One challenge that venture capitalists have to grapple with on a day to day basis is that of selecting ideal startups to invest in. This is a huge challenge: especially keeping in mind the fact that the money that venture capitalists have to invest is (in most cases) not their own money. On the contrary, the money that venture capitalists have to invest is other people’s money. Therefore the people who run venture capital firms have to exercise due diligence in selecting the startups to invest in. That is something they have to do while keeping in mind the fact that they are (in most cases) dealing with other people’s money, which they can’t afford to be careless with.
In my experience, three key factors guide the process of selecting an ideal startup to invest in.
The first factor that guides the process of selecting an ideal startup to invest in is the soundness of the startup’s business idea. To this end, the venture capitalists look at a startup’s business plan, and then they apply their experience and common-sense, to figure out whether or not the startup’s business plan makes sense.
The second factor that guides the process of selecting an ideal startup to invest in is the consideration as to whether the startup has potential to grow in the future. This is a question of scalability: and as a general rule, venture capitalists tend to show interest in enterprises that have real potential to grow into huge businesses in the future.
The third factor that guides the process of selecting an ideal startup to invest in is the consideration as to whether the startup has demonstrated ‘proof of concept’. If, for instance, the startup in question is involved in the manufacture of a certain product, the question would be as to whether it has been able to come up with prototypes of the product — and actually gotten people to buy the prototypes. The level of due diligence required here is akin to that which the US Postal Service uses when recruiting people through its www.usps.com/employment portal: where it requires some basic level of assurance that the people can do the work, before hiring them. It is in a similar manner that venture capitalists need (tangible) proof of any given startup’s product concept, before proceeding to invest in it.