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As a serial entrepreneur and tech company executive who is now a venture capitalist, I have seen and experienced first-hand what it is like to scale and strive to become the next big success. It is a difficult journey where only the cream of the crop emerges victorious, and most require assistance to do so. Many of today’s biggest publicly traded companies — such as Microsoft MSFT, Apple AAPL, and Alphabet GOOGL — began as startups that required venture capital funding to expand.
VC firms provide startups with financial backing, governance, business advice, and valuable connections to customers and partners. They also have extensive expertise in company-building, including board additions, product development, and go-to-market strategy. In exchange for their support, VC investors acquire equity in funded companies, which generates returns.
While a VC firm has its own domain expertise and sector focus, there are evergreen business essentials venture capitalists use to evaluate new investments. Even as market dynamics change, these fundamentals remain. They also offer insights that retail investors can use when evaluating public companies.
Here are the 5 key questions VCs ask and how you can use them as a retail investor.
1. What is the company’s core value proposition and how strong is its intellectual property (IP)?
VC firms perform extensive diligence to understand the true opportunity at hand and value of a company’s IP. Does the company solve real problems and is this proven by market research and customer feedback? A company that creates something real and hard to replicate is attractive to VC investors. We don’t want large, well-funded companies to be able to push the startup out of the market. The IP should be defensible with patents and strong customer relationships.
Identify any market-leading offerings in companies as a retail investor. What sets a company apart from others in their market? To understand the true value a company produces, review their unique products and services, customer feedback, and reputation in the market. Their IP should be a difference-maker.
2. How strong is the company’s team?
One of the main considerations for a VC firm evaluating an investment is the leadership team and the board of directors. Why is this team the one to succeed in this market? Is the company led by a team of proven executives with a strong vision and complementary strengths? We look for a combination of serial entrepreneurs, subject matter experts, experience building VC-backed companies, and an overall shared vision. Without a strong team and an experienced board, a company will not grow to become a global success.
As a retail investor, you should evaluate management in companies you might invest in. Review the backgrounds of C-Suite leaders (both for relevance and tenure – the longer the better at related organizations, which shows ample experience and a proven track record at scale). Evaluate the company mission statement and goals to see how cohesive they are, and whether the CEO and executive staff are delivering on them. Review the board composition and their experience with board governance. Keep an eye on how management personally invests in the company (especially long-term, which can signal a strong belief in future growth) in addition to the company’s history of stock buybacks (which can signal they have sufficient cash reserves).
3. What market is the company operating in?
Venture capital firms also closely examine the company’s market. What is the size of the market they sell to, how saturated is the market, and is the market expanding? Ideally, we want to see a large market that is ripe for disruption, where there’s room for a new entrant to take on incumbent technology or legacy approaches that do not address a critical need. For example, my firm Forgepoint Capital invests in cybersecurity companies that solve emergent risks and threats for organizations globally. Companies focused on small markets are not appealing to us.
As a retail investor, you need to understand the markets and industries a company competes in. Compare the company to a few competitors to get a sense of the market dynamics, size, and trends. Select companies that are well-positioned in growing markets. You should also invest in what you understand. Play to your own strengths, whether that means specializing in a sector, industry, or market capitalization size.
4. Does the company have a scalable business plan?
VC firms are also interested in the company’s market strategy. How strong is their business plan and does it prove an understanding of the market and their place in it? We want to invest in companies that can scale globally. Companies that only sell directly to customers are harder to scale, while companies that build an ecosystem of partnerships to co-market, co-sell, and re-sell show potential to expand globally. We want to invest in global players that have scalable business models and partner ecosystems.
When it comes to investing in publicly traded companies, the basics still matter. Look for companies with solid business plans, a focus on long-term sustainability, and the potential to grow into new markets. Keep track of the latest company news by tuning in to quarterly earnings calls and analyzing the numbers to identify promising opportunities. Key data points to consider include earnings, cash flow, P/E ratio, and market capitalization.
5. Is there an ecosystem of support to help the company succeed?
VC firms want to see a community and ecosystem of support around startups they might invest in. Does the company have a syndicate of supporting investors and businesses who will help it succeed? Starting a company isn’t easy, so we want to see an ecosystem of investors, enterprise organizations, and other stakeholders who support the company to improve its odds of success.
As a retail investor, you can investigate a company’s partnership ecosystem which may include channel partners, resellers, distributors, third party data monetization partners, and joint ventures. Research shows that strong companies create value with strategic partnerships. These ecosystems help companies benefit from each other’s strengths, whether that’s research, rapid product development, or a broad customer base.
Business fundamentals matter when selecting investments.
Though VC firms invest in a different context, these core questions apply to retail investors who evaluate public companies. Investigate the company’s team, market, IP, business model, and partnership ecosystem. This will ground your investment decisions in what matters most: the time-tested principles of successful business.
In Part 2 of this series next month, I will discuss the broader investing strategies VCs use and how you apply them alongside these 5 key questions.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision.
***This blog was originally posted on Nasdaq.com. You can read it here.***
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