Below are the key factors in determining the score. Note that you may be able to increase your score by changing some factors.
Venture investors seek platform-based businesses over product-based businesses because platforms give the business an inherent cost advantage due to the structure of its system. A platforms not only reduce cost but also increase efficiency for the business. Platforms make better reuse of resources than product-oriented businesses. Platforms that can be reused across multiple industries and applications achieve even higher value through greater reuse. If you don’t yet have a platform or a product, a working prototype will demonstrate some value.
A business can provide value to customers on multiple levels. Consulting services are the least scalable choice and thus receive the lowest score. If you have a core product/service that has some elements of scalability, this will receive more points. If you have a platform that carries multiple products, points will be even greater. Beyond basic product/service some companies can aggregate data to give the product more value and additional revenue streams. With meaningful data sets, some can go to the next level and provide AI algorithms to enhance decision making and also provide new products which generate the highest score.
Investors look for predictable revenue. The most common form of predictable revenue is recurring in which the customer has paid for the service in advance on a recurring basis under a contract. If it’s an annual payment it’s called Annual Recurring Revenue (ARR). If it’s a monthly payment, then it’s Monthly Recurring Revenue (MRR).
If you have recurring revenue in software only, this is the most ideal case. Second to recurring revenue with software is recurring revenue with hardware. Next on the list would be no signed contracts but the ability to demonstrate a repeat customer business. Revenue from users who are not repeat customers also fits here and finally, if you have freemium users then it indicates potential revenue in the future which has some value.
In pitching to investors you must have a competitive advantage and be able to demonstrate this advantage. It’s not enough to say your product is better or that your team will execute faster. You must identify your core competitive advantage and show how it gives you at least a 30% cost reduction or 30% revenue increase over the traditional methods. This could be through network effects, virality, channel access, or monetization.
If you are concerned about protecting your business idea, then focus on the benefits of your competitive advantage such as, ‘our software reduces cost by 30% through better algorithms compared to the competition’, rather than explaining exactly how the product/software works. You don’t have to go into the details. In due diligence investors can sign NDAs to see the detailed workings.
Points are awarded based on how sustainable your advantage is based on a number of years.
The size of the market will ultimately determine the growth limitations of the startup. The bigger the market, the more valuable the startup. The larger the market, the greater the growth potential. Most venture capitalists look for a market of at least $1B but there are angel investors and others who can find a decent return in startups with smaller markets.
The team is a critical factor in your deal rating. The core team should have experience. The longer the team has worked together the better. The best case is two experienced founders who have worked well together for over 3 years. Some startups have two founders and bring complementary skills. Some startups have one founder with experience who can do well. Finally, there are novice founders who are making their first pass at a startup.
The growth rate of the company’s revenue is a key factor as it determines how fast you can scale the business. Those with very strong growth rates of 3X per year or more (as an average of the past two years) receive the most points. To be considered a venture deal, you must have an annual growth rate of at least 50%.
The value your customer receives from your product/service is called customer ROI and is one factor in determining the growth rate of the company. The higher the ROI the, stronger the value proposition of the company. The higher the ROI the faster others will switch to your solution. The ROI takes into account the value of the product as well as the reduced cost compared to a competitor.
Using comparables you can determine what type of exit your business will have based on a multiple of revenue. SaaS-based businesses are often marked for a 5X annual revenue. On the other end of the scale are service businesses which are typically sold for 1X revenue if they are successful. Calculate your expected exit multiple based on revenue.
There are other factors that come into play in determining the value propositions of a startup. These include:
- Proprietary technology
This goes beyond filed patents. It’s a piece of technology that is operational and no one else has it.
2. Network effects
If you setup your business to use network effects, then the size of the network you built will generate value for the business.
If you have virality factors in your business, then it will reduce the cost of customer acquisition.
If you have a lock on a segment of the market through regulation, network, or some or other factor this gives you an advantage.
5. Channel Access
If you have a channel to a market that others don’t have, then that is a competitive advantage as well.