Gaining Startup Insights: Investor's Take on Investing in Startups and Key Criteria

✍️ Opinions

Muskaan Kapoor

May 15, 2023 — 4 min read

Mohit Ralhan, Chief Executive Officer, TIW Capital | Investing in Startups and Key Criteria

This article has been contributed by Mohit Ralhan, Chief Executive Officer, TIW Capital.

India has become the third largest startup ecosystem in the world with more than 90,000 startups coming up in the last ten years and yet, the entrepreneurship revolution in India has just begun. This decade is likely to witness a significant expansion of the startup ecosystem in India fuelled by venture capital investors, who have already invested more than US$ 120 billion over the last 10 years. The electronics boom of the 1970s in the USA was bankrolled by venture capital investors and the criticality of channeling private savings to Indian startups will be similarly critical. Venture capital has to play the role of catalyst not only with its capital but also with its strategic and operating expertise.

Founding Team: The Topmost Criterion for VCs

The topmost criterion for VCs to invest in startups is the founding team. This is quite a subjective assessment of the founder’s personality, capability, and skills where VCs draw from their years of investment experience. Often VCs give more weightage to this assessment of the founding team in comparison to the why and how of the underlying businesses. The key skills of the founding team should be aligned with the long-term business case of the startups and the roles, responsibilities, and shareholding structure should be very clear among them with everyone being on the same page. A founding team is preferred over a single entrepreneur, but it is not mandatory.

Clarity of Strategy

Another key criterion is the clarity of strategy. While strategies may change, and then often change along the way, the initial thought process of the founding team indicates the likely success or failure of the startup. There should be an excellent understanding of the market gaps and the client/consumer problems which the startup is attempting to solve. The ability to get into the shoes of the end-user and lay out the benefits of their products/services from the end-user perspective is extremely important. Many a time, a superior technical product fails in the market, because of the misalignment with the end user’s behavioral aspects and cost-benefit fit.

Target Market and Revenue Potential

The startups also need to figure out and demonstrate that the market segment they are targeting is large enough for them to potentially earn significant revenues. There should be a sound logic behind expected demand drivers and price points. The pricing of products/services is quite a complex part since it continues to undergo multiple changes. It is the least understood part as well and in the business plans, it’s often shown as something which goes up linearly. The startups should be well prepared to do an in-depth discussion on sales and pricing strategy with potential investors, indicating in detail why and how much will the end user pay for their products/services.

Path to Survival and Profitability

While startups are not expected to become profitable immediately, it is important for investors to understand the path to survival and profitability. The initial business plan to achieve breakeven is most often delayed by several quarters and that’s when the resilience of both the founding team and business model gets tested. Even so, investors do want to understand the initial strategy of achieving breakeven and the factors which can bring sustainable profitability.

Fitment and Expertise

VC firms also evaluate external factors which also include the fitment of the startup within their existing investment portfolio. They also look at their own expertise and network in the industry segment where the startup is operating. VCs typically need to play an active role in scaling the business through their own network and it is also beneficial for the startups to partner with such VCs who can guide and assist them operationally as well.

Operational Assistance

While founders will typically have excellent domain expertise, without which VC firms will not invest anyways, often, they need assistance in keeping the internal house in order. VCs should be able to draw upon their experience and help startups in improving capital and labor productivity. Apart from business strategy, startups can seek assistance and guidance from VC firms in setting up HR systems, performance management systems, organizational hierarchies, internal technology, financial systems, sales & marketing effectiveness, and strategic cost management. The partnership becomes extremely strong and generates excellent outcomes when the domain expertise of founders is combined with the operational experience of VC firms.

The current investment environment has turned somewhat cautious, and the startups may need to spend more time in their fund-raising endeavors. Still, the early-stage companies, where a bottom-up case can be made, are likely to fare relatively better. High-tech startups are likely to attract substantial funding, while startups that have previously earned funding from optimistic shareholders in 2021 and 2022 will likely face additional difficulties and require a stronger business case to attract funding in the coming quarters. Deep tech startups working on AI, blockchain, biotech, robotics, and quantum computing are also a key focus area for investors. The current cautiousness is temporary since the VC firms have a dry powder of more than USD 18 billion and as the global macroeconomic uncertainty eases, the pace of startup investments will strongly surpass previous peaks.