Though the industry is called venture capital, the goal of a VC isn’t to maximize every risk. Instead, we try to understand all the risks a business might face and weigh those risks with the reward - the exit. Here are the major risks that I typically review when a startup pitches.
Market timing risk - Is now the right time for the business? It’s often hard to evaluate this risk, but nevertheless, it’s an important consideration. There are many stories of people saying I invented Facebook before Facebook, which may very well be true. But the market just wasn’t yet ready for it.
Business model risk - Is there a clear business model? Do the unit economics seem to work? If not, what are the assumptions required to achieve profitability?
Market adoption risk - Are there strong competitive players in the market? What are the major barriers to entry?
Market size risk - If the company is successful, is the exit scenario large enough to provide the types of returns our fund needs?
Execution risk - Does the team have the right skills and passion to reach their goals? If not, are they amenable to finding others to complement their skills?
Technology risk - Does the company have to develop a new technology that may not reach fruition, or may take much longer than expected? This is typically more prevalent in cleantech and hardware companies.
Capitalization structure risk - does the company have enough room in the cap table to take more investment necessary to grow while still ensuring employees and executives are well compensated?
Platform risk - Is the startup building atop YouTube, Twitter or Facebook? How strong is their relationship? Are their product plans in the direct path of the platform or complementary?
Venture management risk - Is the company receptive to feedback? Is the team candid about the state of the business?
Financial risk - How much money does the company require to achieve its goals? Is the financing risk manageable given the current environment and company trajectory?
Legal risk - Does the company have a high likelihood of lawsuit for patent or copyright infringement? Does the company have any outstanding complaints with early employees or founders? Are there regulatory challenges involved in this sector?
The list of these risks applies differently to each startup, but it’s a good general outline for entrepreneurs to think through when they pitch their companies to VCs.
28 March 2013