The 3 Most Important Investment Questions For Venture Capitalists

As a budding venture capitalist, asking the right questions can be the difference between getting a great return on investment (ROI) and losing your money quickly. Probing for more information is a vital step in making the ultimate decision to support or decline someone's pitch. If you're new to the scene, it can be difficult to determine just what information you need--and it can be even harder to determine how to access it. With this overview of the three most important investment questions to ask, you'll discover how to better probe for the information you need to make good decisions.

Does the Company Have Traction?

If someone is coming to you with a request for money, it's not wise to invest unless they have shown traction already. Judging whether the company has traction requires breaking this question down to figure out whether you would be investing in a company, a product or an event. Ask yourself:

  • Is the pitcher showing you a product that they invented?
  • Are they suggesting that you will receive a return for investing in a one-time event, like a Broadway show?
  • Is the real item being sold the pitcher themselves--as is sometimes seen in professional workout videos

Venture capitalists do sometimes invest in products, people or one-time events, but both of these come with a very high degree of risk. Because they can't often be qualified as having traction, it's difficult to judge future success.

So how can you judge traction?

Simply put, traction refers to how much progress the company or startup has made up until this point. You'll want to judge traction by asking:

  • What sales volume has the company achieved up until now, year to year since opening?
  • Has that sales volume grown over time?
  • How do the founders plan to expand sales in the future?

If there are no sales yet, traction can then be judged by asking:

  • How has the company strived to make partnerships for future sales?
  • Have they received orders for the product or service yet?
  • If there are no sales, when does the company expect to achieve sales?

It's not uncommon for a company to come to you requesting money before actual sales have processed, but it is vital that they at least have a plan to create sales in the first place. If they don't have a plan or real sales, then it's likely that they aren't at the point where they should be seeking investment money yet. 

What Competition Exists?

This is a dangerous question for those seeking investment money. Competition is one of the biggest reasons that new startups fail. Considering that startups fail at constantly growing rate of between 25 percent and 77 percent from year one to year 10, it's crucial that this question be asked.

Competition can be a difficult thing to source. It requires heavy research, all of which should be completed prior to the startup coming to you for money. The first step is deep comparative market research in whatever industry or market the startup hopes to carve a niche in. This requires:

  • Identifying all market-localized competitors
  • Identifying potential competitors in the same industry, but a different niche
  • Identifying potential competitors on a national and global level

Once they determine these factors, then it's time to compare their startup with each of these competitors. This will paint a clearer picture of what, if any, competitive advantage exists.

What is the Company's Competitive Advantage?

Branching out from the previous question, the company's competitive advantage must also be scrutinized. Just because one exists, doesn't mean it's strong enough to carry the startup to success. Take a look at this hypothetical situation:

Quick Money ABC decides to create a payment processing service similar to other major online payment processors. They've had minimal success, but have managed to gain some traction over time. Their main competitive advantage is that they charge around $0.30 less for each processed transaction than the competition. However, they struggle with getting noticed in the heavily saturated financial market.

While the traction is good, there's a serious hole that needs to be addressed--what's stopping the major online payment processor from simply outranking them and taking over their niche? All the competitor needs to do is create a similar option for a subcategory of their sales and Quick Money ABC is suddenly obsolete.

Add this to the fact that the major processor is already extremely well known, and therefore trustworthy, and it's a recipe for high risk and potential disaster.

Without a doubt, becoming a venture capital investor can be one of the most major steps you'll ever make in your career. While the potential for stress definitely exists, there's also a great opportunity for both financial growth and the ability to groom new startups to success. If you have questions about approving any potential applicant, or you need assistance with investigating these questions, navigate to this website or contact a securities attorney today. He or she can walk you through the process while helping to ensure that all legal protocols are followed.