors here:
But there is one common factor, that founders know, but often lose track of in their pitch: every VC, at any stage, is looking for outliers.
Your pitch, your team, your metrics, your market position, your vision, your TAM, your everything, should honestly and transparently but aggressively and positively show how you can be an outlier.
It is hard to make money as a VC, as odd as that may sound. You generally need several unicorns per fund, and 1 per year, to truly do well. More on that here: Why VCs Need Unicorns Just to Survive | SaaStr
Now, VCs have a benefit in that not every single investment has to be a unicorn. They do have the benefit of a portfolio approach, which founders don’t. But 1 or more from each “batch”, from each, fund, does need to be to do extremely well.
The risk VCs try to take is that some signals of a potential unicorn are there. And then, they are OK if it doesn’t always pan out. They have 10–20 bets per fund, after all.
But VCs do not want to take the risk, though, on decent growth or metrics, but no signs it could be a unicorn.
So what that means first is, as soon as VC doesn’t believe you at least have a shot at being a unicorn, they need to move on. The meeting ends. The later the stage the VC is, the higher the % odds they need to believe it will happen. But the “conviction” is basically the same at every stage.
Second, it means VCs will be looking for signs you can be an outlier. They do want to believe. That’s their job, after all. And how they get paid. Those signs include:
- Incredible, proven team. They don’t always do it again. But often enough to justify the risk.
- Incredible, sort-of-proven team. Maybe they didn’t already do it once, but they are one of top teams from Facebook, Salesforce, Google, Twilio, etc. You take a bet on a top team.
- Top 10% growth. So you can get to $100m+ ARR in 7–10 years. Sometimes, companies that grow quickly do stop growing. But in SaaS, if the customers are happy, and the founders are strong, it’s not that common. It does take “Top 10%” growth or so, though, to build up to $100m in ARR in 7–10 years. VCs are looking for that.
- Incredible word-of-mouth. Even if the metrics aren’t there yet, word-of-mouth is the ultimate marketing tool. If everyone is using Trello, or Mixmax, or Notion, or Superhuman, or whatever … that suggests a future of hypergrowth.
- Fantastic logos (more than a couple). If you are early, and have no track record or even word-of-mouth … but if both Google and Facebook have bought your product and said you are the best-in-next-generation now … everyone will want to invest. Even if the metrics and team aren’t there yet.
VCs are looking for signs. Signs you can be the next Zoom or Slack or at least Eventbrite.
So package up those signals in your pitch. Do it honestly, but make sure you highlight them. They are almost all that matter to a VC.
(note: an updated SaaStr Classic answer)