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The VC Perspective: 4 Questions Every VC Asks Before Investing
Masterclass, Episode 3: Learn how the investment process looks like from an early-stage VC's eyes, and the questions they'll need to answer before saying 'yes'.
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This post is part 3/12 of our Masterclass series. Subscribe to get access to the slides and updates for new episodes:
For entrepreneurs, closing an investment round is very similar to closing a sale. Your customer is the VC. And as any good salesperson will tell you, you have to become an expert in the customer’s problems in order to offer a solution. This is exactly what we’re going to do in this article.
In this Masterclass, you’ll learn to see things through the VC’s eyes. By the end, you’ll have a good idea of the questions they’re going to ask you, and the rationale behind them. Hopefully, in true salesperson spirit, you’ll also be able to handle objections before they’re even raised.
What you’ll learn:
The professional challenges that VCs need to deal with, and how they impact the investment process.
The key criteria VCs use to gauge new investment opportunities.
Strategies and focus areas to enhance your startup's pitch to meet VC expectations.
Meet the expert:
Renana Ashkenazi is a General Partner at Grove Ventures, an early-stage venture capital investment firm with over half-a-billion dollars under management. Renana comes from a strong technical background with extensive product and managerial experience at Applied Materials, and has an MSc in Engineering from Northwestern University.
The Problems: What’s Keeping VCs Up at Night?
Let’s start with the main problems VCs have. These will in the back of their minds when they’re considering their next investment.
Need to deliver big returns. We’ve covered this in our previous article – LPs are expecting big returns, and to deliver them the GPs need to make a few really successful bets. These big winners - startups that manage big exits or IPOs - are vanishingly rare, meaning the odds are stacked against the fund.
Noise and FOMO. VCs meet with thousands of entrepreneurs every year. They hear dozens of pitches every week: many will be for similar products. Amidst all this noise, there are some really great opportunities, but it’s very easy to miss them. This creates a constant state of FOMO: Did I make the right call? Should I have taken that meeting? Someone else invested in a startup I turned down - what do they know that I don’t?
Picking winners is hard. VCs need to make an expensive investment decision that may or may not pan out within 5-10 years. Especially at early stages, there’s almost no concrete data to rely on. “At the end of the day, almost everyone relies on their gut instinct to make the decision”, says Renana.
Relationships are long term. Making an investment isn’t just signing a check: you’re committing to a relationship that outlasts the average marriage (and is much harder to break up). You’re going to need to decide whether you’ll be comfortable spending many years of your life with the people you’re partnering with, through good times and bad, until exit or bankruptcy do you part. And you’re not going to date them for years beforehand either…
Expecting the unexpected. There’s inherent uncertainty in the venture business. Known unknowns and unknown unknowns abound. There could be 30 startups currently in stealth that are doing exactly the same thing; a war or a global pandemic could crash the market. No amount of due diligence can prepare you for these contingencies.
The Day-to-Day: What the Process Looks Like From the VC’s Side
Let’s continue our journey into the VC’s day-to-day. As a founder, you might speak to a few dozen VCs every year or t
wo. Each meeting is a major event that requires extensive preparation.
From the VC’s side, things look a bit different:
At the very top of the ‘funnel’, there are intros. As a VC, hundreds of these land in your inbox every week.
You’ll end up meeting about 1000 entrepreneurs every year for an initial pitch meeting. About 75% will drop off at this point, and 250 will continue.
The 2nd meeting will be more of a deep dive, and probably involve more people on the VC’s side.
There will be 3-4 additional, shorter meetings, with people who can validate the idea - potential customers, industry experts, academics, etc. “These meetings are meant to give value to the startups, not just to us”, says Renana. “Obviously we need to do our due diligence; but in most cases talking to prospects and industry insiders is something that founders want and need to do more of anyway.”
After the process with the entrepreneurs is complete, the decision will be made at the investment committee. This is a meeting where all the fund’s general partners convene and decide which startups they are going to get behind.
A handful of entrepreneurs will get a term sheet, the rest will be politely turned down.
How long does all of this take? From the first meeting to the decision, it would be a few weeks to a month, depending on how familiar the partner is with the area in which the startup operates.
Takeaways for entrepreneurs
Your first goal is to get a second meeting. Ultimately you’re trying to get funding; but if you don’t get that second meeting, this isn’t going to happen.
This means that in that initial pitch, you’re not necessarily trying to convince the partner of every last detail about the product. You’re mostly trying to get to the ‘lean in’ moment – to make it clear that there is something worth exploring here.
The partner you’re pitching needs to sit through these meetings every day. Boredom and distraction inevitably set in. You need to tell a story that’s compelling enough to warrant further investigation – without resorting to vague generalities, and without drowning in the granular details. This delicate balance is key to a successful pitch.
The most important part happens when you’re not in the room. Your fate is eventually decided in internal meetings between partners at the fund, where your champion (usually one of the General Partners) will be making your case for you. Your job is to equip them with all the ammunition they need to make your case.
First and foremost, they’ll need a clear, one-sentence explanation of what your startup does. Even if you’re solving a technical problem, it can’t take 60 seconds to explain. If it does, go back to the drawing board.
The Four Questions VCs are Trying to Answer
Now that we understand the challenges that VCs are facing and what their routine looks like, we can understand what they’re actually looking for in a startup. If you can convincingly answer these key questions about your company, your chances of securing funding will significantly increase.
1. Is there a big enough market that’s open to disruption?
Notice the second part of this question. Yes, you should demonstrate that there is a large target addressable market (TAM). But that’s not enough: you also need to show that this market is ripe for disruption and open to embracing the type of solution you’re offering.
Regulatory environments, customer behavior, and technological readiness all factor into this equation. Renana gives the example of the healthcare sector: “Things have changed now - but for many years, doctors were resistant to digital solutions. They knew best and they had no intention of giving up their pen and paper.” This tripped up many startups, even when the solutions they were marketing were objectively better than what was in place at the time.
Takeaway: As a founder, you need to show that your target market is both large and ready to accept new technology. Come prepared with answers to questions about barriers such as entrenched ways of work, regulation, or large incumbents.
2. Are there customers with a real pain, and are they willing to pay?
This question ties into the fundamental principle of any business: are you solving a real problem for your customers? But it's not enough for there to be a problem. Your potential customers need to be aware of it and, crucially, they must be willing to pay to have it resolved.
There’s also some level of cognitive effort involved in adopting a new solution, even if it’s easier. Renana recalls an example:
“We met a team who was developing a spit-based pregnancy test. Yes, this is probably more comfortable than peeing on a stick. But is it enough to change consumer behavior that's been ingrained for so long? Would people pay a premium for this? I wasn’t convinced.”
As a startup, you're in a race against time. Educating the market sounds great in theory. In practice, it doubles the time to make a sale and triples the difficulty. This can be brutal when you need to move fast and is not something most startups should dabble in.
Takeaway: The pain you’re describing should be acute enough that people will be willing to spend to relieve it. If the benefits you’re selling are incremental or subjective, it will be very difficult to get behind your idea.
3. Is there a strong, differentiated, and protected product offering?
VCs are looking for a defensible competitive advantage. (You’re probably familiar with the term moat.) This doesn't have to be patented hardware. It could be a devoted user base. It could be your team's unique skills or experience, or even a business model that’s hard to replicate.
Takeaway: The best way to prove your product’s value is through validation signals. Market sizes are rough estimates, financial projections are educated guesses, and even the best business plans tend to be littered with over-optimistic assumptions. What you’re looking for is objective confirmation that the market wants your technology.
Validation can come in many forms - from users who are actively using and benefiting from your product, customers who have signed contracts, experts who endorse your solution, or early revenue. It's concrete proof that you're onto something, and that your assumptions about your product, market, and competition are correct.
4. Is this a winning team?
“You invest in people, not products” might be a cliche, but there’s more than a bit of truth to it – especially in early rounds, where hard data is scarce. “If I think the product is mediocre and the market is weak, I’d find it difficult to invest just because I like the team”, Renana clarifies, “But when push comes to shove it’s probably the most important factor.”
VCs like to see a good mix of strengths: someone who understands the market, someone who knows the technology inside out, and someone who can build and scale the business. This is one of the reasons why VCs typically steer clear of solo founders: it’s rare for one person to be exceptional at all of these things (not to mention how psychologically taxing it can be).
Takeaway: What if your team doesn't have 15 years of experience or a multiple successful exits under its belt? According to Renana, the answer is to surround yourself with people who have a proven track record:
“Create a wishlist of the best people who you would like to have on your team, and then do everything you can to bring them on board. This not only brings immense value to your startup but also signals to VCs that you are capable of selling your vision to the right people. If these industry veterans believe in your startup enough to join your team, that’s a strong positive signal.”
When VCs choose teams, they’re also taking into account that the road ahead is going to be long and potentially bumpy. There needs to be good interpersonal chemistry. This is another reason for the process taking weeks rather than days: it takes a while to understand whether you get along with someone. The month or so it takes to close gives both sides time to figure out if they’re on the same page: chat between meetings, go out for a meal, and just have more opportunities to interact in both formal and informal settings.
Check Whether Your Pitch Addresses Common VC Concerns
Now that you have a better understanding of the VC process, it’s time to reevaluate your own process. Take another look at your slides and your ‘script’ and consider whether you are really tackling the issues that VCs care about most.
For example, you might ask yourself:
Are you telling an exciting enough story to justify a second meeting, even without knowing all the details?
Can you foresee the objections that VCs are likely to raise about your technology or market sizing? Do you have good answers?
Do you have a moat? What’s preventing your competitors from copying your product?
Does your product address an audience that’s very set in its ways? How would you convince them to change their habits?
Does your ‘Team’ slide highlight how each founder compliments the other?
Which validation signals or proof points can you bring to make a more compelling case?
In the next chapters, we’ll be offering more practical tips on how to analyze your TAM, build your slide deck, and more. Stay tuned!
Remember, you can also listen to all episodes on Od Podcast.