The Main Decision Criteria VC Firms Use to Pursue Deals

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Jaap de Jonge
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The Main Decision Criteria VC Firms Use to Pursue Deals

🔥NEW In a paper, Julius Smit examined 3 different theories to understand how venture capitalists use investment criteria in their decision making process of funding a startup:
  • According to theory around the investment process, certain investment criteria are used in the pre-deal phase, in the screening and evaluation phase.
  • According to theory about venture capital investment criteria, these can be distinguished into 5 categories: (1) the entrepreneur/team characteristics, (2) characteristics of the products/services, (3) market characteristics, (4) financials and (5) other characteristics. The entrepreneurial/team characteristics are the most important.
  • According to theory on individual decision making like MBTI, it is clear that there are major differences in the way people take in information and make decisions.
More recenly, Prof. Gompers et al. published more quantitate findings about how Venture Capitalist firms (VC firms) are deciding on deals (firms) to consider for investment (I) and actually buy into (II):
  1. CREATING A FUNNEL - To find potential deals / firms requiring VC funding and continuously generate a deals flow, VC's like to remain in the background and focus on their network (colleagues, former colleagues, trusted investors, other entrepreneurs, professors) rather than extensive research.
  2. ACTUAL INVESTMENT - What are the most important factors VC firms consider when deciding which deals to actually invest in?
    1. Founders (mentioned by 95% of VCs interviewed). They are by far the most important factor. In particular their ability to build a superb management team is regarded as crucial for the success of the venture and the rewards for the VC.
    2. Strategy and business model (74%).
    3. Market (68%).
    4. Industry (31%).
    5. Valuation. VC's focus on finding firms that have a potential for a big exit (multiplying the original investment many times), rather than on cash flow predictions.
⇨ What are your ideas on assessing startup funding opportunities? You are cordially invited to share your comments.
Sources:
Smit J. (2018), "How do venture capitalists use investment criteria in the decision making process of funding a startup?", Working Paper.
Gompers P., Gornall W., Kaplan S.N., Strebulaev I.A., "How Venture Capitalists Make Decisions", HBR Mar-Apr 2021, pp. 70-78
. 1-6-2021

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