When Private Equity (PE) or Venture Capital (VC) firms evaluate a new business plan presented by a founder, they assess several critical aspects of the business. These criteria are often weighted based on the stage of the business, the industry, and the specific investment philosophy of the PE/VC firm. Here’s a general overview of key criteria and potential weightages:
1. Financials (20-30%)
- Revenue Growth: Consistent and high growth rates are critical. Firms prefer companies with a track record of strong growth or high growth potential.
- Profitability and Cash Flow: Especially important for later-stage businesses, but early-stage startups may have less emphasis on profitability and more on unit economics and burn rate.
- Capital Efficiency: How effectively the company uses its capital to grow, as well as its runway and cash burn.
- Financial Projections: PE/VC firms look for realistic financial projections that show a clear path to profitability or market dominance.
2. Product-Market Fit (20-25%)
- Customer Validation: Whether the product has strong customer adoption, usage metrics, and retention rates.
- Pain Point Addressed: How well the product addresses a clear and significant customer pain point. A strong product-market fit often means less capital is required for customer acquisition over time.
- Competitive Differentiation: How the product is differentiated from competitors in the market, its defensibility, and the unique value proposition.
3. Size of the Market/Category (15-20%)
- Total Addressable Market (TAM): PE/VC firms look for large markets where the company can grow. A small TAM limits the growth potential.
- Category Growth Rate: Markets that are growing rapidly attract more interest since they provide more opportunities for expansion.
4. Category Creation (5-10%)
- Innovation and Disruption: If the startup is creating a new category, PE/VC firms will consider the potential to redefine the industry. This is high-risk but can lead to high rewards.
- Customer Education: Category creation often requires educating the market, which could mean more time and capital required to see returns.
5. Unit Economics (15-20%)
- Customer Acquisition Cost (CAC): How much the company spends to acquire customers and whether it is sustainable as the company scales.
- Customer Lifetime Value (LTV): The expected value a customer brings over their lifetime relative to the CAC.
- Gross Margins: High gross margins are an indicator of profitability potential and scalability. If margins are too thin, scaling could be difficult.
6. Sustainability of the Business Model (10-15%)
- Recurring Revenue: Subscription or recurring revenue models are highly valued due to their predictability.
- Revenue Streams: Diversified revenue streams reduce risk and provide stability.
- Dependency on Key Clients: Over-reliance on a few customers can be risky. PE/VCs look for a diversified customer base.
7. Scalability (10-15%)
- Operational Scalability: How easily the business can scale its operations without proportional increases in costs. This includes product distribution, technology infrastructure, and supply chain management.
- Geographical Expansion: The ability to expand into new markets (both domestic and international).
- Team Scalability: Whether the leadership and management team can scale the business while maintaining quality and culture.
Additional Factors:
- Founder's Vision and Leadership (10-20%): The team’s ability to execute the business plan is crucial. Strong leadership and a clear vision are significant intangibles in the evaluation.
- Risk and Compliance (5-10%): PE/VCs assess the regulatory risks, intellectual property protection, and competitive risks.
Example Weightage Breakdown:
- Financials: 25%
- Product-Market Fit: 20%
- Market Size/Category Growth: 15%
- Unit Economics: 15%
- Scalability: 10%
- Sustainability of Business Model: 10%
- Category Creation (if applicable): 5%
A template summarizing the criteria's and weightage is as under :-
Weightages can vary based on the stage of investment. For seed-stage companies, product-market fit and unit economics may take precedence, whereas for Series B or later-stage, financials and scalability are given more weight.
Please mention in Comments what are the factors and weightages you would consider while funding a new start up.
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4moVery informative