There are lots of ways you can fund a bootstrapped startup. You can try and find the money yourself, ask friends and family for help, or apply for grants. But let's be honest, securing the backing of a venture capital firm is the holy grail.
Of course, knowing that is one thing, but finding the funding is quite another. Learning how to make your startup look attractive to VC funds requires understanding how investors think.
It's rare that anyone will be as passionate about your startup as you are. Sure, you can sell people on your grand vision, but it's going to be challenging to secure buy-in unless you can back that up with cold, hard financials.
In this guide, I'll show you:
- How to make your startup look convincing to VC firms
- Which metrics matter most for securing funding
- Practical advice that you can use in pitching sessions to communicate why your idea is financially viable
The state of VC funding
We are living in the golden age of VC funding. 2021 was a record year for VC funding, with US startups raising £329 billion alone. While 2022 hasn't hit quite the same heights, the number and value of deals have regularly been $40 billion a month. Money is still moving, but focus has turned to profitability from exponential growth.
Rampant inflation, stock market woes, and a hawkish Fed may have slowed down some investors' interest in technology-growth and late-stage investing, but seed funding is still looking strong.
Sure, there is a lot of uncertainty about the economy now, and 2021's fevered highs were most likely unsustainable. However, there is no shortage of VC funds out there looking for the next big thing. The key to finding funding is knowing what they want.
How to secure VC funding
Venture capital funding is inherently risky. Across all industries, about 90% of startups fail — with about 70% gone within the first five years. VC investors are, in effect, placing bets on businesses with unsecured loans. If things don't work out, they lose everything.
With failure rates so high, VC investors need to be selective. They need to mitigate risk as much as possible in their quest for the next big thing. While business ideas are important, what they really care about is your business fundamentals.
If you want to secure VC funding, you need to know how investors think. You need to learn and understand the metrics they use to predict success.
Every year there are tons of cool ideas. Many of them seem interesting, useful, and even potentially disruptive. However, on closer inspection, they don't have a viable business model. Investors who stay in the game know how to tell the difference between the two.
Some figures suggest that only around 1% of startups get funded. While VC investors have a large appetite for risk, they aren't making blind bets. Packaging your startup in a way that is attractive to VC investors is essential if you want to get funding.
Below, we'll explore some of the main things VC investors want to know about your business, so you can go into pitches and confidently present your idea and business fundamentals in a language they understand.
1. Understanding the whole business
As Warren Buffet famously said, "Never invest in a business you cannot understand." It's a simple piece of advice, but it cuts straight to the heart of a sensible investment strategy.
If you don't understand your business, you won't be able to explain it to an investor. If they don't understand it, they won't be able to see the opportunities.
But what do we mean by understanding the whole business?
From an investor's perspective, here are a few things that they will need to understand about a business before they decide if it's a promising investment opportunity.
Investors need to understand:
- the product or service
- the market that it proposes to enter
- the business model
- the management team
- the momentum the business has
- how the startup has arrived at its valuation
Let's explore each in a bit more detail.
The product or service
VCs want to invest in startups that can scale. Offering unsecured loans in exchange for equity is risky. These bets work out far less often than they succeed, meaning the successes must cover the failures.
As we mentioned, 90% of startups fail. To put it another way, if a VC fund invests in 10 businesses, on average, only one will make money. Because of these low odds, the successful business has to cover the others and make at least X10 of the initial investment to break even before accounting for their own costs — but in truth, they are looking for far more growth than that.
When you pitch your product or service, you need to ensure the investors understand not just the offering but also how it can make money and grow.
The post-dotcom boom Silicon Valley mantra of "build things people want" has led to some incredible products that were very consumer-focused. However, it also resulted in many other interesting and novel products that lacked a viable business model.
When you examine why startups fail, a common theme constantly emerges. In the vast majority of cases, it's either:
- Failure to find market fit
- Market problems
- Running out of capital
While you can break down these three reasons separately, they are all symptoms of the same thing: A cool idea that no one really wants to buy or invest in.
Usually, this results from a lack of market research or bad market research. If you want people to buy a product, you need to provide them with VALUE. And that means your product needs to solve a problem.
Too many products don't even come close to solving a problem. Many of them solve something very minor, and many more are solutions in search of a problem.
So when you're pitching a product to investors, you need to be able to explain to them in clear language how your product will be able to help an actionable market do something quicker, cheaper, or better. You need to be able to show how your offering will make your prospective customer's life better.
And a big part of that is understanding how your product fits inside the market, which we'll cover next.
The market proposition
Before you build your product or service, you must research your market and identify a need. Many companies don't do this. Instead, their founders misinterpret the market or what people want and flounder for years trying to convince people and investors they need a product.
Investors want products with a high probability of breaking into or disrupting a market. For example, to use some huge, well-known examples:
- Airbnb disrupted the hotel and hospitality industry
- Uber and Lyft disrupted the private carriage industry
- Netflix disrupted TV by going over the top (OTT)
- Amazon disrupted the retail sector
All of these businesses had a clearly defined market of people who felt underserved for a variety of reasons.
What investors want and need to see is that your idea has a market and that your product can serve that market. That means you need to do deep research on the current market, how it could grow, who your competitors are, and most importantly, what differentiates you from other businesses that offer a similar service.
Of course, your product or service doesn't always have to turn an entire industry on its head, a la Uber. But it at least needs to be in a high-growth sector. Again, you'll need to prove why what you are offering marks you out as different.
So do your market research and be able to demonstrate:
- The current size of your market
- The future size of the market
- How much of the market you can realistically capture
- Why your startup is better than your competitors
Your business model
OK, so you've explained why people need your product and identified the market you can break into. Now, you need to explain how you'll make money.
There are a bunch of different business models that you can choose from to monetize your product or service. Choosing the right one depends on several factors, including what your product is, your competition, and the market or sector you are entering.
Whatever the particulars, you need to be able to communicate to investors how you plan on financing your business.
Some examples of popular business models are:
Subscription: Subscription models have become standard across SaaS businesses in recent years. Basically, the consumer pays a monthly or annual fee for access to the product or service.
Freemium: Freemium is also a popular model. The customer gets free access to the product but "pays" with ads (Facebook, Google, Spotify). This model can be combined with a Premium service.
Marketplace: A marketplace model is used in platforms that connect buyers and sellers but take a cut of transactions. (Doordash, Airbnb, Amazon, Uber, etc.)
eCommerce: The traditional model where businesses pay for a product with a one-time fee.
All of these are viable and valid models depending on your product or service. But you need to be able to communicate your model to investors so they can understand how you plan on making money.
Other essential elements that investors want to know are:
- Financial projects (typically over five years)
- How do you plan to use the funding to grow the business
- A timeline for breaking even / scaling
- What are your sales channels strategies
- What your route to market acceptance is, and how much that will cost
- Why people can't just copy your idea
If you're pitching to VC investors, they need to have answers to these questions. So do your homework so you can answer them.
There is an old cliche in investing circles that goes, "invest in people, not companies." It's a cliche for a reason. Markets are unpredictable, and VC funds are essentially making educated bets on which companies will be able to triumph.
The founder and their team are an essential element of any product. They can adapt, work hard, make responsible decisions, be committed, and more.
Anyone investing in a business needs founders that can see the task through — or a team with enough humility to step aside for the good of the company. Coaching and mentoring can overcome most weaknesses or deficiencies if the founder and team are willing.
Another thing that investors want to see from founders is something special. They could be visionaries, great programmers, have a deep understanding of their sectors, or anything else that will conceivably give them a competitive edge.
While many bootstrapped startups will be the brainchild of one or two founders, if you have a valuable team, ensure you make them part of the pitch. It's not necessary to have them there in person, but let VC investors understand exactly what it is that makes your team special.
Momentum is very attractive to investors. It's also strong evidence that your product is viable and can grow or scale if it gets access to capital.
Initial users, customer trials, social media buzz, and progress with the product's design and build are just some examples of momentum that inventors will want to see.
So, capture and quantify anything demonstrating your startup's progression toward your goal. Any sign of stasis or slowdown could make investors think twice about both your management and your idea.
If you're looking for investment, you need to have a valuation in mind. However, coming up with the correct figure can be as much of an art as a science.
How you come up with a valuation depends on a lot of things. You can rely on revenues, expenses, and projects if you are already trading. If you're not, you'll need to estimate how things will go in the future.
There is a definite balance between the overvaluation and undervaluation of your startup. You shouldn't accept a low-ball offer you'll regret, but likewise, you don't want to give the idea that you don't know what you're doing with an outrageous valuation.
Ensuring that your investors understand your business, i.e. the product, market, users, and financials, is the cornerstone of any pitch. If you feel like the investors aren't on the page, it's perfectly OK to stop your pitch and ask them if they understand what you are saying.
Remember, you know your business like the back of your hand, but they're just finding out about you. So don't be afraid to clarify or give them a spot to ask questions. Make sure they understand.
2. Understanding whether customer acquisition is profitable
Customer acquisition cost (CAC) is one of the most critical metrics for any startup. It's something that VCs will want to know because alongside a few other metrics we'll mention later, it gets at the heart of whether your business is viable.
CAC is a simple yet powerful metric. The formula is:
CAC = cost of sales and marketing divided by new customers.
That's it. But despite its simplicity, this metric can tell investors a lot. CAC tells investors:
- the cost of acquiring customers
- a lot about the health of a business
- the sales and marketing budget
- how effective sales and marketing teams are
In short, it's a handy way for investors to measure how viable a venture will be over the short and long term.
Accumulating customers at a fast rate will look impressive to investors. But any VC worth their salt will want to contextualize these gains. If you're acquiring customers, but you're burning considerable sums to do it, investors will have doubts about the sustainability of your growth.
CAC will be a big part of any evaluation and investor makes on your business. You must calculate these sums as accurately as possible.
Accurately calculating CAC
Calculating CAC seems fairly simple. However, many entrepreneurs get it wrong. The prime reason is that it can be challenging to keep track of all the activities you use to get new customers.
You can split CAC costs into measurable and non-measurable categories.
Measurable CAC is things like:
- paid ads
- content marketing (SEO especially)
- email marketing
- influencer marketing
- sales and marketing team's salaries
- agency fees
These are all reasonably easy to measure as a function of doing your accounts. However, there are other non-measurable CAC categories like:
- brand campaigns
- speaking engagements
So, as you can see, we have multiple different channels. It's essential to measure each one individually to understand which areas are working and which aren't.
For example, if email marketing is proving fruitful, but pay-per-click advertising isn't bringing a return, you need to:
a) dump the underperforming channels
b) determine why they are not performing and remedy the situation.
When marketing a business, there is always going to be a certain amount of experimentation to do. Some channels will perform well depending on the product or service, but sometimes you need to test them out to see if they'll work.
What you don't want to do is go into a pitch and show investors that you've been shoveling money into a channel that isn't producing results. It will be a red flag for your investors, and they might begin to question your judgment.
CAC alongside LTV and Churn Rate
To really unlock the power of CAC, you need to look at it in the context of two other metrics: Customer lifetime value and churn rate.
Customer lifetime value — which we'll explain fully in the next section — measures the average revenue produced by each customer over their entire relationship with your startup.
The churn rate measures how many customers you lose per month.
So between these three metrics, you can know:
- How much does it cost for you to get a customer
- How much revenue that customer will bring you
- How many customers you are losing per month
The LTV: CAC ratio is a fairly good predictor of company health. Generally, a 3:1 ratio is considered the minimum amount. That means for every $1 you spend acquiring customers, you bring in $3.
Now, of course, it's very common for early startups to have to invest a lot of money in sales and marketing to break into the market. Penetrating a market can require a period of aggressive sales or marketing spending to get a foothold. Investors will understand this.
Another thing to consider is that bootstrapped startups often calculate LTV: CAC too early. And by too early, we meant that the information inputted into the calculations isn't reliable enough to be meaningful and therefore predictable.
If the founder is making a lot of sales and deals themselves, by right, their salary should go into the CAC. However, if the company grows, that arrangement is unlikely to continue because there will be a sales team or person who will be doing the outreach.
Similarly, if you are selling to people based on pre-existing relationships, this will skew your CAC.
So, depending on where your startup is at, think carefully about when you define your LTC: CAC.
There is a classic Peter Thiel quote that goes, "LTV: CAC ratios are to be used, not believed." Knowing your LTV: CAC is essential, but it's important to remember that they are, in general, an oversimplification of a complex set of data.
Investors know this too. They are going to do their due diligence before signing any checks, so make sure you don't do anything too misleading. Transparency is important. It builds trust.
And remember that while LTV: CAC is important to investors, it's a metric that can be made more efficient with expertise. For example, if you're a bootstrapped startup, your expertise might not lie in sales and marketing. You could be doing your best until you raise enough money to hire more employees.
A good investor will be able to understand and interpret your LTV: CAC numbers. They'll be able to see where it can be improved and optimized so that acquisition bears a more favorable relationship to long-term revenues.
3. LTV optimization
As shown above, customer lifetime value (LTV) — when viewed in conjunction with customer acquisition cost (CAC) — can tell investors a lot about your business. In the last section, we mainly concentrated on the CAC side of the LTV: CAC ratio. Now, we'll explore LTV and, in particular, how it can be optimized.
There are three main concepts we need to think about here:
- Product-market fit
- ICP optimization
- How to build a strong LTV
We've touched on the product-market fit above, but let's go a little deeper. A product-market fit happens when you:
- Identify your target market
- Serve them with a product they need
You can attempt to define product-market fit through user or audience interviews. Something as simple as asking your existing audience (or prospective target market) if your product is a "nice to have" or essential. However, while quantifying these qualities can be helpful, it's really more about putting in the research.
Some of the things you need to understand are:
- Who are your customers?
- How do they feel about you and your business?
- Are people willing to advocate for your product?
- Are they willing to pay for your product?
Now to be clear, you should do all of this as easily as possible. You need to validate your idea before you start building it. This process can be done with minimum viable products (MVPs), prototypes, research, etc.
However, you should also perform this type of research along the way too. As users get your product in their hands — and as it improves — their sentiment will evolve.
Again, a lot of this relates to momentum. If you are getting your product into the hands of users, and they're finding value from it, it should create some word-of-mouth buzz.
There are marketing models that are entirely built around the idea of getting great software into the hands of people who use it and getting them to do the work. For example, product-led growth, exemplified by startups like Slack, eschews marketing and sales and instead uses the quality of the product to do the work.
That won't work for all products. But you should be able to achieve a certain amount of word-of-mouth growth if your product actually solves customers' pain points. Having evidence of this adoption data — via social media, user signups, surveys, etc. — will be helpful for pitching to VCs because it will be evidence of organic growth.
As your understanding of your product and consumer grows, you can collect more data. All this leads us to the need to define your ideal customer profile (ICP).
How ICP helps LTV
Many startup products attract a wide array of users. However, not all of them stick around and help you generate revenue. If you want to explode your LTV: CAC ratio, you need to find a way to optimize your LTV, and one of the most effective ways you can achieve that is by finding your ideal customer profile (ICP).
When you start a business, it can be easy to see any customer who is willing to pay for your product or service as welcome. Creating revenue is the name of the game, right? But as we know from the section above, if your CAC is sky high, the income needs to be worth it.
As we covered in the CAC section, every interaction with a customer or prospect costs you money. For example, to drive revenue, you need:
- Content marketing
- Administration costs
- Staff costs
If you're just mashing customers into your product and hoping they'll stick around long enough to make a return on your CAC investment, you'll probably have a high user churn. You can maybe keep that up for a bit, but eventually, the attrition will swallow up your capital.
What we're saying here is that of all your customer base, there will be some people that make you money, while there will be others that don't. Figuring out who is profitable, AKA your ideal customer profile, will help your startup look far more attractive to investors.
Defining your ICP requires a mix of real-world experience and data. When you're running a bootstrapped startup, you'll probably have a sense of who your best, most profitable customers are already. But it's still essential that you do the work to confirm your hypothesis — because sometimes you can be surprised.
So, once you find out which customers are producing a sustainable LTV, you need to figure out a few things about them and start looking for patterns. Some of the questions you need to ask are:
What was their customer journey? If the majority of your profitable customers come from influencer marketing or referrals, but your sales process is primarily driven by PPC ads, then at a minimum, you need to fix or get rid of that sales channel.
Why do they find your product or service valuable? You can get this information from interviews, polls, surveys, social media listening, and more. Essentially, what is it about your product that your power users find valuable? Understanding this can help inform your marketing and sales efforts and give you helpful feedback on features you need to include.
What sector or industry are they operating in? Understanding what the people who love your product use it for will also help guide your marketing and development.
The above are some of the most vital questions to answer when defining ICP and growing LTV. If you're pitching to investors, being able to share that information can help them understand why your product or service can thrive.
The tech boom has resulted in a situation where VC funds are eager to find the next big thing. However, successfully pitching to these investors requires nowadays more than presenting a good idea. You need to show them a solid business plan and ensure they understand the product and the market you want to enter.
Additionally, you need to be able to show a harmonious relationship between LTV and CAC to demonstrate that your business can grow and scale.
All founders should be on top of these figures no matter what because understanding them — and where you can improve them — will show you what you need to do to gain the sort of momentum that investors need to see before getting involved.