CHAPTER EIGHT: Part D – Although VCs will typically give you the chance to present your business idea in a formal meeting, they will still ask questions about your business (probably when you approach them to submit your proposal or on phone) before scheduling the meeting. Most, however, will delay and save their questions for the due diligence phase.
The bottom line is that you must be prepared to answer questions whenever you are approaching a venture capitalist. And the truth is, there’s no ethical way to know which questions you will be asked.
But then, there are some important questions that virtually all VCs tend to ask, and that you are not likely to escape from. Most of these questions are similar to those typically asked by angel investors (given in the previous chapter).
Aside those given in the previous chapter, here are few other questions that VCs will most likely ask you about your business.
10 Important Questions Venture Capitalists are Likely to Ask You
1. What is the market potential for your product or service? And what is your industry’s revenue potential and growth rate?
VCs only pursue big opportunities, so they want to know if the opportunity you are presenting is large enough to pursue. How do VCs determine opportunities that are large enough? By figuring out whether they will be able to achieve huge returns within 3-5 years.
VCs focus on growing industries, specific ones. So, they want to know if your business is growing and if it falls within an industry they are always interested in.
2. How did you determine your market potential and industry growth rate?
Many entrepreneurs include very large market potential figures in their business plans and then indicate that they require only a minute fraction (e.g. one or two percent) of the market to achieve their projections. These figures usually raise a red flag. Besides, VCs usually prefer opportunities that capture a large fraction of the market. So, you should conduct thorough research and get your figures right, else you will be blowing smoke.
3. How do you know that your business has high-growth potential?
VCs want to know how you came about your revenue estimates. Most importantly, they want to be sure that your business presents a large opportunity that scales quickly and allows them to realize their ROI as soon as possible. So, you must be prepared to give a detailed explanation on how you estimated your revenues from market potential.
4. What are the risks facing this opportunity?
When they ask you this question, VCs want to hear more than just “the competition.” While it’s true that the competition poses a big threat to any business, it is just one of many risks. Other risks include changes in technology, labor market conditions, government and regulatory policies, Product liability, business climate, computer crime, and so on.
In addition, there are financial risks. For example, how would you handle a situation where your current capital does not allow you to reach breakeven or your next financial event? A risk assessment of possible threats to your business can help you prepare to answer this question brilliantly.
5. Who are your competitors?
By asking this question, VCs expect you to mention names. The warning here is “don’t say none.” There is more to this question than meets the eye. Firstly, VCs want to know the extent of competition your business will encounter (and this will lead to the question of how you will distinguish your business).
Secondly, VCs want to use this question to assess your maturity as an entrepreneur. Giving “none” as your answer is typically incorrect because you will have at least two competitors; but you probably have not done enough research to figure them out!
Furthermore, if the VC is aware of some other competitors that you did not mention, they will lose faith in your business assessment skills. So, find out every competitor before meeting a VC.
6. Does your business have intellectual property in the form of patent, copyrights, or trademarks?
VCs want to ensure that you have taken proper steps to protect your company’s intellectual capital through NDAs, non-competes, and employment agreements.
In some industries, patents help to protect the research and development investments of a company and help to ensure that there is a window of opportunity for the company to realize a significant share of revenue for a certain category. Trademarks and copyrights, on the other hand, help to protect a company’s intellectual assets as well as its “brand.”
7. When will your company break even in terms of profitability and cash flow?
The implied meaning of this question is, “When will your business become financially independent enough to sustain itself?”
VCs want to know how soon your income will start exceeding your expenditures or how soon you will stop becoming a liability. Since their ultimate goal is to reach an exit scenario quickly, they will invest in your business if it won’t take long to break even.
8. What drives customer satisfaction for this industry and for the product? And how do you know?
By asking this question, VCs want to know if you have really conducted research to assess in order to figure out what is important to your customers. They want to know if you have made arrangements to ensure the ongoing satisfaction of your customers, especially since customers may have changing needs.
They want to know how you are going to support your product or service and the expenses required for such support. They want to know how you will ensure that existing customers purchase your products again. And they want to know if you have regular and consistent customer feedback in your plans.
9. How do you plan to extend your labor force?
VCs will be interested in not only your existing workforce, but also in how you plan to fill in key positions in the future. Will you use an executive search firm?
10. What are the likely exit scenarios?
VCs need to know how they will monetize their investment, hopefully at an ROI of 50 percent or more; so exit strategy is very important to them. You need to take your time to think about who could acquire your business down the road. Or would you opt for IPO, instead?
While there are many other questions that VCs may ask you, preparing to answer these questions brilliantly will help you answer other questions that may stem out of these.
Four Possible Documents and Requirements that VCs would Request
Before approaching a venture capitalist, it is important that you prepare the following documents, as they will be requested:
- Your executive summary: This should be about two pages long. It is usually sufficient for an initial submission. If it attracts the attention of the VC, they will request for other documents.
- Your business plan: The VC will request a copy of your business plan after reading your executive summary and showing interest in your business.
- Resumes: VCs like to see the resumes of all the members of your team. Try to keep these just to one page if possible.
- Financial projections: You must ensure that these are realistic, well-researched, and accurate.