Startup Series: What do investors look for in a tech startup?

hiddenMar 31, 2016 16:57:50 IST

By Mahesh Bhalla

What do investors (VC/PE) look for in a tech startup? At one level, an investor is an investor. But there are nuances as to how various investors look at different sectors, and therefore their relative ‘appetite’ for the same opportunity may differ. This variance is driven by one or more of the following: their (relative) understanding of the sector, their current portfolio (over/under leveraged in a particular sector), market trends / fads, their personal risk appetite at that point in time, their own sectoral preferences and biases, among others.

A number of investors prefer to operate in specific areas e.g. payments, food startups, enterprise security or e-com. Therefore, one of your earlier filters as a startup looking for investment, is to shortlist investors who have an interest in your area and pitch your idea to them; this way both of you will get the most output from the time spent together.

We know that at a basic level all investors look for maximum ROI (Return on investment); they want to maximise returns on their investment, with minimal risk to the capital invested. How does this manifest itself in the case of a tech start-up -- what are the things that will enable a technology startup stand out in a crowded space?

Firstly, the idea needs to be scalable; it should have the potential to become a reasonably large business which can deliver superior returns to its investors. Great ideas that lack scalability will be challenged to find backers. Next, it should have something unique – some IP or a differentiator that sets it apart from the others – something that will ensure that it not only survives but also thrives in a very competitive market.

The product/solution proposition needs to be strong; ideally so strong that it should grow purely by word-of-mouth, thus delivering a near-zero CAC (Cost of customer acquisition). This is an ideal scenario, and very difficult to achieve in reality - you can probably count on your fingers the number of companies that were able to successfully do this on the strength of their product alone. Examples that come to mind are Google, Instagram, and WhatsApp.

The product must have stickiness – instead of a single transaction/use instance, the customer should want to use it again and again; the more often, the better – think WhatsApp. Is the Customer LTV (Lifetime value) > CAC? This is a fundamental hurdle to be cleared. You would need to make some assumptions on the value of a customer and verify them with some pilots.

Say, a customer is expected to spend Rs 5000 over the course of using the product (say over a period of 5 years) and you make 20% margin on this – therefore the LTV would be Rs 1000, or more precisely a NPV (net present value) of future income, discounted at the rate of cost of capital. Compare this figure (NPV of Rs 1000 over 5 years) with the “all-in” cost of acquiring a customer. In this case, it would make sense to spend a couple of hundred rupees (in marketing costs, promotions, etc.) to ‘acquire’ a customer. Of course, one is assuming here that the customer stays with you for 5 years, and therefore we also need to bake in the calculations for customer attrition, which could dramatically lower the LTV.

Does the tech startup have a winning team? Have the entrepreneurs identified their collective skill gaps and brought onboard talent that compliments their skills? Do they have a hustler on board? Every startup needs a ‘business’ guy – one who can sell the dream; This skill is critical not just to bring in more customers, but also to bring in the necessary capital into the company.

The author is the President of Qwikcilver Solutions. He is an angel investor and actively involved in the startup space. The author does not have any investments or equity positions in any of the companies named in this article.

This is the third part in a series on the startup ecosystem in India. Follow this space for more.